Quarterly Newsletter - 2nd Quarter, 2014
PERIOD FMR* Taxable FMR* Retirement S&P 500 DOW Russell 2000
1st Qtr +2.90% +2.50% +1.80% -0.72% +1.12%
2nd Qtr +8.45% +8.05% +5.24% +2.84% +2.05%
YTD +11.60% +10.77% +7.14% +2.68% +3.15%

    Five Mile River portfolios, which outperformed the S&P 500 in both the first and second quarters and therefore first half of 2014, are year-to-date +11.60% in taxable accounts and +10.77% in retirement accounts. This surpasses our full year expected performance of +8% to +9%. The S&P 500 was up +5.24% in the second quarter and first half performance for this broad index was +7.14%.

    What is behind this strong second quarter performance?

  • The Federal Reserve Chairman, Janet Yellen, re-emphasized that the Zero Interest Rate Policy (ZIRP) would continue for a very long period of time despite rising concerns about inflation. The Chairman’s vote on this board always rules.
  • Fear from multiple international crises (Iraq, Ukraine, Syria, Iran and Afghanistan) subsided quickly and deemed not relevant to U.S. equity markets.
  • Mergers, acquisitions, spin-outs, share buybacks, and restructuring activities rose dramatically. With interest rates and thus borrowing costs historically low, revenue (sales) growth was modest in a 2% slow growth economy and cash on balance sheets at record highs, corporations have turned to acquisitions and restructuring steps to grow earnings. Over $1 trillion in merger and acquisition activity has occurred in the first half, and Five Mile River portfolios have benefited from several of these value-creating events.
  • Retail and institutional investors have been underweighted in equities after the March 2009 market bottom that scared all investors. Retail investors quickly left the equity market for the safety of cash and bonds. Institutional investors (pension funds, public funds and endowment funds) also reduced U.S. equity holdings substantially, some to as low as 16% from what had been 50% weighting allocations, for the “safety” of alternative investments such as hedge funds, private equity, venture capital, and international equities. As a result, many retail and institutional investors underperformed their benchmarks and their return objectives by moving away from U.S. equities at the bottom.

    It is now more than five years since the 2009 market bottom and stocks are up 200%. The S&P 500 and the Dow Jones Industrials made new highs heading into the Fourth of July weekend. This compressed enthusiasm of late looks to us as somewhat overdone in the short-term. We said in our first quarter letter that most stocks were fairly valued at the end of that quarter, and only a small percentage were overvalued. Our expected 2014 return of +8% to +9% has not changed as a quite reasonable total return for this calendar year. This fast second quarter rise came earlier in the year than most expected, and the positive FMR portfolio performance was driven by company-specific “events,” as we will discuss later. 

    The “Camelot” scenario referenced in our first quarter letter of +15% for the year assumes an orderly wind down of the Fed’s money printing exercise by year end and some semblance of functional fiscal policy decisions out of Washington. The latter is a low probability which is why our “Camelot” upside estimate is also a low probability. Nevertheless, putting numbers on the “Camelot” outcome could be $127 of earnings for the S&P 500 and a 17 X price earnings multiple (P/E). That would leave at best only about +9% appreciation from current levels. This upside is NOT a reason to pay up for stocks based on expansion of P/E’s. 

    At this stage in year six of the bull market, we are focused, more than ever, on finding and investing in specific company events that will create value. We are also focused on making sure that our dividend growers can continue to increase their annual dividend payouts to us as shareholders. We reiterate that there has NOT been a 10% correction in the market for the last two and a half years. And, it is important to emphasize that FMR long-term investors should not be thinking about “end of the world” scenarios when the next 5% to 10% correction does happen. Just know that this size correction will happen, and is normal after an extended bull market move like the last five years. Markets are cyclical and small declines of 5% at any time in a bull market are at least a 50/50 probability, and 10% declines have a one in three probability. 

    When does the ZIRP policy end?  

