Investor Insights

October 2018 Investor Report

Published: October 25, 2018Updated: May 15, 2019

It was a very volatile month for the stock market which saw a vast majority of equity sectors decline in value. We witnessed a lot of selling very early in the month of October with the S&P 500 and the Dow Jones giving up most of their year-to-date gains within the first 14 trading days. Fortunately, our portfolios favor lower risk instruments and therefore avoided much of this downside pressure. Being on the top of the capital structure requires companies to pay us our interest payments (in the case of bonds) and a contractual priority (in case of our preferred stock), so we experience less volatility than common stock, which saw declines as much as ten percent, as with the NASDAQ.

We continue to monitor the Federal Reserve, which provided another interest rate increase in September and is guiding toward another in December (with three more interest rate increases forecasted in 2019). It was the release of the minutes from the September Board of Governors Meeting that drove much of the decline in markets as it seems that the Federal Reserve is committed to tightening monetary policy with 0.25 percent interest rate increases every 90 days. The Federal Reserve has been the most hawkish of all the major central banks in the world for the last two to three years. The prospects of a weaker dollar over the next year are very real if the Federal Reserve continues to raise interest rates that choke the economy of growth, accelerating the growing US government budget deficit and debt. The President has been very outspoken about his concerns that the Federal Reserve will continue to raise borrowing rates and hurt the stock market and the economy alike. It is important to note that financial assets and our economy have distinct, neutral interest-rates. Neutral interest rates will be one of the major topics in next month‘s letter.

This will be our last monthly letter before the midterm elections and investors are keenly following how the results may alter the majorities in both houses of Congress. The latest polling suggests that Democrats may take a majority in the House of Representatives, while Republicans will keep the Senate. If the Democrats take either chamber on Capitol Hill, this could disrupt the Trump Administration’s policy agenda and further unsettle equity markets. The US was the only major economy to enjoy a tax cut in the last 12 months. The response was widespread stock buybacks, which created a short-term, material increase in demand for stocks. This deficit increasing fiscal plan (the tax cut) is the major reason why the US equity markets are outperforming the rest of the world. We have seen a lot of weakness around the world. For example, the Shanghai Composite Index is near a two-year low, and down 25 percent year-to-date. In combination with the ongoing trade talks and tariff battle with United States, China should be one of the major points of interest going in to 2019.

Please review the following updates from some of the existing positions that we manage:

Scorpio Bulkers (SLTB) – On October 22nd, SLTB company reported strong third quarter earnings. It announced record high levels of EBITDA at $28.8 million for the quarter. This provides great momentum the remaining 11 months of the company’s bonds that we own. We are actively watching this bond for an opportunity to get a good interest rate for such a short period of time. The bond is currently callable and trading above par, and we do not want to recklessly purchase the bond at any price.

TPG Specialty Lending Stock (TSLX) – This common stock is held in our moderate investors’ portfolios and has been a good performer over the 90-120 days that we held it.  On October 8, TPG’s received shareholder approval to lower its minimum asset coverage ratio to 150 percent. We have spent time in the monthly letters discussing how we were going to keep an eye on BDCs that move to this new regulated leverage limit. As of now, we are going to hold the position but will continue to evaluate it over the next 30 days. We believe the company will report strong third quarter numbers and will look to use those strong quarterly figures to exit the investment.

PHI Bonds maturing March 2019 We sold out of our remaining bonds after the tender offer was terminated by management in the middle of the month. This was a disappointing outcome as PHI had the refinancing for our bonds lined up but chose not to take the $600 million that was raised because the debt was deemed to be too expensive. Instead they chose to start a process to sell a part of the company. In the meantime, the Chairman and CEO bought out the company revolver with his own money making him the top of the capital structure. We were surprised that management would walk away from financing during these tough times in capital markets. We are skeptical that PHI will be able to negotiate and finalize the sale of its subsidiaries before the March 2019 maturation deadline. We simply do not want to take the risk of a possible bankruptcy if capital markets deteriorate between now and then.