Dont get to comfortable


It was a profitable first part of the year for your account. The stock market continues to drift higher, with very little volatility.  We don’t expect it to continue, indefinitely.

 We sold IBM this quarter in all our managed accounts. We lost confidence in IBM’s successful transition to the cloud and data analytics.  Up until the first quarter of 2017, there were positive signs IBM was turning around its business. Each quarter, it released its gross margin percentage for its sales. Gross margin percentage is the percentage of each dollar in sales retained after suppliers are paid.  For most companies, the gross margin on a quarter-to-quarter basis is very stable. That was not the case with IBM. We were shocked when it posted its lowest gross margin in a long time.  IBM’s explanation for it wasn’t convincing.  

We interpreted a declining gross margin as competitive pressures on the products IBM sells.  It may be losing the data analytics business to Google and Amazon. Although Watson, its artificial intelligence product, is fantastic, significant revenue from it is farther away than we originally thought. When a company must discount its prices to sell its products, yet sales continue to decline, you have a real problem. IBM has a real problem.

 When we buy a value stock, we try to acquire it at about half its market price.  This allows leeway regarding the direction of earnings.  We initially bought IBM with its pretax earnings at around $21 billion.  In this case, we were way wrong about the direction earnings would take.  Last year, IBM’s pretax earnings were $13 billion, and may be worse this year. The margin of safety we thought we had has eroded.  Based on the last quarter, there’s little evidence it can fix its problems quickly. We hope it can, and does, but won’t reenter this stock anytime soon. 

Happily, our methodology proved right, regarding Apple. It, too, was bought at about half the market price, and its pretax income was $51 billion. We thought the market was too pessimistic, expecting Apple’s earnings to crater. Today, its pretax income is $61 billion—a significant increase.  Our reward for optimism was the stock rising, from $57 to $145. Had Apple not grown its pretax income, but stayed at $50 billion, we’re confident the stock would still have made it to around $100. 

Apple does face future challenges in the consumer cell phone sector, but later this year, its new, ten-year anniversary phone should boost earnings.  Apple’s consumer brand-loyalty will be hard for any competitor to overcome.   

A quick update on a few of our other stocks. We still expect the Level3 merger with CenturyLink in the third quarter. CenturyLink is dealing with class-action lawsuits regarding alleged, unethical billing practices. At this time, we don’t view this as a material event. 

BGC Partners will spin out an IPO to real estate division shareholders. We don’t have the financial details, so stay tuned. 

Maxwell is apparently fixing its issues in China, which we view as a positive. 

Bank loans have declined of late, which won’t help our bank stocks’ earnings in the short term. We think uncertainty about potential new tax laws has slowed commercial lending. 

We want to point out, American consumers’ balance sheet is getting healthy again. The chart on the next page represents the equity U.S. homeowners have in their houses. From it, we can derive an indication of how consumer spending might trend in the future. Increasing homeowners’ equity translates to eventual increases in consumer borrowing. 


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The stock market has just finished one of its least volatile six months in its history.  A 5% market correction has not occurred in over 250 days. This won’t last.  A normal, 10% correction might happen very fast, and be very scary. 

Market complacency shatters quickly in the age of the Internet. On June 9th, market leaders declined 5% in about two hours, before coming back up. We mention this to let you know, we haven’t forgotten about bear markets at Trend. We have been fully invested in the stock market for ten years, with the exception of raising 20% percent cash, in 2015. That money was reinvested in the second half of that year, when the market took a big hit. 

Today, we have over 5% in cash that will grow when Level3’s merger pays a $26.50 dividend this quarter. Add that cash to investments more impacted by which way commodities go,  (DJP, RGLD, ILF, NUE, XOM) than by the Dow Jones, and we might have over 30% of our portfolio in cash or stocks less correlated to the Dow. 

We are not inferring another 2008-09 is about to occur. What we do emphasize is, investors are too calm and happy, and it won’t last. We have a long list of stocks to buy, if the market drops. Some prices are over 20% away; some are much closer. Our job now is to wait for our price. Stocks on the list are not tied to commodity prices, which we think can grow, even if the economy entered a recession.  

 The bond market lately is giving some indication we are headed for one, despite the fact it correctly predicted two of the past seven recessions. Bond investors don’t have a crystal ball, either. Commodity prices have also been weak, which indicates global demand isn’t as robust as we want it to be.  Both are signals earnings in the second half of 2017, may not be as great as the consensus thinks they will be.

 We will try and navigate whatever the world throws at us, and plan to be profitable doing it. We have many scenarios in our heads, but no clear winner predicting how the economy plays out. If there is a recession, it won’t be like the Great Recession. The system is now in much better shape, than it was then.  The bond and commodity markets are alluding to the economy needing some sort of boost. We have assumed it would come from fiscal stimulus, but not sure it will happen this year. We will keep you up-to-date on these developments in future letters.






Mark Brueggemann IAR                   Kelly Smith IAR                       Brandon Robinson IAR .