July brought uneven performance as the AI-technology trade put downside pressure on the major domestic equity indices throughout the month. An end-of-month rally could not spare the Nasdaq Composite from red figures. The tech-heavy index lost 0.75% for the month. The late rally saved the S&P 500 on the last day, which gained 1.3% for July. The Dow Jones Industrial Average was the noteworthy winner for the month, appreciating 4.4%. The 10-year U.S. Treasury interest rate fell 33 bps to 4.06% as the Fed decided to keep the borrowing rate range at 5.25% to 5.50%. Precious metal gold experienced a renewed bid as geopolitical developments sowed doubt. The safe haven metal appreciated 5.28% in July.
The month’s theme was the rebound in forgotten stocks that fell behind the broader domestic indices since the start of the year. A combination of positive stock performances from the laggards and material pullbacks in the “Magnificent 7” stocks, which have single-handedly pushed the indices higher, have created an interesting situation of the likes we haven’t witnessed in some time. The banking sector, a notable laggard in 2023, saw a nice uplift in stock prices as investors increasingly price the chances of rate cuts in the coming months. If we were to experience rate cuts, the funding costs would come down, and we would see an increase in spreads and profitability. The real estate sector, sans office, also saw an uplift in share prices as a decrease in Fed Fund rates and Discount Window rates assisted the interest rate-sensitive sector. Finally, the consumer discretionary sector continues to show weakness as various companies like McDonald’s and Lululemon are within arm’s length of their 52-week lows. In particular, the former company (McDonald’s), in their recent earnings, management warned that pressures that negatively impact consumers “have deepened and broadened.”
The June PCE report showed a consumer who continues to get stretched thin. The Details of the Personal Income and Outlays sub-report detailed that while spending growth continues moderating, income growth slowed quickly. The core PCE deflator (the Fed’s preferred inflation metric) rose 0.18% month-over-month, leaving the year-over-year core PCE inflation reading at 2.6%. While not at the Fed’s target, we continue to moderate closer to their target. We have stated and continue to believe these last tenths of a percent will be the toughest. If the Federal Reserve starts to cut in September, as the futures market thinks, and the economy avoids a recession, the stock market believes. We will likely see inflation metrics increase away from the Fed’s long-term target. Concerningly. Personal income and the personal saving rate continue to come in below expectations. For June, personal income grew 0.2%, while the personal saving rate decreased to 3.4% (from a downwardly revised May and April). These data points inform us that the average American consumer is under-saving to spend at slowing growth levels. In summation, consumer patterns do not indicate material consumer growth in the near term.
Please see the following updates on existing positions held at the firm:
CF Bankshares (Ticker: CFBK)- The Columbus, Ohio-based small regional bank amended their Charge of Control (COC) Agreements for CEO Tim O’Dell and President Brad Ringwald. The new Change of Control package for CEO O’Dell is not particularly noteworthy. The COC package for President Ringwald was notable in that it increased his pay package by 50% upon a sale. Private equity bank investor Castle Creek is in year 5 of their ownership, and we continue to believe a sale of the bank will occur in a couple of years. We forecast material upside upon a sale where management is financially aligned ($28-$30 per share on a sale).
Equity Commonwealth (Ticker: EQC)—Over the last 30 days, two more activist shareholders have publicly pressured management into seeking a liquidation event. This current round of activism supplements prior pressure from Jonathon Litt’s Land and Buildings, which came in the early Spring. Yesterday (July 31st), the company announced that leadership will proceed with a liquidation process. If performed promptly, we project a $22-$23 per share liquidation price. We agree that liquidation is the best course of action, with no recovery in sight for the office market that EQC focuses on. A shareholder vote will occur in September, allowing management to liquidate the company. EQC leadership is guiding for “substantially winding down the company by the end of the second quarter of 2025.”
Franco-Nevada Corporation (Ticker: FNV)- Franco-Nevada and Osisko Gold Royalties acquired a gold stream from SolGold’s Cascabel copper/gold project in Ecuador for $750 million. FNV used $525 million of their $1.3 billion in cash and cash equivalents to make the controlling investment. Ecuador is a pro-mining country, and the investment agreement has structural protections. Franco-Nevada CEO Paul Brink said, “Cascabel ranks amongst the best copper-gold development projects in the world and can potentially add significant GEOs to our growth pipeline. We are pleased to provide pre-construction funding to derisk project development and construction financing that provides a balance of funding certainty and financial flexibility.”
Kinetik Holdings- (Ticker KNTK)- The midstream company announced a series of transactions to de-lever the company to its target goal of 3.5x debt/EBITDA. In May, KNTK sold its GCX (Gulf Coast Express) stake for $510 million and reallocated some of the cash to invest to shore up gathering and processing assets by completing its acquisition of Durango Permian. The acquisition will grow its’ attractive Delaware Basin footprint. We believe this midstream company will be sold in the coming years. The run-up in the stock price over the last year has been welcomed, but the investment thesis has yet to be realized. We will continue to monitor the company closely. In the meantime, we will recognize an over 7% cash dividend yield.
Lagging technology mega caps highlighted this month’s inconsistent performance, which we have previously warned leaves headline domestic indices at risk of downside pressure. If this downside move in the AI-related names continues, we should continue to witness, in the near term, more downside pressure to the technology-heavy indices (S&P 500 and NASDAQ Composite). If you did not see our quarterly video call from earlier this month, I would encourage you to reach out to the team, and we can provide you a secure link to watch the video where Michael and I recap the previous quarter and provide our thoughts for the rest of the year.
Best regards,
Stash J. Graham
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