On the market’s prolonged run-up…

Those numbers [the year-to-date return of +7.84%] are nothing to scoff at, but given the downward spiral with which the year began and a prolonged multi-year bull run, these milestones carry even more weight. The S&P 500 closed at 2,168.27 for the quarter—that’s 19.8% above the intra-year low hit in early February (1,810.10). For even broader context, since hitting a low on March 9, 2009 (at 672.88), the index has rallied almost 225%.

 

On recent trades in the financial sector…

We used recent interest rate uncertainty to fine-tune our perspective on financial institutions and make adjustments in a generally under-valued sector. We added some money to familiar positions like Bank of America (ticker: BAC) and picked up new positions like Citizens Financial Group (ticker: CFG) where appropriate. But the largest adds in the financial sector were Citigroup (ticker: C) and Wells Fargo (ticker: WFC).

 

On other recent buys…

We also identified a number of undervalued individual entities. Flowers Foods (ticker: FLO) was disproportionately (we think) affected by negative headlines and speculation about the treatment of contracted delivery drivers. We used that relative weakness to move into the stock (which also pays a nice dividend north of 4%). Additionally, we picked up General Motors (ticker: GM) stock to diversify our automaker holdings (Ford is the primary holding in that space) at what we believed to be undervalued prices.

 

On our Twitter “miss” and exit…

On the sell side, we finally “gave up” on Twitter (ticker: TWTR). We bought Twitter at various points in 2015 (and on limited occasion in 2016) hoping that the strength of the platform—not just in terms of users but also in terms of use on regular broadcast programming, etc.—and deceptively strong improvements in monetization might outweigh management missteps. That theory may or may not ever come to fruition, but continued miscues from leadership backed the stock into a corner in which the entirety of its valuation was driven by buyout speculation. We exited the position between $18.83 and $18.93 in one fell swoop as the stock rebounded from a low of $13.73. Shortly thereafter, continued speculation drove the price briefly north of $25, but the stock is currently trading in the $17-range as all speculated bidders have bowed out. Twitter is a fantastic (in a bad way) example of a miscalculation of management and abandonment of our core strategy (buying undervalued stocks). Fortunately it was never a large position for the firm.

 

On challenges in the fixed income space and opportunities created…

As has been the case for some time, our greatest challenge in day-to-day portfolio management remains fixed income. For the quarter, the Barclays Municipal Bond Index returned a loss of 0.30%, and as interest rates remain low (and push lower internationally), filling bond allocation buckets has been difficult. We wrap up seemingly every portfolio management meeting with the prompt: If anyone sees anything attractive in the area of fixed income, let us know. We keep thinking things have to turn around and we are starting to see some growth on the longer end of the yield curve (layman translation: longer-dated bonds are starting to pay a littttttle bit more), but at the same time demand seems poised to keep yields low for some time.

 

The flip side of this frustration that dividend paying stocks (which we always favor) are being placed at a premium and seeing a run up. A simple way of viewing this phenomenon is by comparing DVY (the iShares Select Dividend ETF) to IVV (the iShares Core S&P 500 ETF). Over the past 12 months (as of 10/17/2016), IVV (a close approximation of the market) has returned 6.85%. DVY (again, with an emphasis on dividend-paying stocks), is up 13.23%. That’s significant out-performance.

 

The entire newsletter is available here.

 

Andrew Hall is the Vice President of Narwhal Capital Management.

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