4th Quarter - 2003 Investment Update January, 2004
Economic Commentary
GDP growth and productivity have proven incredibly strong as of late. As rosy as the picture looks today, there are numerous potential pitfalls that investors are facing in the year ahead. The increased threat of terrorism, our increasing national debt, a falling dollar, abnormally low interest rates (which can lead to higher inflation among other things), and our trade imbalance all loom as we enter 2004. That being said, it is only fair to mention that much could go “right” also. It seems we are getting closer to having peace on fronts unimaginable in past years. Pakistan and India are in talks and Libya seems willing to trade their weapons programs for economic assistance. John Snow, U.S. Treasury Secretary, recently theorized that if the economy continues to chug along the deficit may be greatly reduced as a percentage of GDP in only a few years. I have never read more diverse “expert” opinions on the future of the economy and stock and bond markets as I have this year.
This cartoon (present in the actual letter) correctly points out that there are so many variables at work no one really knows what the year-ahead might bring. While this fact may be unsettling to some, there is good news to be shared. The practice of buying a dollar bill for 50 cents (e.g. getting a good deal) has proven to be an effective investment strategy over extended periods of time regardless of the economic landscape. By sticking to this principle investors are thankfully not reliant on predicting interest rates, economic growth or overall levels of the stock market. However, it is important to be knowledgeable of the forces at work as a backdrop for making sound investment decisions. In essence, the economic overview proves to be less helpful in bubbling up great stock ideas or bond ideas but more helpful in establishing the framework within which decisions are made.
Investment Commentary
"An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative".
-Benjamin Graham. The Intelligent Investor
In periods of stock market euphoria it becomes increasingly difficult to employ the discipline necessary to make a good “investment” versus a “speculation” as defined above. There is an old saying that a bull market makes everyone look like a genius. An article in Barron’s, the financial publication, recently stated “small orders for speculative call options are running at a furious clip of late.” The article went on to say that the investors are emboldened by the “couldn’t-lose” aspect of investing in aggressive stocks in 2003. The risk pendulum seems to clearly have swung to speculative buying. Caution has effectively been thrown to the wind.
The verdict is out on whether or not this is a secular or cyclical bull market but there is no denying the market currently has an upward bias. Importantly, and counter intuitively, the question to be asked is not “how much can be made” but rather “how much can be lost” in today’s market. The combination of fiscal and monetary stimulus, extraordinary low interest rates (it seems the stock market is being viewed as an alternative to money market funds), and increasing earnings has proven a honey pot for even the most ardent bears.
As my previous letter stated, absolute not relative returns are what should really matter to an investor. This approach helps to significantly reduce the chance of making a foolish speculation as opposed to a prudent investment. If one’s analysis finds a company attractive because the stock trades at a significant discount to its peers it really does not give the investor an idea of the true return potential. This lesson was learned (and it seems just as quickly forgotten) by the collapse of the NASDAQ from its lofty levels of a few years ago. Simply put, the fact that Yahoo! is trading at 100x earnings per share doesn’t make Amazon a good value if it is trading at 60x earnings per share. The danger in speculating is the very real risk of losing your capital on a permanent basis. Before the last market correction, permanent loss of capital meant to many investors the stocks or bonds of companies that went bankrupt. This of course is still true but most investors have come to realize that it also includes stocks that hit such lofty heights in the previous bull market that they will never ever see those prices again. The litany of companies that fit this description is unfortunately too long to mention.
Thank you very much for your continued confidence. As always, please call or write with any questions or comments.