September 11, 2004
To Our Investors and Friends:
Three years after 9/11, despite all that has happened since that day, the socioeconomic tone of our country is best described as uncertain; uncertain about terrorism, uncertain about politics and the election, about the war in Iraq, about the price of oil, about the dollar and, mostly, uncertain about the economic well-being of our country and world.
Since socioeconomic attitudes are what drive the stock market, it too is very uncertain. In the three years since 9/11, the S&P 500 Index has risen just two percentage points. In other words, the Index’s highly touted 26 percent gain in 2003 just barely offset its losses in 2002 and its virtually flat performance thus far in 2004. Since the market had declined significantly in the months prior to 9/11, a more realistic measure is to look at market performance since the beginning of 2001. Viewed that way, the S&P Index has lost approximately 15 percent, a deficit that requires a 17.6 percent gain to offset. In other words, a money market cash investment with a very low yield during that whole period has significantly outperformed an investment in the S&P 500 Index! These unsatisfactory results have occurred despite a significant recovery in corporate profits during the last two years, created by massive monetary and fiscal stimuli.
It’s the economy! In our view, despite terrorist threats, election year rhetoric and the war, what mostly underlies market uncertainty are macroeconomic issues. Here is a non-political description of the situation by Stephen Roach, chief economist of Morgan Stanley, dated September 3rd:
“Forget about politics -- at least for the moment -- and consider the facts: This economic recovery, by most conventional measures, has been amazingly lousy. Annualized growth in real GDP has averaged 3.4% over the first ten quarters of this upturn, far below the 5% norm of the previous six business cycles. Nonfarm payroll employment is up only 0.1%, on average, over the past ten quarters -- hugely deficient when compared with the 2.7% record of the past six recoveries. Real wage and salary disbursements -- the essence of the economy’s organic, or internal, income-generating capacity -- is up at only a 0.8% average annual rate over the past ten quarters versus the 3.9% norm of the previous six upturns. The federal government budget is out of control, having swung from surplus to deficit by six percentage points of GDP from 2000 to 2003. This was key in pushing the net national saving rate down to its all time low of 0.4% of GNP in early 2003. Lacking in domestic saving, the US has had to import foreign saving in order to keep the economy growing; that has given rise to a record current account deficit of 5.1% of GDP. All this speaks of a vulnerable and exceedingly low-quality recovery in the US.”
Considering these facts, but also keeping in mind continued growth in corporate profits, we are carefully proceeding to deploy client capital into the market. Since 2002, when we conserved a significant amount of capital in the market downturn, we have been carefully selecting conservative, value-creating (EVA) equities that we have identified as fairly valued through our intrinsic-value modeling discipline. Many of these stocks have better dividend yields than equivalent money market cash investments and, in our opinion, all provide much better opportunities than the market in general. Our present strategy is to be approximately 70 percent invested in equities, with the balance in money market cash, between now and the election. We took some profits during the summer to protect capital and will not hesitate to do so again. However, we also will not hesitate to deploy additional capital if we see the right opportunity.
We believe that our capital-conserving and carefully analyzed equity strategies have significantly benefited our investors during the challenging times of the past three years, and should continue to do so in the uncertain times ahead. As always, we will be pleased to hear from you.
Saturday, September 11, 2004
Thursday, April 08, 2004
Client Letter - 4/8/04
April 8, 2004
To Our Investors and Friends:
While still seven months from the presidential election, we are being bombarded by extreme political and economic rhetoric. One side says that because of tax cuts, unusually low interest rates and a weak dollar the economy is growing and that more jobs will eventually be created. The other side says that huge fiscal and trade deficits currently being created will eventually impact us, that jobs are being shipped offshore faster than ever, and that the deficits combined with the weakening dollar will result in substantially higher interest rates that could throw us back into recession.
Who is right? Well, judging by the performance of the stock market in the first three months of the year, both sides are right; it just depends on your time frame. As measured by the S&P 500 Index, the market is up about 2% year-to-date, and despite all the rhetoric about last year’s gains, the market has still not offset the losses it sustained in 2002. In other words, short-term positives are being offset by long-term negatives.
From a strictly economic perspective, it seems to us that corporate earnings, employment and capital spending should continue to increase in the short term, which should result in stronger stock prices between now and the election. On the other hand, regardless of who wins the election, they will have to deal with the macro-economic realities, which indicate that the path we are currently on may not be sustainable in the long term. From a strictly non-partisan point of view, the current administration, if re-elected, may have a better political opportunity to deal with the longer term economic issues, since they would have four relatively rhetoric-free years to bite the economic bullet. However, regardless of who administers it, the economic medicine is potentially quite bitter.
