For the year ended December 31, 2009, The Burnham Fund rose 31.11% (with dividends reinvested) outperforming both its benchmarks: the S&P 500 (with dividends reinvested) by 5.5%, and the Morningstar Large Cap Blend Index by 3.8%.
In our Semi-annual report for 2009, we discussed how in early March we made decisions formed by our view that market lows had been touched and tested. Since that time, and with no material interruption, the DJIA rose 59%, the sharpest rally since 1933.
The primary driver of this strength has been monetary liquidity on a domestic and global scale. The two-pronged approach by the Federal Reserve to provide support to consumers, businesses and financial institutions has involved maintaining fed funds rates at near 0%, while providing liquidity via programs such as the Term Asset-backed Securities Loan Facility (TALF). Both approaches have been effective in stabilizing the US banking system, and restoring its profitability and capital structure. Increased activity in international currency swaps has also led to more liquidity among US and international banks, easing the freeze that occurred in late 2008/2009. The timing of increases in interest rates is uncertain (consensus seems to be around second half 2010, after the mid-term elections), and TALF and other lending programs that have been extended will expire in 2010. The Fed has also announced it would slow its purchases of long term securities in order to provide smooth transition in markets to more ‘normal’ conditions. The jury is out on the stimulus package passed by the Obama Administration, which was meant to be long-term and targeted at construction and alternative energy industries. A second stimulus packaged aimed at job creation may be forthcoming.
According to S&P estimates, earnings on average will grow by 12.7% for 2009 (versus a decline of 40% for 2008), and will grow 37% in 2010 – a recovery year. Areas expected to have shown the strongest rebound in earnings for 2009 are those which sustained the most damage in 2008: Financial Services and Consumer Discretionary (led by autos). For 2010, Financials, Energy, Materials, Consumer Discretionary and Information Technology, respectively are anticipated to be the earnings leaders.
Careful sector allocation contributed in large part to The Burnham Fund’s outperforming its benchmarks. The Fund’s largest sector allocations were in Energy, Information Technology, Consumer Discretionary and Financial Services – each of which showed significant valuation rebounds in 2009. (Financials, Consumer and Technology held slightly less in the Fund as a percentage of assets relative to their weights in the S&P 500 Index.) The Fund’s sector investments in Energy, Consumer Discretionary and Technology each outperformed their indices by a significant margin – propelled by the performance of their constituent holdings. On an absolute basis, the best performing positions in the portfolio were Ford Motor Co (+336%), Mark West Energy (+325), Freeport McMoran (+228%), Apple Computer (+146%) and Intuitive Surgical (+138%). The positions which had the biggest impact on performance (a combination of performance and asset allocation) were Apple, Freeport McMoran, Ford, American Express and Google.
Conversely, the sectors which detracted from performance, while still higher on an absolute basis, underperformed the S&P on aggregate and thus were a drag on returns. These sectors were Health Care, Telecom, Consumer Staples and Utilities. The Fund underweighted the Healthcare, Consumer Staples and Utilities sectors, and its investment in Telecom matched the index on a percentage basis. The five positions that hurt performance were (in order) ExxonMobil, Hain Celestial, General Electric, Wells Fargo and Bank of New York. Of these securities, ExxonMobil and Wells Fargo are no longer held.
As we look ahead to 2010 and beyond, we are confident that the equity markets are telling a story, which states that the worst of the crisis is behind us. However, the US is deeply divided over a path to follow (fiscal stimulus or budget restraint) and the economy is still fragile, with delineation between winning and losing industries, and whether challenges are cyclical or secular.
On this first point, political fractures are is emerging that has placed much of the Obama Administration’s agenda in question, and may affect its ability to target stimulus where it is needed due to Congressional impasse. However, history has shown that the US prefers divided government, punishing incumbents in mid-term elections, after which bi-partisan, moderate legislation may follow.
Reported data shows the economy is stabilizing, with glimmers of improvement, but the mood of the country is grim. The unemployment rate has not yet ticked downward, but the pace of decline has abated. The unemployment rate generally improves after recovery gains traction, thus we do not expect to see better numbers for another 6 to 12 months. The housing sector is stabilizing and improving in some areas. Consumers may continue to be risk averse – not only because of employment uncertainty and stagnant wages, but also from their actions to reduce debt, combined with tighter and more expensive credit.
On the second point, we see opportunities in the equity markets as we open the book for 2010. Commodity prices have risen as the economy recovers, and in combination with the lower dollar. Energy transmission markets – specifically MLPs -- provide high total returns. Consumers are cutting back on many items, but not when it comes to innovation and value -- to the benefit of strong consumer franchises such as those enjoyed by Apple Inc., Amazon, and McDonalds, but to the detriment of apparel, publishers and networks and those servicing them. Finally, banks are showing earnings growth, as problem loans have been written down, lending is more conservative, spreads are positive, and investment banking is on a cyclical upturn. Consumer finance is also recovering for many of the same reasons. However, political backlash and tighter regulation may hamper the returns of multi-line bank conglomerates.
We believe 2010 will be a year of recovery, characterized by continued low interest rates, low inflation, and slow to moderate growth in GDP, within a volatile political environment. Earning recovery may be dramatic because of draconian cost cutting. We believe that active, strategic asset allocation and stock selection will again drive returns.