Tuesday, September 30, 2008

How We See Things

We were very surprised and disappointed that the Paulson plan did not pass the House of Representatives on Monday. The markets’ reaction was not unexpected and, while we did not expect this to happen, we were prepared for it. Here is where we stand:

  • We have approximately 20% cash in all of our accounts, which is securely invested in U.S. Treasury money market accounts. This is the result of consistently taking profits off the table for the last several months.

  • Last week we invested approximately 2.0% of our portfolios in Goldman Sachs’ AA3/AA- rated senior notes, yielding 8.5% to maturity in January 2011. We saw this as an opportunity to position ourselves two steps ahead of Warren Buffett on the Goldman balance sheet, after Berkshire Hathaway invested $5 billion in Goldman preferred stock, yielding 10%, and Goldman simultaneously raised another $5 billion in the public equity market.

  • The balance of our portfolios are invested in strong, undervalued companies, many of which have been relatively unaffected by the market downturn, while some, particularly those in oil, metals and infrastructure, are being affected by a now well-documented world recessionary scenario. Many of our companies present compelling values, but we are being patient in committing additional capital, while waiting for stability to return to the markets.

  • Our year-to-date performance, while in negative territory, continues to track well ahead of the S&P 500 Index benchmark.

We are paying very close attention to everything that is happening in the markets and it is our opinion, at the moment, that we will still see some form of bailout plan in the next week or so.

As always, we are happy hear from you.

Jack and Peter Falker

Note: Both Jack and Peter Falker, and the clients of FalkerInvestments Inc., are long both the common stock and bonds of Goldman Sachs, as well as the common stock of Berkshire Hathaway.

Tuesday, September 23, 2008

Trading in a Turbulent Week

Our clients know that our strategy ordinarily does not involve short-term trading, but last week was a notable exception.

Goldman Sachs (GS), which in our judgment is the premier investment bank (now commercial bank) in the world, fell sharply last week and by Wednesday was trading at its book value of just over $100 per share. This was such an unusual circumstance that we felt we should take advantage of it to average down our cost basis in this core holding. We bought the stock at 108 on Wednesday, which had the effect of significantly lowering our average cost.

As the week went on and the entire financial system literally began to fail, the U.S. Treasury announced, on Thursday night, its plans to initiate a huge purchase of the toxic mortgage-backed debt that had frozen the system. On Friday, financial stocks rallied strongly on the news, and that enabled us to lock-in a 21 point (19%) gain on the GS position we had just taken. We decided that taking this gain was prudent in the face of the turbulence of the market. We also took additional gains in U.S. Bank (USB), which, despite the fact that it is one of our favorites, had gotten well ahead of its valuation on Friday, in the euphoria following the Treasury announcement.

In combination with other actions we have taken over the last few weeks, these moves have enabled us to protect a significant amount of client capital, which we believe is prudent, given the seriousness of the situation. All of this cash is invested in a U.S. Treasury fund; not quite under the mattress, but close to it.

We have continued to outperform the market, year-to-date, and we intend to keep it that way.

If there are any questions about our strategic moves, we will be pleased to respond.

Jack and Peter Falker

Note: Both Jack and Peter Falker and the clients of FalkerInvestments Inc. are long both GS and USB

Thursday, September 18, 2008

Breaking the Buck ’08 (Not!)

Last November we moved all of our cash holdings to Schwab’s U.S. Treasury Money Market Fund in anticipation of conventional money market funds potentially “breaking the buck”, i.e. falling below $1 share value as the result of losses in asset backed commercial paper or the commercial paper of bankrupted companies.  Therefore, our clients’ funds have been protected from that unfortunate scenario for nearly a year now.  We have paid a price in terms of lower yields on cash that result from this level of security, but we have felt it was worth it.

We wrote a blog note in November 2007 describing our concerns and actions.  You can read that post: “Breaking the Buck (Not!)” by clicking on the 2007 on this link.  Breaking the Buck (Not!)

Here are a few words from that article: 

“We had been suspicious that this might happen for some time now, so we have moved all of our clients’ cash investments to U.S. Treasury money market funds (or the equivalent), thereby insuring that we will continue to receive some positive return on all of our cash investments.  Even though it is widely assumed that major brokerages would support the value of their funds, a large exodus from money funds could impair their ability to do so on a timely basis.  We feel it is important to be early in our decision if in fact this scenario develops.”

With all the attention being paid to money market funds in the press over the last few days, we thought it would be a good idea to remind everyone that their cash is invested in U.S. Treasury securities. 

Jack and Peter Falker 

Tuesday, September 16, 2008

Current Thoughts

Here are a few of our thoughts in the midst of a very turbulent time. First, it is important to recognize that what we are experiencing right now is probably equal to or greater in magnitude to anything that has happened in the history of our financial system. The mechanisms that were set in place after the great depression have protected the financial markets thus far but, make no mistake about it, these mechanisms are currently being severely tested.

At this time, it is yet to be seen if the Federal Reserve will be able to offset increasing systemic risk in the financial system by extending their charter to the protection of commercial banks from the counterparty risks of non-commercial bank financial entities, such as investment banks and large insurance companies. As we write this note, they have opted not to directly backstop the counterparties of Lehman Brothers in the way they protected the counterparties of Bear Stearns; a rather strange and oddly political call in our minds. Now, it is unknown if they will protect the counterparties of AIG, which is a potentially far more serious problem for virtually every large bank in both the United States and Europe. In our judgment, they must step up to this situation to avoid financial chaos, but their unwillingness to try and calm the markets seems odd to us. We can only assume that their own capacity may be in question.

Having said all of this, it’s worth repeating what the CFO of Goldman Sachs said in their conference call this morning: “In difficult times, nothing is ever as bad as it seems at the bottom and, in good times, nothing is ever as good as it seems at the top.”

With that in mind, we have left considerable cash on the sidelines to protect ourselves from downside and to take advantage of some rather extraordinary opportunities that we are currently seeing. Recently, our biotech, consumer staples, and medtech/pharma sectors have held up very well, offsetting some of the weakness in commodities, infrastructure, and energy, where many good values are being exposed. While we are well aware of the weakness in the economy, all of our holdings have significant value that will continue to rise over time. Under current circumstances, we may trim positions, where sensible in the near term, while keeping an eye toward investment opportunities that are developing.

Given the challenges of today, we find comfort and confidence in sticking to our conservative strategy and valuation process. It will guide us through these chaotic and volatile markets and provide significant returns to our investors over time.

We welcome your comments and questions.