On August 1st, markets across the globe were rattled as President Trump announced new tariffs on China. Stocks plunged and the 10-year Treasury yield dropped below 1.9%. The news shouldn’t have been such a shock as it has become increasingly clear that China hopes to stall. If a new administration takes over in 2020, it would seem likely that negotiations might be a bit easier on them. China has taken advantage of the world since it jointed the WTO, most glaringly in areas such as patent infringement and counterfeit goods. It is painful over the short-term to fight against it, but over the long-term, a new deal could be extremely beneficial for world trade.
Economic data has been much weaker in the 2nd quarter, especially in manufacturing and trade. The U.S. economy has been helped by strong consumer spending and lower rates are providing some stability to the housing sector. Affordability is a huge issue, especially for millennials. The Fed cut interest rates by 25 bps this week and there is an expectation that they could go lower.
Neither China nor interest rate cuts change much for our key investments. We don’t buy anything based on predicting these sort of macro or geopolitical issues. We are finding a lot of deeply undervalued stocks in Europe at the moment, where growth is really slow. Trade and fears of a “no deal” Brexit are the most likely culprits there. I tend to think that many people have sold out of European stocks based on these issues, so when we finally actually get past Brexit and move on, we could see a relief rally, and valuations are enormously compelling.
Earnings season has gone very well for our major investments that have reported thus far. ALLY Financial has been a huge winner for clients of T&T Capital Management. At the December lows, the stock traded around $20, and now it trades around $32.50. This was a very large position for us and we have made a lot of money through owning the stock, selling puts, and selling covered calls. The more than 50% rally, has allowed us to close out many of our sold puts after making most of the profit. We have sold some more longer-term puts and have kept our stock. The stock currently trades around tangible book value so it still isn’t expensive.
Citigroup and Bank of America continue to perform well, while returning nearly all of their earnings to shareholders via dividends and stock buybacks. The stocks aren’t “no-brainer” investments at current levels, but they aren’t expensive either.
U.S. and some European airlines are still very cheap. U.S. airlines are making billions of dollars, despite some big headwinds. The Boeing 737 Maxx has been a problem for American Airlines and Southwest particularly, but the stocks offer good value here.
Vivendi continues to produce strong results, led by its Universal Music Group division. UMG sells music licensing rights to streaming companies such as Spotify and Apple. Growth has been very strong, but the stock still trades at a material discount to its breakup value if they were to sell their various subsidiaries.
BNP Paribas (BNPQY) produced great earnings this week. Low interest rates in Europe don’t help, but its diversified businesses such as Fleet and auto financing are showing strong growth. Efficiency gains are a major part of the story there and the valuation is ridiculous. Credit is strong and should hold up well even in more adverse circumstances.
Auto companies such as BMW, Fiat Chrysler, and Daimler offer very compelling values. We are talking low single-digit earnings multiples on the operating companies when you adjust for various subsidiaries.
Berkshire Hathaway trades at a lower price than Warren Buffett has been willing to buy back stock at, which likely is a compelling value. Berkshire has over $100 billion in cash that can be used for acquisitions, buybacks, or future dividends. It is the type of company that would hold up really well if the economy were to take a major downturn, and they have the resources to capitalize on distress. I think it will do better than the S&P over the next decade, despite its under-performance over the last 10 years.
Unsurprisingly to anyone that reads my writing, the Puerto Rico government’s corruption has proven to know no bounds. Their governor has been forced to step down after blatantly sexist and homophobic text messages, in addition to a major investigation into government contracts being given to friends and allies, to the detriment of taxpayers and citizens. The incompetent and conflicted Oversight Board has enabled this governor in every way, despite it being obvious what was going on. Despite all of these issues, AGO continues its strong performance, and upside is still very great from here. Adjusted book value should be over $100 per share within 2-3 years, and at that point, the stock should trade around $70-80 arguably. There are risks of course but we have that strong margin of safety we want.
The last thing I’ll say is that I think a lot of market participants are underestimating the amount of risk out there. Many assume that trillion dollar market cap stocks such as Microsoft and Amazon are invulnerable. We owned Microsoft in size 6 or 7 years ago. At that point in time the stock was in the mid-$20’s and its valuation was 10 times free cash flow and 12 times earnings. Now it trades at 8 times sales and 27 times earnings. Amazon is way more expensive than that. While these are great companies, that doesn’t mean they are great stocks at current prices. A 40% haircut is not impossible on either of them, and even then they wouldn’t be unbelievable bargains. We want to buy companies that we shouldn’t be able to lose money on, even if things get much worse. We only can do that by buying them at major discounts to intrinsic value.