   The short answer is we do not know exactly when the ZIRP policy will end, and neither do all the Fed watchers, pundits and even the board members on the Federal Open Market Committee (FOMC). After an unprecedented ZIRP for five and a half years, the Fed will eventually react to inflation or be forced to act. Suppressing short-term and long-term interest rates for this long is an unprecedented experiment. The Fed has a target of 2% inflation and it has been our belief for the past year that the economy is already at that level and even beyond for the goods and services that matter most to the majority of citizens who have to live on a budget.  

   Food, energy, healthcare and shelter are all running +3% to +7% for at least the last six months, despite the consumer price index (CPI) or the personal consumption expenditure (PCE) indices that the Fed uses to measure whether inflation is a problem. We recently read a commentary on inflation and the zero interest rate policy by economist John Mauldin that raises the argument that the Fed is “behind the curve” once again. The table on the following page of this letter shows some of the living expenses he cites in his article. All of these items are central to our standard of living and our budgets. Also troublesome, but not in the table, are increases in pricing of coffee, cars, movies, college tuition, pork, electricity and natural gas during the same timeframe. 


Table 1.  Mauldin Inflation Table



January 2000


March 2014


% Increase



Barrel of Oil




Gallon of Gas




One Dozen Eggs




Annual Healthcare




(spending per capita)

Ground Beef (1lb)




Avg Monthly Rent




(Case Shiller)



PCE Deflater


(Fed's preferred measure)

   Why has the Fed not started tightening (normalizing) interest rates?  

   Probably two reasons: first, they are not done buying government debt and printing excess money, but the quantitative easing (QE) policy is finally winding down to hopefully a stop by year end. The FOMC seems committed to NOT raising the short-term federal funds rate until their QE program is over. Secondly, Chairman Yellen has moved the “goalposts,” saying the committee is not overly concerned about short-term price increases as wages are not increasing very fast. Wages certainly are NOT making progress after inflation. It is unfortunately a fact that wages and salaries are only up 2% over the past 12 months, which helps explain continuing QE, and delaying normalization of interest rates.  

   The Fed has exhausted most of their “lifesaving” tools when the sources of low growth and low job creation come principally from counterproductive fiscal government policies that include: 1) the highest marginal corporate income tax in the developed world at 35%; 2) the job-killing regulations of the Environmental Protection Agency on U.S. factories and utilities; 3) The Affordable Care Act (Obamacare) with its higher insurance premiums and taxes and penalties on businesses, insurance companies, medical device companies, and drug companies, with the net effect of pushing employees to part-time status under 30 hours a week and keeping a workforce total under 50 employees at individual companies; 4) Minimum wage legislation which is estimated by the Congressional Budget Office to kill a half million jobs; 5) The Dodd-Frank law which has led banks to pull back on lending to anyone other than their very best customers with the highest credit ratings. Dysfunctional and delusional may be accurate descriptors of this job growth/slow growth conundrum.  

   The fed funds rate is likely to increase gradually at +¼% (25 basis points) each step on the way back to normalization. The long bond, called the 10-year Treasury Note (an important benchmark), has benefited from factors that have temporarily kept yields at low rates of 2.5% to 2.6%. Some of these factors are likely to diminish in the near term including: money seeking a safe haven from multiple worldwide crises; the Fed’s QE government bond buying program; and an indeterminate amount of professional money that followed the Fed’s purchases. Therefore, it is likely that this lessening of liquidity will cause the long bond to adjust to higher normalized rates. Historically, the Fed has had to react to this type of yield move in the long bond by belatedly raising short rates to catch up.  

   Portfolio activity in Five Mile accounts  

   The FMR style of portfolio management that focuses on dominant, free cash flow business models with safe and growing dividends has served FMR clients well. This investment strategy will be a critical defense against rising interest rates when the Fed finally begins to back away and reduce the size of its balance sheet of U.S. government debt. This moment may trigger the 5% to 10% correction we have discussed, which will be healthy and provide more opportunities to buy both dividend growth companies and value-creating restructuring companies. For the last few years, several FMR portfolio companies have consistently had attractive restructuring opportunities to spin off an unrelated or slower growing business to enhance their profitability, growth, and mix, as well as sometimes attract a buyer for a division or the entire company.  

