Matthew J. Mulholland joined Hotaling Investment’s advisory team in June 2017. Born and raised in Summit, New Jersey, Matt moved from New York, where he worked in the Managed Solutions Group of Merrill Lynch. While gaining experience implementing portfolio changes for over $60 billion in managed assets, Matt passed all three levels of the Chartered Financial Analyst exam. Matt works closely with Bruce Hotaling (Managing Partner), and Trish Markell (Sr. Investment Advisor). He adds tremendous value to Hotaling’s portfolio management, investment advisory services, and trading oversight.
Matt is a graduate of Johns Hopkins University where he received a Bachelor of Arts degree in Economics. While attending Hopkins, Matt was on the varsity football team and is a member of Alpha Delta Phi.
Matt currently lives in Philadelphia with his fiancée, Colleen, who is finishing her surgery residency at Thomas Jefferson University Hospital. Matt and Colleen enjoy their downtime by exploring Philadelphia’s many cycling paths and Philly’s burgeoning restaurant scene.
The recent announcement by Macy’s that they will be closing 100 stores is a rational reaction to the changing retail dynamics. For professional store shoppers like my mother-in-law, the news was quite unwelcome! However, the reduction of a high cost infrastructure is likely to continue as consumer buying habits change. This trend will ultimately be positive for sales and earnings growth longer term, but getting there could be quite painful for management teams and shareholders.
The price action of the various retail segments foreshadowed these changes. While we have all known Amazon (the ecommerce powerhouse) has significantly outperformed the S&P 500 since going public, the stocks of store based retailers have only recently begun to underperform the S&P 500. Investors have been well rewarded for embracing fundamental change in retail. The Bespoke “Death by Amazon” index, which includes a number of traditional retailers, is down close to 28% vs the S&P 500 over the last two years, while Amazon has outperformed the S&P by almost 200%. The changing landscape is also impacting the mall operators. An index of mall REITs is down 34% during the same timeframe as their customers, the retailers, have begun to struggle in terms of sales.
The stock performance of the “Death by Amazon” index foreshadowed the significant weakening of fundamentals for the group. While the stocks peaked in 2015, fundamentals did not peak until 2016. In early 2016, same-store sales growth began to slow and EPS growth turned negative in mid-2016. Sales and earnings growth could remain a challenge for some time as the move to e-commerce has not been fully embraced.
Online sales frequently have lower profitability, limiting the retailer’s ability to offer free shipping without putting significant pressure on margins. Store and online inventory systems may not be integrated, causing retailers to invest in duplicate inventory. IT infrastructure to meet the demands of the increasingly mobile consumer base may need further updates. Solving these problems requires higher capital spending. Profitability will remain under pressure as lower margin online sales become a higher percent of the business. Supporting online sales while carrying an increasingly less productive store base creates a very challenging situation for management teams that are being asked to increase sales and earnings.
The rationalization of the store base is a logical response. This trend will ultimately be a positive for store based retailers in the long term as they work to stabilize and ultimately grow earnings. However, the transition period could be painful due to higher capital spending requirements and to pressure on profitability. Some retailers may be unable to adapt and will go bankrupt. Mall operators face “collateral damage” as retailers reduce their square footage and pay lower rent, leading to potential cash flow problems. Fundamental change is difficult for managements and shareholders, but by focusing on the winners, shareholders can be rewarded with significant outperformance.
Low Interest Rates – Good today, but bad tomorrow?
Blog by Jean M Rosenbaum, CFA, Hotaling Investment Management, LLC
Borrowers typically find low interest rates very attractive because it reduces the amount of money they have to repay to their lender. Think about the impact of lower interest rates on your mortgage or your auto loan!
Savers on the other hand, find them less attractive as lower interest rates means lower earnings on their savings such as bank deposits, CDs or bonds. Have you seen the rates on bank “interest” checking and savings accounts?!
While a brief period can be positive for consumption, an extended period of low interest rates can cause some long term problems. The longer rates remain low, the more difficult it will be to generate income and savings needed for future consumption. The lower rates mean lower earnings for pension funds which rely on investment gains to meet their obligations. Insurance companies may also find it increasingly difficult to meet their obligations as the return on their investment portfolios continues to fall below previous assumptions. When the obligations for these firms were first established years ago, the assumption was the investment portfolio would grow and in some cases, the growth is critical to their ability to meet the future obligations. This situation could result in individuals receiving less money (or even no money) from sources they had previously believed were secure.
