January saw rebounds across the markets until the final several days, which brought a return of selling pressure. our positions came back with the broad market and held strong. Even after the rebound, the S&P 500 is still down by ten percent since the highpoint in late September. The NASDAQ, which comprises some of the largest technology companies in the world, is still down more than 13 percent since its high-water mark of 8,133.30 on August 30, 2018. We are pleased to report that our positions have almost universally outperformed the markets since the end of the summer. In particular, we continue to be assured by the performance of our higher priority positions that pay out cash consistently.
As mentioned, investor confidence returned to the markets after the asset value shocks of December. Many investors feel they are getting stocks at good values. We disagree, however, and believe the stock market is still overvalued, which we will address below. It is certainly possible that markets could perform well over the next six to seven months, but it is less likely if certain conditions do not find resolution; a trade deal with China must resolve the ongoing stalemate and some long-term agreement on funding the government must head off a pending government shutdown.
The China trade negotiations have seemingly protracted over many months. Farmers are experiencing the effects of this as goods like soybeans are trading at unfavorable prices while Fortune 500 companies have been nearly unanimous in their concern that investment is being discouraged. We were cautiously optimistic in early January amid reports from the White House that progress was being made, but as the month is ending more recent headlines have dampened this outlook. In particular, on January 28, the US Justice Department filed charges against Huawei, one of China’s largest telecom companies. The indictment accuses the company’s founder of lying to the FBI and rewarding employees who stole trade secrets. The Chinese government, through its Foreign Ministry spokesperson, responded that “for some time now, the United States has deployed its state power to smear and crack down on targeted Chinese companies in an attempt to kill their normal and legal business operations.” This news is particularly discouraging given that there is a ‘hard deadline’ of March 1 where tariffs will rise to 25 percent. The stock market and the economy broadly both depend on a healthy trade relationship with China in order to grow.
The government shutdown, while historic in duration, was only partial (around 25 percent). Nonetheless it did impact on consumer demand, the lifeline of our economy. The initial estimates placed the cost of the shutdown to the US economy at approximately $11 billion, including a permanent $3 billion loss. Per the report by the Congressional Budget Office “among those who experienced the largest and most direct negative effects are federal workers who faced delayed compensation and private-sector entities that lost business … some of those private-sector entities will never recoup that lost income.” In discussions with numerous representatives on Capitol Hill from both sides of the aisle, there is pessimism about the likelihood of reaching a deal before the next government shutdown deadline of February 15. This is probably no surprise to many, considering the polarizing rhetoric coming from both sides.
In view of these factors, while the market saw gains in January, the S&P 500 is still down more than five percent since the beginning of December (The DJI and NASDAQ are also down). Moreover, we still have a systemically overvalued market. Historically, markets priced at 130 percent market capitalization/GDP have negative three-year returns. One reaches a similar conclusion when considering the CAPE ratio; the current score of 29.2 is over 70 percent above historical averages (slightly below 17). This level corresponds with negative future returns. CAPE and nearly all other fundamental metrics also show a US market more expensive than all but two country markets. This is why we continue to focus on less volatile, less risky investment positions.
Please review the following updates from some of the existing positions that we manage.
Targa Resources Partners Preferred Stock -Series A- (NGLS-A): The preferred stock fell in December (with the market) but has rebounded strongly. In the third quarter, the company reported the “strongest quarter in Targa’s history” and continues to perform well. We believe the company will call the preferred stock in November of 2020 in order to avoid paying out the stepped up cost. In the meantime, we will collect monthly checks and an attractive 9 percent coupon yield from this $10 billion market cap company.
Wells Fargo Bank Class A Preferred Stock -Series Q- (WFC-Q): After acquiring this QDI-paying dividend investment in the fall at around $25.45, the price of this stock from the systemically important bank fell to below $24 in December. As of January 29, the price is already back up to $25.35 and we collected a dividend payment ($0.36 per share) on December 15 (we are nearing next one). Wells Fargo is a high grade bank whose credit risk is low; with our priority position on the capital structure (our preferred stock) we expect a quicker bounce back compared to the general stock market.