   A few notable examples of these companies in FMR portfolios include Allergan, the eye care and “Botox” company. Allergan received a very high takeover offer. That position was sold from Five Mile Growth portfolios after a large gain on this announcement and stock price appreciation. Another example, International Paper, spun out its paper distribution business (xpedx) to shareholders to form a new publicly-traded company called Veritiv, which was sold on distribution. Also, Rayonier, a real estate investment trust or REIT that owns timber and a performance fiber business spun out the latter as a new public company, Rayonier Advanced Materials. This spin out was kept in portfolios, and more was added. CBS Corp did an initial public offering of one of its divisions called CBS Outdoor Americas, a large owner of standard and electronic billboards in all of the 25 largest markets in the U.S. and over 180 markets in the U.S., Canada, and Latin America. CBSO has an above average dividend which is likely to grow with substantial free cash flow to reward shareholders.  

   Finally, a major company event that impacted all FMR portfolios significantly in the quarter was the announcement by The Williams Companies (WMB) that they were acquiring the general partner of another one of our major holdings, Access Midstream Partners (ACMP). ACMP is held in all taxable accounts. It is a master limited partnership that owns, operates, develops and acquires natural gas gathering systems and other midstream energy assets. They gather, treat, and compress natural gas under long-term fixed-fee contracts and operate in the most prolific natural gas shale basins in the U.S. ACMP will likely be merged within a year with another one of our master limited partnerships, Williams Partners LP (WPZ), which was created by the Williams Companies. Both ACMP and WMB appreciated significantly during the quarter. The synergy of combining the two will immediately increase the dividends distributed to shareholders. The ACMP dividend distribution will rise 25% for 2015 and 2016, and then grow in the 10% to 12% range over the long-term. The WMB dividend is currently $1.70/share and will be $2.24 annualized with the third quarter 2014 distribution increase, then $2.46 in 2015, and grow at 15% through 2017.  

   The core message in chronicling these company-specific events in several FMR portfolio holdings (up to 15%+ weighting in taxable portfolios) is to emphasize that even in a fairly or fully valued stock market, there are best in class companies with incentivized management and excess cash flow to initiate buybacks, grow dividends, make acquisitions, and spin-out or sell pieces of their companies to create shareholder value.  

   Since inception in April of 2003, FMR has realized 10%+ annualized returns. At the annualized rate of 10%, a portfolio’s assets will double in seven and a half years. We look forward to the opportunity to continue to grow and protect FMR clients’ invested assets. Thank you for your interest in Five Mile River. Please do not hesitate to call or email with any questions. We wish you a relaxing and fun summer!  


    Thank you for your continued support of Five Mile River. We welcome referrals of friends and family that you feel could benefit from our conservative value/dividend approach to preserving and growing capital. We welcome all questions and comments about our holdings and investment strategy. Our best wishes for an enjoyable summer.


Lee                                        Todd                                        Martha                                   

The performance information above *  is not audited and has not been otherwise reviewed or verified by any outside party.  While Five Mile River Investment Management, LLC endeavors to furnish accurate information, investors should not rely upon the accuracy or completeness of this information.

This letter is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendation concerning the manner in which any client's accounts should or would be handled as appropriate investment decisions depend upon the client's investment objectives.  Any offer to sell or the solicitation of an offer to buy any interests in any securities may be made only by means of delivery of a Five Mile River Investment Management Agreement and or other similar materials which contain a description of the material terms and various considerations and risk factors relating to such securities or fund.  Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be either suitable or profitable for a client's or prospective client's portfolio, and there can be no assurance that investors will not incur losses.