2019 Q2 Review
Review of the quarter including results, market commentary, portfolio commentary, and insights.
Markets continue their recovery in the 2nd quarter, nearly recouping the entire drop in late 2018. We are now halfway through 2019 and Torre Financial accounts are up an average of 22.11% versus 20.65% for the S&P 500. Politics and M&A have dominated headlines throughout the 2nd quarter.
The trade war with China has been a prevalent theme throughout the last year. The 2nd quarter of 2019 may have marked an inflection point. Just as the dire situation appeared to be deteriorating, Trump and Xi announced a truce after their meeting in June. With interest to continue conversations, both USA and China made accommodations as a sign of goodwill. While this is a positive development, this may not be the end of the uncertainties. The story continues to develop. We expect discussions to continue for quite some time. USA, with the strength of the markets, is well positioned. China’s situation, on the other hand, is bleak. The markets in China hit much deeper lows, have been slower to recover, and many local businesses as struggling with over-burdened debt. It seems China has more to win through cooperation.
Merger and acquisition activity spiked this year. Our portfolio companies have been involved in a number of the year’s major deals, particularly in healthcare. Early on in the year Bristol-Meyer Squibb’s (BMY) announced the acquisition of Celgene (CELG), a $74B acquisition. Pfizer (PFE) announced the acquisition of Array Biopharma (ARRY), a $11B deal, adding a promising colorectal medication to Pfizer’s suite of solutions. In another healthcare mega-deal, AbbVie, the producer of the most successful drug, Humira, agreed to purchase Allergan, the owner of Botox, for $63B. With Humira facing a patent expiration cliff, this strategic alliance will help AbbVie bridge the revenue gap as they develop their promising early-stage medications. Outside of healthcare, our defense contractor, Raytheon, agreed to join forces with United Technologies in a merger of equals. With diverse products and services, the new company would become a one-stop shop. Both companies have been historically excellently managed. While management is excited about the merger opportunity, it has not gained tremendous favor with shareholders on either side.
Portfolio
Our portfolio companies performed well in the second quarter. We’ll review a couple of highlights from the quarter.
After being stagnant for a couple of years, Disney (DIS) shares began moving up. Since announcing Disney+, their upcoming streaming service, the stock has gone from under $100 to above $140. The steaming service will be the only place to view the high-quality, desirable, and unique content that Disney has built up over many years. At an attractive price point of $6.99/month, expectations are high. Notwithstanding the growth opportunities, we find the growth to be fully priced in today. While we are no longer accumulating, we continue to hold current positions.
As reviews above, the healthcare industry is seeing some consolidation. Prices have been depressed. Political risks and uncertainty have driven the sector down. The businesses themselves are operating on all cylinders. We see a lot of value and find the sector very attractive. The services are recession-proof; people will need medical services and solutions regardless of the economic climate. In fact, we believe that in a recession political energy would be refocused from healthcare to more urgent needs, clearing some of uncertainties and unlocking value. We’ve been building positions in a couple of names including Pfizer (PFE), Johnson and Johnson (JNJ), AbbVie (ABBV), CVS (CVS), Walgreens (WBA), and United Healthcare Group (UNH). United Healthcare is a new addition to our portfolio due to its excellent operating history, projected growth rates in the mid-teens, and excellent portfolio of services.
In the industrial sector we’ve been opportunistic in building positions in 3M (MMM) and FedEx (FDX). 3M (MMM) is an industrial stalwart, knighted as a Dividend King, a company that has paid growing dividends for over 50 years. The recent concerns over a global slowdown have depressed the price to an attractive entry point. FedEx (FDX) is taking action to transform from an express document delivery service to a full shipment solution provider, focusing on the e-commerce opportunity. FedEx plans to take a larger role in last-mile delivery and is extending operations to deliver on Sundays. Interestingly FedEx decided to drop Amazon as a customer, freeing up resources to provide better, higher-margin solutions to the rest of the e-commerce players. While these bold actions may create short-term uncertainties, we believe going after e-commerce and all of its growth is a worthwhile opportunity. We have been accumulating both 3M and FedEx.
Insights
At Torre Financial, we take the business owner perspective. We invest in individual companies that are attractive investments. Our companies have excellent management teams, excellent track records, and high-quality earnings. Unless the story changes at any of our portfolio companies, we see no reason to exit our position. At the same time, we understand the effects the wider market can have on our investments.
We are in the midst of the longest ongoing expansion. The bull market is now over 120 months old. Many investors are getting nervous, making it difficult to hold their positions. Some build up their cash positions. Others may look to place money in private markets. Outflows on major ETFs have hit all-time highs. Inverse ETFs, which bet against the market, have seen new money come in. All the while, the markets have been hitting all-time highs in unison. We interpret these recent behaviors as quite bullish. That cash will eventually find its way back into the market. Those short positions will eventually be closed out, leading to additional buying.
It is important to consider the market in terms of the macroeconomic situation. In 1981, yields on the 10-year peaked at 15.8%. Securing a that level of income sounds quite attractive. Today, the picture is very different; we do not find many, if any, attractive alternatives to equity markets. The yield on the 10-year and the dividend yield on the S&P 500 are both hovering at 2%. Low interest rates support a higher multiple for equities. Notwithstanding, the P/E on S&P 500 sits at 16.7, right around the 25-year average multiple of 16.2.
For now, the most attractive opportunities are in equities. In line with our appreciation for low volatility and concerns of the upcoming recession, we have been taking advantage of dips in healthcare companies to make our portfolios more resilient. Our strong conviction in our companies and their growth opportunities gives us the support we need to hold tight and stay the course.