Appended to this letter is a summary on the lion’s share of topics that seem to be keeping people up at night. Please call to discuss these any of these issues or to offer additional comments. Last quarter we communicated our expectation that above consensus economic growth would probably materialize in 2010, and at least through the first quarter, this has been dead wrong. Our optimism came from the close contacts we keep with the companies we follow which usually we expect to grow sales at around two and a half times the rate of GDP growth. We have been encouraged by sales growth for the companies we follow, yet first quarter GDP growth was a puny 2.7%. There seems to be one simple explanation for sales growth of our portfolio companies vaulting to more than five times GDP growth: the companies we follow generally dominate their industries. And as we have said time and time again, the strong should emerge from the crisis even stronger at the expense of weaker, more poorly run competitors.
Presumably individual investors are taken by the numerous circulating comparisons to the 1930s and general uncertainty because money continues to flow out of stock mutual funds and into bond mutual funds. Historically their timing is so bad that this is good news for long term investors who can stomach taking an unpopular contrarian view. At the pit of the depression in 1932, President Hoover enacted the largest tax increase in US history; for example, the top marginal tax rate was increased from 25% to 63% - and President Roosevelt later increased it to 79%. Smoot-Hawley increased tariffs on international trade and the economy suffered mightily for these government policy errors. In our opinion the sum total of effects of policies that President Obama has considered would not hold a candle to the policy errors in the 1930s. It is worth further mention that President Obama has been woefully unsuccessful in many critical policy endeavors.
In summary, we view the current situation and market conditions in a favorable light and look forward to catching up with you soon.
Tuesday, September 21, 2010
Tuesday, May 25, 2010
Exerpt From 2010 First Quarter Letter To Clients
Coming out of a severe economic recession we think it is “normal” to have a swelling of popularity around an outlook akin to today’s “new normal” (sluggish economic growth with persistently high levels of unemployment). We suspect the “new normal” is rooted in the mantra of “this time it is different,” and that is “normally” wrong. The Chief Economist for DuPont recently spoke at the Richmond Association of Business Economics and commented that the strength of an economic recovery is directly related to the magnitude of the downturn and that the current pace of economic recovery is right in line with what one could project using prior economic cycles. Such a projection yields an expected initial economic growth rate above 8.0%, yet we surmise the “new normal” view only expects economic growth between 2% and just over 3%. It is also interesting how some pundits have stated that the decline in economic activity from inventory destocking was normal, but increase in economic activity from inventory restocking is to be discounted as a temporary event. Either way, we expect 2010 economic growth to be well above the average forecast, though economic forecasts do not affect the long term value we see in your holdings.
It is also interesting to look at the movies that lead box office sales, as an indication of the state of mind of the US population. The top three movies of 2000, presumably with a genesis in 1999 which was preceded by a decade of stellar economic growth and a massive bull market, fit the broad category of “amazing feats of the common man” (Mission Impossible 2, Gladiator, and Cast Away). Yet three of the top five movies of 2009, presumably with a genesis in 2008, fit the broad category of “the innocent suddenly facing the possibility of the end of the world” (Avatar, 2012, and Transformers). As an aside, Planet of the Apes hit theaters at the height of the Vietnam Conflict and was re-released in 2001. Being weary of crowds at extremes, this would normally make for a fine opportunity to identify stocks which inappropriately reflect an end of the world scenario.
The present phases of the psychological market cycle seem to be progressing nicely. Our estimation is that most people have moved past despondency and depression. The next phase is one of hope. I can share that I have had conversations with a handful of clients each of whom estimated their portfolio values to be nearly twenty percent below where they actually were. A great many people were concerned about an “end of the world scenario” as GE’s stock price declined from $40 to $18, and not as many are relieved to see GE’s stock price rise from $6 to $18. But once everyone is relieved, we think the stocks of GE’s and many others will be higher.
