Investor Insights

February 2017 Investor Report

Published: February 4, 2017Updated: April 25, 2019

February concluded another strong month for Graham Capital Wealth and your respective account(s). We have, of course been participating in the widespread newfound investor confidence that has drawn more capital into equity markets. While it is our nature to keep an eye on downside risk, we do marvel at the appreciation that has occurred. One variable that stands out is the lack of volume; for the past 30 days we have observed well‐ below average trading in general, which is slightly concerning. Additionally, we wish to draw your attention to the following chart:

This chart is generally seen as one of the best indicators of overall market valuation at any given time. Warren Buffet has lauded it as the best valuation snapshot an investor could have. The chart is the market capitalization (blue line) of all domestic companies divided by the gross domestic product (GDP, green line). The market capitalization is defined as the share price multiplied by the shares outstanding of a given company; for example if a company had ten shares outstanding and its share price was $10, the company’s market capitalization would be $100. The GDP is the value of all goods produced or sold within a given period. The prevailing thought is that market capitalization (the value of a company’s stock) should not be consistently higher than the value of all goods produced and sold within the country. Historically, when the market capitalization (blue line) begins to separate from the GDP (green line), the market capitalization tends to pull back to the GDP. With the dotcom bubble in 2000 we saw this disparity reach 140%. In 2008 it approached 130% with the Great Recession (obviously the Great Recession was created by various factors other than stock prices). Invariably, when the blue line falls, the stock market falls.

Our month was highlighted by two equity positions: Hostess Brands (well known as the maker of Twinkies),

TWNKW, and Hennessey Capital, HCACW (which will be designated as DSKEW starting with your March statements). Both positions are up approximately 50 percent since we invested in them (late December/early January). Moderate investors will have exposure to both investments. Additionally, approximately 60 days ago we added two equity positions: Ladder Capital and Jernigan Capital. These respective positions are unlike traditional equity positions. Rather than focusing on short‐term growth, these work to produce cash and distribute that cash to investors. We spoke with the President of Jernigan Capital on two occasions over the last 90 days and we have the upmost confidence in their leadership. They have a niche focus on the self‐storage storage industry, which is a very resilient subsector of the real estate market. Jernigan Capital recently declared a dividend that will be paid into your accounts in approximately 30 days. It is noteworthy that the dividend increased to a forward yield of over seven percent. Likewise, Ladder Capital pays a quarterly dividend that has a forward yield of over eight percent and also pays out a special annual dividend, which we received for our ownership in December 2016 yielding an additional one percent on our entire holding. Our confidence is boosted by the near/intermediate future of Ladder as one of the founding investors recently exercised an option to buy $80 million worth of Ladder Capital stock. Knowing the founding investors are going to have better insight into the company than anyone else, them acting on their own options is a strong indication of their own confidence.

Considering that we believe markets are overvalued, our focus has been on finding lower risk‐profile investments, largely bonds. One of our most recent investments, NewStar Financial Senior Bonds, fits the category of investment that we are striving to identify. In the short term, this is consistent with keeping a position within our company’s capital structure, while also receiving a positive dividend yield of between four to seven percent.

As noted, while being a good month, February was also a quiet month in terms of trading volume. Again, what was most remarkable about the last 30 days is the lower than average trading. This gives us a sense of caution. When March comes to a close and the summer approaches, we will be rebalancing all accounts to prepare for a difficult summer. We may sell “legacy positions” that might have carried over in your account from a previous firm which would not match our goals. We may also possibly sell our positions if the underlying thesis for a given investment changes. While a pullback is certainly not guaranteed, we need to be cautious to help us protect from real downside risk that could damage the overall value of portfolios.

We are partners in this journey with you. Our job is to research and act on valuable investments that would fit a specific person’s profile. We have a fair amount of capital in cash and we will wisely disperse it as opportunities arise. As always, if you have questions or concerns, please feel free reach out to us and we will happily work to resolve to your satisfaction.