Taking this a step further, many European debt instruments are yielding negative rates. Negative interest rates means that investors pay to hold debt obligations as opposed to a positive rate environment where investors get paid to take risk and hold the debt of another entity. In the case of an investment portfolio that holds negatively yielding instruments, the investment portfolio will shrink! These companies cannot abandon the bond markets as they are regulated by their respective governments. The basic operating assumption of these organizations is that they can take in money and then generate a positive investment return and meet or exceed their obligations. This assumption has now been turned upside down as investment returns are meager at best.
The low interest rates helped consumption at a time when the sales of consumer durable items (houses, cars, etc.) were at very low levels. These sectors have recovered, but the ongoing environment of ever lower rates could cause more serious long term damage. Workers that have entered retirement may need to find a new source of income which could be very difficult. New workers will need to save even more money than expected to counteract the inability to generate a positive return or accept greater risk and/or volatility in their investment portfolios. With one part of the population saving more and another receiving less income, the outlook for consumption growth looks difficult. The economy could remain in a slow growth or even deflationary environment due to the “medicine” that has been used to try to counteract the problem of low economic growth.
Why is the high yield bond market struggling with liquidity concerns?
Blog from Jean M. Rosenbaum, CFA, Portfolio Manager
Hotaling Investment Management, LLC
The high yield market has been in the news recently due in part to its lack of liquidity. The increasingly poor liquidity situation was brought to the forefront by Third Avenue’s decision to halt redemptions in its Focused Credit Fund mutual fund. (Open end mutual funds provide daily liquidity to investors so the inability to withdraw funds has caused concern among investors in the asset class.) The liquidity concerns come from 3 primary sources – the fund itself, the energy sector and the regulatory environment.
The first problem lies with the fund itself. The fund invested in assets which were illiquid. Providing daily liquidity from such an asset base is possible only if the fund is growing. Once the fund stopped growing, the inability to sell assets impaired its ability to provide liquidity.
The second problem is the financial stress in the energy sector. The energy sector has become a larger part of the high yield market in recent years. Investors were happy to fund these cash flow negative companies in a high and rising commodity price market. Once the oil and gas prices began to weaken, investors became increasingly concerned about the ability of these companies to service their debt. Default rates, which are at cyclical lows, are likely to rise.
The third problem is related to the post-Financial Crisis regulatory environment. New regulations are changing the way bonds are traded. The bond market is an “over-the-counter” market. Unlike stocks, bonds are not on an exchange. Bond trading had been facilitated by an investment bank’s use of their own capital to create market liquidity by buying and selling securities, engaging in what is called proprietary trading. Following the financial crisis, new regulations limit the ability of investment banks to engage in proprietary trading, thus limiting their ability to create a liquid bond market. The limitation on proprietary trading, while put in place to safeguard the banking system by limiting the size of the balance sheets, has had the unintended consequence of severely limiting bond market liquidity.
Over time, market liquidity will return as the challenges of moving an over-the-counter market to an exchange are solved. The problem is most acute for active bond traders and for other investors that require liquidity and need to sell their bonds. Recent market events could be the catalyst to force market participants to solve the trading gridlock.
Image by By Svilen.milev
US Banks – Why the malaise?
Banks are a key component in the economic jig saw puzzle. They make up between 6-8% of the S&P 500 and roughly half of the financial sector of the index. Banks as a whole have modestly underperformed the S&P 500 for the last two years. The industry continues to struggle with the “pricing” environment. The low interest rate environment, coupled with ample liquidity, has led to ever lower rates banks can charge for loans and earn on their securities. While loans continue to grow, the revenue line for banks has been almost stagnant as the price they can charge continues to decline.
Banks have been able to grow earnings in this weak top line environment through an improvement in credit quality. Following the financial crisis, banks significantly increased their loan loss reserves. In the subsequent years, as defaults (or net charge offs) came in lower than initially anticipated, banks have been able to reduce their reserves providing a tailwind for earnings. Loan loss reserves are now approaching previous lows, so this improvement appears to be ending, or at least slowing.
The next driver of earnings for the industry may be operating expense control. Many banks have been experiencing cost growth ahead of revenue growth due in part to additional regulatory expenses. The banks have also been reluctant to limit their branch networks. However, with earnings drivers limited, it appears that some management teams have begun to take action. Going forward, physical infrastructure (a bank on every street corner) is likely to be replaced by more digital infrastructure at an accelerating pace.
Many bank management teams have been hoping for a Fed rate increase and a steeper yield curve, but the ability to wait may be coming to an end. The recently announced hiring and wage growth data was nothing short of robust. This may give the Federal Reserve the impetus to raise rates later this year, and potentially offer some relief to the banking sector.