November 2002
When early drafts of this newsletter took shape, the proposed title was “Let the Big Dog Eat.” The thesis being that the stock market correction has allowed us to add a number of high-quality large Blue Chip companies to our Buy List.
The title changed because of the wonderful news of the birth of three baby boys. Nancy Trela, our Operations Manager and her husband, Jon, became proud parents of twin boys last week. Scott McCartney, and his wife, Beth, had a son just days before. With three newborns, we just had to dedicate this newsletter, and an appropriate title, to them.
Back to investments. Allow us to break Mr. O’Shaughnessy’s ode into two parts … the first being “Each age is a dream that is dying, … ” We have little sympathy for those in the investment business with dying dreams right now. We have never paid any mind to Wall Street Research analyst ratings on stocks. While the quantitative information provided by analysts is useful, the actual recommendation is not.
Few in the investment community are surprised by the conflicts exposed within some firms doing investment banking, IPOs and research. Prior to the Internet, Wall Street’s shenanigans were handled quietly in person or by phone. That changed during the dream state of the 1990’s when the thing to do was to talk with your fingers via email. Live by the sword (Internet stock bubble), die by the sword (Elliot Spitzer is reading your true thoughts by looking at emails). Forgive us for using O’Shaughnessy and shenanigans in the same newsletter.
Let’s move on to the second part of the ode “… Or one that is coming to birth.” We cannot emphasize enough that there are some very good things going on right now. Specific to Wall Street, nothing but good will come from renewed interest in truly independent board directors, unencumbered research and cleaner accounting practices. We believe we are transitioning from period where corporate America “over-promised and under-performed” to one where they are “under-promising an outperforming.” This is a huge and positive shift of focus and attitude. It is also quite bullish.
The good news on the international front is that some dreams are dying while new and better ones have arrived. The communist economies of the Soviet Union and China are being replaced with open communications with the West and capitalist reforms. The global standard of living is rising and will continue to do so. North Korea has even talked of a stunning
experiment within their Stone Age country. Mr. Kim has proposed a 75-square mile, walled-off city within which North Korea will experiment with capitalism. Although in an embryonic stage (a popular phrase these days), the whiff of capitalism in North Korea is good news.
Unfortunately, not all the global news is good. The most troubling and potentially dying dream is held by some in the Middle East with extremist views. Despite talks of war, we believe there is a good chance that the Iraq situation will be resolved sooner and more peaceably than the worst projections indicate. Global risks beyond the Middle East are many and include a fragile Japanese banking system and weakness in South America. Closer to home, a real estate bubble may be emerging and government deficits at all levels, local, state and federal, are growing.
It is worth noting that a risk-free time to buy stocks has never existed. For this reason, most of our accounts are managed on a balanced basis (bonds and stocks). It is our job to compare the potential positives of the coming decades with possible negatives. As we look forward, we view the trend toward peace with China and Russia as a much more favorable influence than the current trouble in the Middle East. As manufacturing throughout the world grows, prices and, therefore, both inflation and interest rates can remain low. Moreover, $3.0 trillion of investment cash remains on the sidelines and some of it is beginning to return to the markets.
We have taken advantage of the stock market correction by adding a number of new, high-quality Blue Chip companies to our Buy List. These are organizations we have admired for years, but avoided due to their high valuations. In the technology sector, we now own IBM, Microsoft, Oracle and Intel. These stocks were purchased at prices 40%-80% off their highs. Combined, these companies have $60 billion in cash and research and development spending which totals $15 billion per year! Another “Big Dog” that will eat in almost any market condition is Wal-Mart, the leader in retailing. In the post-bubble world, large and profitable companies have the proprietary advantage of access to capital and they are gaining market share.
In this investment environment, we are more pleased than ever with our emphasis on quality and diversification. A few of our holdings have disappointed us, including Bristol Myers, Motorola and Interpublic Group, but more than one-third of the 35 stocks on our Buy List are up in the last year. Importantly, we have rotated some equity exposure to well-managed, mid-sized companies with market capitalizations in the $1.0-$5.0 billion range. Our balanced accounts are doing much better than the overall market and our Quality Core Blue Chips are off less than comparable indices.
In conclusion, we are happy to report that our work family is growing and we feel strongly that decades of economic growth lie ahead. This market correction has allowed us to improve upon the stable of Blue Chips with which to align ourselves. Our very best wishes to Johnathon McCartney, and Owen and Benjamin Trela for “the new age that is coming to birth.”