It is also interesting to look at the movies that lead box office sales, as an indication of the state of mind of the US population. The top three movies of 2000, presumably with a genesis in 1999 which was preceded by a decade of stellar economic growth and a massive bull market, fit the broad category of “amazing feats of the common man” (Mission Impossible 2, Gladiator, and Cast Away). Yet three of the top five movies of 2009, presumably with a genesis in 2008, fit the broad category of “the innocent suddenly facing the possibility of the end of the world” (Avatar, 2012, and Transformers). As an aside, Planet of the Apes hit theaters at the height of the Vietnam Conflict and was re-released in 2001. Being weary of crowds at extremes, this would normally make for a fine opportunity to identify stocks which inappropriately reflect an end of the world scenario.
The present phases of the psychological market cycle seem to be progressing nicely. Our estimation is that most people have moved past despondency and depression. The next phase is one of hope. I can share that I have had conversations with a handful of clients each of whom estimated their portfolio values to be nearly twenty percent below where they actually were. A great many people were concerned about an “end of the world scenario” as GE’s stock price declined from $40 to $18, and not as many are relieved to see GE’s stock price rise from $6 to $18. But once everyone is relieved, we think the stocks of GE’s and many others will be higher.
Wednesday, January 13, 2010
Excerpt from 2009 Fourth Quarter Letter to Clients
So where are we now? We are in one of the most exploitable stages of the emotional cycle of investing. We think some people are still despondent, most people are depressed, and some people are starting to feel hopeful. We characterize despondency as a state of mind in which one has an aversion to mental activity, specifically an aversion to thinking about investments. When despondent people start thinking again they become depressed. We characterize depression as a state in which people do not want to own stocks but they do not want to sit on cash; the end is not in sight; change is desired but nothing is trusted; so many questions remain unanswered the problem cannot be solved; turning to experts yields even more confusion because their opinions vary wildly. Asset values have recovered significantly from March 2009 which is requisite for people to move from depression to feeling hopeful. We think the start of feeling hopeful is marked by contemplation of questions about the recovery in stocks being for real or the evidence of stabilization being enduring.
This is one of the most exploitable conditions because we believe:
• Tremendous amounts of information have been garnered since Lehman Brothers went under sixteen months ago (the financial crisis ended, the economy recovered, business has generally stabilized, employment has stabilized, residential values have stabilized, housing has stabilized, energy prices have stabilized, even the commercial real estate crisis seems to have passed the midpoint).
• Yet today with the S&P 500 at 1133, it is 5% below where it closed on the day Lehman Brothers declared it would file for Chapter 11 bankruptcy, credit markets froze, and stocks tumbled.
• Ten trillion dollars is available to flow into equities
• Most people are despondent/depressed
Over the past ten years Wal-Mart’s earnings doubled and dividends quadrupled as the company expanded internationally with masterful success. The stock has basically been flat for ten years with the primary difference being that ten years ago Wal-Mart traded with a PE above fifty and today it trades with an estimated PE of thirteen. It has been a situation where one could sleep well with the company and sleep on the long flat stock chart. Do not be surprised if stocks of the Wal-Mart ilk comprise a portion of purchases in the coming months. Such a thesis may also be timely as it would seem a likely recipient of investment dollars from the newly hopeful.
This is one of the most exploitable conditions because we believe:
• Tremendous amounts of information have been garnered since Lehman Brothers went under sixteen months ago (the financial crisis ended, the economy recovered, business has generally stabilized, employment has stabilized, residential values have stabilized, housing has stabilized, energy prices have stabilized, even the commercial real estate crisis seems to have passed the midpoint).
• Yet today with the S&P 500 at 1133, it is 5% below where it closed on the day Lehman Brothers declared it would file for Chapter 11 bankruptcy, credit markets froze, and stocks tumbled.
• Ten trillion dollars is available to flow into equities
• Most people are despondent/depressed
Over the past ten years Wal-Mart’s earnings doubled and dividends quadrupled as the company expanded internationally with masterful success. The stock has basically been flat for ten years with the primary difference being that ten years ago Wal-Mart traded with a PE above fifty and today it trades with an estimated PE of thirteen. It has been a situation where one could sleep well with the company and sleep on the long flat stock chart. Do not be surprised if stocks of the Wal-Mart ilk comprise a portion of purchases in the coming months. Such a thesis may also be timely as it would seem a likely recipient of investment dollars from the newly hopeful.
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