While all of this may sound complex, we truly wish the situation were so simple. Unfortunately, layered on top of this are all of the geopolitical realities we face as a country today. What will happen in Iraq and the Middle East? When will we be hit by another terrorist attack that our leaders seem to be telling us is inevitable? Doesn’t the attack in Spain just before their election tell us that something like that is likely to happen here? These are wild cards vis-à-vis the markets that are totally non-quantifiable.
So what is a conservative investment manager with a strong belief in the ultimate strength of this country to do? First, we believe we must take advantage of good economic conditions when they are occurring and, second, we believe we must continue to be very careful. In mid-2003, we began reinvesting the capital we had so carefully conserved in 2002. Currently we are about 70% invested in stocks, which, together with invested cash, has allowed us to moderately outperform the market this year. As always, we are focused on value-creating companies that are selling at reasonable valuations. We are also trying to own a number of companies that pay dividends, which will provide a consistent “bond-like” return, despite what might happen in the short term. Our largest holding is GE, followed by names like Johnson & Johnson, United Healthcare, General Mills, ConAgra, Berkshire Hathaway, J.P. Morgan Chase, TCF Financial, Dell, Medtronic, Wal-Mart, The Gap, TJX Companies and ATK Systems.
Because of the terrorism wild card, we expect to continue holding a percentage of invested cash, which will vary depending on our perception of the situation between now and the election. It is also our intention to take some of our profits as the year goes on to guarantee returns and generally conserve capital. After the election, we should have a better idea of what is likely to happen in the longer term.
As always, we welcome your thoughts and questions.
To Our Investors and Friends:
While still seven months from the presidential election, we are being bombarded by extreme political and economic rhetoric. One side says that because of tax cuts, unusually low interest rates and a weak dollar the economy is growing and that more jobs will eventually be created. The other side says that huge fiscal and trade deficits currently being created will eventually impact us, that jobs are being shipped offshore faster than ever, and that the deficits combined with the weakening dollar will result in substantially higher interest rates that could throw us back into recession.
Who is right? Well, judging by the performance of the stock market in the first three months of the year, both sides are right; it just depends on your time frame. As measured by the S&P 500 Index, the market is up about 2% year-to-date, and despite all the rhetoric about last year’s gains, the market has still not offset the losses it sustained in 2002. In other words, short-term positives are being offset by long-term negatives.
From a strictly economic perspective, it seems to us that corporate earnings, employment and capital spending should continue to increase in the short term, which should result in stronger stock prices between now and the election. On the other hand, regardless of who wins the election, they will have to deal with the macro-economic realities, which indicate that the path we are currently on may not be sustainable in the long term. From a strictly non-partisan point of view, the current administration, if re-elected, may have a better political opportunity to deal with the longer term economic issues, since they would have four relatively rhetoric-free years to bite the economic bullet. However, regardless of who administers it, the economic medicine is potentially quite bitter.
While all of this may sound complex, we truly wish the situation were so simple. Unfortunately, layered on top of this are all of the geopolitical realities we face as a country today. What will happen in Iraq and the Middle East? When will we be hit by another terrorist attack that our leaders seem to be telling us is inevitable? Doesn’t the attack in Spain just before their election tell us that something like that is likely to happen here? These are wild cards vis-à-vis the markets that are totally non-quantifiable.
So what is a conservative investment manager with a strong belief in the ultimate strength of this country to do? First, we believe we must take advantage of good economic conditions when they are occurring and, second, we believe we must continue to be very careful. In mid-2003, we began reinvesting the capital we had so carefully conserved in 2002. Currently we are about 70% invested in stocks, which, together with invested cash, has allowed us to moderately outperform the market this year. As always, we are focused on value-creating companies that are selling at reasonable valuations. We are also trying to own a number of companies that pay dividends, which will provide a consistent “bond-like” return, despite what might happen in the short term. Our largest holding is GE, followed by names like Johnson & Johnson, United Healthcare, General Mills, ConAgra, Berkshire Hathaway, J.P. Morgan Chase, TCF Financial, Dell, Medtronic, Wal-Mart, The Gap, TJX Companies and ATK Systems.
Because of the terrorism wild card, we expect to continue holding a percentage of invested cash, which will vary depending on our perception of the situation between now and the election. It is also our intention to take some of our profits as the year goes on to guarantee returns and generally conserve capital. After the election, we should have a better idea of what is likely to happen in the longer term.
As always, we welcome your thoughts and questions.
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