Market Selloff
Dear Clients and Friends,
Thursday and Friday marked the 4th time in the last 50 years when the S&P 500 had a 2-day drop of over 10%. The other 3 times were October of 1987 (Market Crash), November of 2008 (Financial Crisis), and March 2020 (Covid). This one is different in that it is self-inflicted.
The Trump Administration is playing a high stakes game of poker with the global economy right now in order to balance trade flows and bring manufacturing jobs back to the US. Countries such as Vietnam and Cambodia have reportedly already made offers to reduce their tariffs on US imports in exchange for a reduction of the new tariffs we announced last week. However, China raised their tariffs on us.
The market hates uncertainty and nobody knows how far Trump is willing to take this. If countries reduce their tariffs on the US, and we materially reduce our just announced tariffs then that would be great for the US economy and our stock markets could be at all-time highs soon. If this is prolonged and other countries retaliate, we would enter a recession. The outcome is unpredictable. Everyday we wake up to a new headline. Unlike Covid or the Great Financial Crisis, this could all end today if Trump decides he has gained enough to declare victory.
Recall that we highlighted in past letters that the abnormally strong returns of the market the past few years couldn’t continue in perpetuity. As such, we are holding more in cash/treasury bills than normal in our strategies. Note that the GCI strategy has always operated with the philosophy that holding cash has option value, but that option value becomes expensive over a multiyear period. Therefore, the GCI strategy is 100% invested at all times. Also, as a reminder, we are invested in high quality companies that are leaders in their industry, have great management teams, and solid balance sheets. We do not own any apparel or auto companies such as Nike or GM which seem to be most at risk from tariffs should they become permanent. Some of the companies we own such as Amazon and a few industrial companies will be directly impacted by tariffs, but we think the issue is manageable for them.
We don’t know where these companies that we own will be trading tomorrow (no one does) but from here the long-term returns they will provide us with are very enticing. We have been through market downturns before and panics like this are the time to think about buying more, not selling. We don’t know where the bottom is, and we won’t know if the market bottomed until well after the fact. In 2009 the market bottomed on March 9th. It did not feel like the bottom at the time. In 2020 the market bottomed on March 23rd, but it wasn’t until November of 2020 that Pfizer announced successful results of a Phase 3 Trial for their Covid vaccine.
This is just to say that time in the market is more important than timing the market. 7 of the 10 best days for the market occurred within 15 of the 10 worse days. If you miss these days, it can have a material impact on your returns as seen in the chart below. For this reason we will typically never make reactionary wholesale changes, try to time the market, or resort to large scale liquidations.
We are invested in a number of great companies that we believe will create a lot of value for us over the long term. Clients should take comfort in the fact that each of these companies are more attractive today than they were at the beginning of the year.
For a great example of why this is true, consider Heico which is one of our largest holdings in our Focused Equity strategy. They sell aerospace parts and components to airlines. We bought Heico several months before Covid and before global travel fell off a cliff – creating one of the worse operating environments imaginable for Heico’s business. Even though our timing was as unlucky as it could have been, the investment still worked out well over time. Remember that when you own truly great businesses, time will always be your ally. You can read more about Heico below.
We don’t know what the market will do this week, but we have been through these situations before. We plan on opportunistically upgrading our portfolios and we will put our excess cash to work as opportunities present themselves. As always, we are grateful for your continued trust and partnership and we are always happy to answer any questions you may have so please feel free to email, call, or come into the office to see us.
Sincerely,
Jonathan, Mark, Gabe and David
Heico
In February I went to Florida with a group of investors to visit Heico, which is one of our largest holdings in our Focused Equity Strategy. Heico is a unique Aerospace company that is the largest seller of Federal Aviation Administration (FAA) approved aircraft replacement parts. We began purchasing the stock in late 2019. Several months later Covid happened, airline traffic collapsed, and Heico’s stock was down 50% from the high. Today, more people are flying than ever before, and we are up by over 100% from our purchase price in 2019.
In 1990 the Mendelson family took a controlling interest in Heico which at that time sold 1 product, which was an engine combustion chamber. A Boeing 737 has over 300,000 parts. As Heico grew in size they realized that there was a market for selling replacement parts at a discount to the original equipment manufacturer (OEM) part. These replacement parts, which are called PMA parts must be approved by the FAA. Today Heico sells over 20,000 PMA parts and they are adding hundreds more to their catalog every year. These parts typically will cost an airline 30% less than a part from the OEM. Replacement parts for an airplane are incredibly expensive and airplanes can save a ton of money if they buy parts from Heico, which are of the same and sometimes better quality than the OEM. Below is a small bag of 4,000 Spring Seals that fits in the palm of my hand.
Believe it or not GE sells this for $100,000! Alternatively, an airline can buy the same bag from Heico for about $70,000. Heico is the Costco of Aerospace companies. Their philosophy is to be a partner with their customers and provide them with great parts and services at a great price. In 2023 Heico acquired Wencor, which was their largest competitor in PMA parts. Today Heico is by far the #1 seller of PMA parts in the world. Airlines prefer to deal with Heico as they can buy all of their PMA parts from one company, and the more they buy the bigger the discount they get. The US Military buys virtually zero PMA parts. Unlike airlines that care about their profits, the US Military has no incentive to save money. Many Military aircraft are derivatives of commercial aircraft. For example, the KC-135 is similar to the Boeing 707. The P-8 Poseidon is similar to the 737. Heico has an abundance of PMA parts that they can today sell to the US Military and save them a significant amount of money. Heico has been trying to sell PMA parts to the Military for years, but they have not been interested as the OEMs have done an amazing job making sure the government pays the highest price. Heico is optimistic that things are changing in Washington, and that the door may be opening for them to sell PMA parts at a lower price to the government. This is potentially a significant long-term opportunity.
Heico has said that tariffs will have a minimal impact on them. The cost of raw materials in their products is not significant. They think the added cost of tariffs would be in the single digits and that they would have no problem passing on that cost.
Heico has been very acquisitive over the years. Wencor was their largest acquisition ever, but most of their deals tend to be smaller in size. Heico has an advantage in purchasing other companies in that the founders oftentimes want to sell to Heico. Heico typically lets the founder keep an ownership stake in his company, keep all the employees, and they let the founder continue to run their business. This philosophy is almost identical to Berkshire Hathaway’s M&A philosophy and some investors think of Heico as the Berkshire Hathaway of Aerospace. Regarding Berkshire Hathaway, they began buying stock in Heico in Q2 of 2024. I’m sure Berkshire would love to buy all of Heico at the right price, but Heico has said that while they are flattered that Berkshire is a shareholder, they are not for sale. We think Heico can grow for a long time as airlines and hopefully the US Military use more PMA parts, as global air travel increases, and as the company continues to make savvy acquisitions. This is a stock we are planning on holding indefinitely, and we don’t consider it for sale.
This is going to be a volatile year for the markets, but we are thinking about the next 2 to 5 years and not the next month. Volatility presents opportunities. A lot of investors sold Heico in March of 2020, but that was an unbelievable time to actually buy the stock. We are trying to buy great companies at attractive prices and hold them for a long period of time. There will always be years of disappointing returns, but what really matters is long-term returns. We believe we can generate attractive long-term returns by holding onto stocks like Heico and finding more stocks like Heico through the ups and downs.
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