FI Update - 3/11/06

To Our Investors and Friends:

The equity markets ended the week on a positive note, with short-term good news on U.S. Payrolls. That seemed to counteract long-term macro-economic news earlier in the week on the ever-worsening U.S. trade deficit. If the order of the announcements had been reversed, market results would likely have been significantly worse, since the trade-deficit implications greatly outweigh employment data in the longer term. But that’s how the markets work in the short term, irrational though that may seem.

We have seen nothing to contradict our opinion that we are in the midst of an economic dichotomy, i.e. in a micro-economic, short-term context, things are going pretty well, but in a macro-economic, long-term context, they’re not going well at all. The bond market continues to reflect this dichotomy, with a virtually flat yield curve. For example, at the end of the week, the 30-year Treasury bond yielded 4.74% vs. the 10-year at 4.72%, the three-year at 4.76% and the 90-day T-bill at 4.46%. Anyone want a 30 or 10-year bond when you can get virtually the same yield at 90 days? Hardly! There is clearly something wrong with this picture, and the economists we read (who don’t have a political agenda) are rending their garments waiting for the next shoe to drop, and long-term interest rates to start rising.

So far, it hasn’t happened, and it may be some time before it does, because there are so many dollars in the hands of foreign governments who need to keep those dollars invested. In other words, it’s a matter of supply and demand, until some better investment comes along for those foreign dollar-owners. The Dubai ports deal, which we have heard so much about recently, is a good case in point of a vast excess of foreign dollars trying to find a permanent equity ownership home in the U.S.A., their country of origin. Look for many more such efforts by foreign governments, particularly China and the Arab oil producers.

We saw some movement this week toward higher international interest rates when the Bank of Japan abandoned its long-standing zero interest rate policy (ZIRP), signaling an end to five years of deflationary economic trends. Long-term U.S. rates immediately moved up several basis points; in other words, long-term U.S. government rates were actually lower (and more inverted) a week ago than those quoted above.

For the moment, we feel comfortable with a close to fully invested position in properly valued, dividend-paying stocks. This week we deployed some of the profits we took earlier in the year (see our 2/09/06 blog note) by taking a core position in TCF Financial (TCB). We have done very well with this high-quality holding in the past and have re-entered at a level lower than our last very profitable sale of this stock. Incidentally, when we last sold TCB we redeployed that capital in Moody’s (MCO), which has since doubled in value. TCB is an excellent Minneapolis-based national bank, with a growing retail base, which keeps its cost of funds (which it calls “Power Liabilities”) among the lowest in the business. TCB ranks first among the 50 largest banks in Return on Equity (ROE), one of the most important statistics in the banking business. It also pays a very bond-competitive 3.5% dividend. Right down our EVA alley!

We welcome your comments and observations.

Jack and Peter