Economic news in the second quarter centered on the vote by the United Kingdom to exit the European Union, commonly referred to as Brexit. While Brexit is a major financial event, it certainly is not the first time a member of a group thought they would be better off on their own. While some might imagine that a world with only one country would be an ideal outcome, most equity investors note that the actual synergies achieved in mergers rarely meet initial projections. In fact, activist investors often push for spin-offs, divestitures, and carve-outs in order to better incentivize management teams and unlock shareholder value. While the United Kingdom will have to address pressing issues such as renegotiating treaties and preventing Scotland and Northern Ireland from seeking an exit of their own, we believe continental Europe will bear the brunt of the pain from the separation. Continental Europe has suffered from stagnant economic growth and rising debt levels that were partly made possible through the construction of the European Union and the euro as a common currency. The departure of Great Britain makes the road to sustainable economic recovery even more difficult and raises additional questions regarding the long-term cohesiveness of the European Union. Our portfolio of microcap U.S. companies has almost no direct exposure to either the United Kingdom or continental Europe, but we recognize a growing risk that a destabilized and debtridden European continent could have negative ramifications for the rest of the world.
After initially projecting as many as four interest rate hikes in 2016, the Federal Reserve again decided to keep the Federal funds rate unchanged at their June meeting. This decision was at least partially attributed to the potential impact a vote in favor of Brexit could have on the global financial markets. While the Fed’s actions might seem prescient after the fact, we find it unusual for central bankers to alter monetary policy in anticipation of an election result, especially when the election is being conducted overseas. The probability of an interest rate hike through the remainder of the year has also been greatly reduced following the vote. Meanwhile, the unemployment rate in the U.S. ended the quarter at 4.9%, only slightly higher than the previous trough of 4.4% in May 2007. We remain concerned the Fed’s targeted range of long-term unemployment of 4.6%-5.0% is overly aggressive and well below the 6.4% rate that unemployment has averaged since 1980. Core inflation readings remained relatively tame during the quarter with the core PCE (the Fed’s preferred measure of inflation) increasing 1.6% y/y. Inflation remains below the Fed’s target of 2.0% and provides significant leeway for the Fed to maintain a highly accommodative monetary policy. We continue to believe the only objective of monetary policy should be to promote long-term economic growth. The Fed’s current dual-mandate targeting arbitrary rates of unemployment and inflation will continue to encourage a prolonged period of easy monetary policy that will likely lead to a misallocation of capital and resources and ultimately reduce the long-term growth potential of the United States.
[us_separator] The above post has been excerpted from a recent letter of Gate City Capital Management.
Performance for the period from September 2011 through August 2014 has undergone an Examination by Spicer Jeffries LLP. Performance for the period from September 2014 through December 2015 has undergone an Audit by Spicer Jeffries LLP. Performance for 2016 is unaudited. The performance results presented above reflect the reinvestment of interest, dividends and capital gains. The Fund did not charge any fees prior to September 2014. The results shown prior to September 2014 do not reflect the deduction of costs, including management fees, that would have been payable to manage the portfolio and that would have reduced the portfolio’s returns. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. The net compounded impact of the deduction of such fees over time will be affected by the amount of the fees, the time period and investment performance. Specific calculations of net of fees performance can be provided upon request.