What have you done for me lately?
May Day 2001
The Model Portfolio is up 19% for the year, and coupled with last
year's +1% performance and 1999's plus 42% gain in the portfolio,
we have to be content with our current market approach. With accounts
up 10% to 30% for the year, we are quite pleased with ourselves.
While not yet masters of the universe, we have been lucky
over the last year as well as prescient. We remain cautious on the
outlook for the markets. And so we have been quick to take profits
even if this created a short term taxable gain. Notice we don't
say problem, since we have never considered profits to be a problem.
Also with the Bush tax cut coming the differential between long
and short profits will be reduced - and last year is the perfect
example of why taking a short term profit is sometimes preferable
to having a long term losing position.
In our Winter 2000 Lemley Letter published on February 1, 2000 we
expressed our disdain for the "new" market mantra that
"it is truly different this time." in that letter we said:
"Our argument is not with the merits of the products (produced)
by these high flyers. It is with the valuation .......We just don't
believe that paying any price for a tech stock is warranted. And
we know the current speculative binge will end. We just don't know
In the Spring 2000 Lemley Letter published on April 10, 2000, we
discussed our short term trading versus long term investing. This
discussion was engendered by phone calls from clients who had incurred
large tax bills from our performance in 1999 when accounts were
up 20% to 40% and taxable account had significant tax bills. Since
we have significant short term gains again this year we will probably
be receiving similar calls in the spring of 2002. Our answer then,
as now, is that we have a trading style that has served us well
over the years and that consistency is the best policy when it comes
to making money in the stock market. Moreover many of our accounts
are tax free retirement accounts and so tax considerations don't
enter into the buy/sell equation for them. Since we believe in our
trading method, we treat taxable and tax free accounts the same.
Eventually, the tax free accounts will have to pay regular income
taxes also - so the tax day is delayed - not avoided. We are active
because we try to limit risk and because we believe that the old
days of buy and hold are over - for now at least. But when clients
ask us not to trade we comply as best we can.
On this point the following letter that we wrote recently to a client
discusses in more depth our philosophy.
Dear Trish and Phil,
Presidents Day 2001
Happily, the January 2001 statement showed a good recovery in the
value of all portfolios. We are in receipt of your letter requesting
less activity and will of course be happy to comply.
For your benefit as well as ours, we thought we would discuss our
views on investing/trading given various market conditions. Over
the years we have evolved an investment/trading style. As you will
note we tend to buy and sell the same issues but try to take advantage
of the volatility in share prices that market conditions present.
For example, over the last year we have traded Abercrombie and Fitch
several times. We first bought ANF in 1998 at a split adjusted $8
per share. We sold a few weeks later when the stock jumped to $12
per share for a 50% gain. The stock then ran to $36 per share before
falling to the mid teens (split adjusted). In late 1998, we repurchased
the stock at $16 and sold when it ran to $26, again a 50% gain.
ANF continued again to climb to $50 per share. It then fell to the
low $30s where we began to buy as earnings visibility became clearer.
Unfortunately in late 1999 ANF misjudged the teen clothing market
and same store sales comparisons dropped from monthly same store
sales gains of plus 10% to 15% to negative percentage sales drops
on a monthly basis. Even though same store sales comps were negative,
ANF management predicted and delivered 10% earnings gains all through
the year 2000. Unfortunately the stock price dropped from the mid
$30s to $8 per share in the summer of 2000. During this time period
we doubled up and took losses on our high priced stock and continued
to add the stock to accounts. It became our largest single stock
holding in most accounts. As ANF rallied in the fall we sold part
of our holdings in accounts for small gains or losses and when the
stock reached $24 per share we sold our entire position. Through
early 2001, we continued to trade the stock between $18 and $24
per share. Without the large profit we made from managing our holdings
of ANF during the year we would not have been able to show the results
we did for the year. Moreover, at $8 per share the stock was selling
at 7 times earnings, at $16 per share ANF was selling at 12 times
earnings, at $24 per share it sold at 20 times earnings. The first
was a steal, the second a good buy point, the third a good sell
point. The reason for the price volatility in ANF is the herd nature
of institutions that jump into and out of stocks on buy and sell
recommendations with very little concern for price because any one
stock is such a small percentage holding.
It is our belief that most folks don't like trading because they
don't want to pay taxes on their gains. Yet these same folks will
get up every morning, commute for an hour in rain, sleet, snow,
or 90 degree weather and endure the turmoil of daily work all for
the pleasure of paying 50% of whatever they make to Uncle Sam, Social
Security, and state and local authorities. With tax rates for most
of our clients at 30% or less, even if we make a lot of money trading,
we are of the view that paying taxes is a pleasure. Last year trillions
of dollars were lost by folks who didn't want to pay taxes.
Our experience with Lucent and A T & T last year was the opposite
of our pleasant results with ANF. Several years ago, we sold Lucent
when we received it as a spinoff from AT&T because we didn't
agree with their practice of financing sales to customers. And while
we have traded A T & T over the years, for the last few we have
avoided the stock because we thought C. Michael Armstrong didn't
know what he was doing. Because of greed and hubris, we allowed
ourselves to ignore our correct analysis to try and capture some
gain by buying two stocks that were relatively cheaper than others
in their respective industries. We bought two lemons. Such trading
mistakes often occur when we are feeling like "masters of the
universe" after a good trading year like 1999. While we tried
through the later part of 2000 to overcome the results of our mistaken
purchases by averaging down and trading, we eventually decided to
eliminate our holdings in early 2001 when the Federal Reserve cut
rates on January 3, 2001 gave a 15% plus boost to our accounts.
Your belief in long term investing is the result of your great fortune
with Times Mirror stock. Had you been given Polaroid, or Xerox,
etc. back in 1970 we don't know if you would feel the same enchantment.
Moreover, since 1970 the market has risen 1000% (10 times) in value.
Back in 1970 the house you currently live in probably sold for $50,000
or less. Now it is worth 15 times that price. When oil was $40 per
barrel in 1980 and inflation was rampant and interest rates were
20% on short term money, very few predicted no inflation, $7 oil,
and 3% interest rates in the year 2000. In fact many gurus predicted
doomsday by 1990. As in all of life and nature, the markets are
a pendulum. Our constant worry about market pricing and conditions
over the past few years is what has caused us to be so "quickly
on the trigger" as we would say or "frantic" as you
would suggest. But we stop worrying and raise serious cash when
the Fed Chairman suggests that paying off the national debt will
create problems so it's ok to cut taxes. (That was a dumb statement
for such a supposedly smart man to make to a group of politicians.)
When politicians assure us that surpluses will exist for the next
15 years, we instinctively want to raise serious cash. (More recently
Treasury Secretary Paul O'Neill suggested that the Treasury might
issue new debt to keep the Treasury bond market afloat and use the
proceeds from the bond sales for further tax cuts. We were flabbergasted
that a person in O'Neill's position could make such a proposal,
and also flummoxed by the fact that the mainstream press ignored
the inflationary implications of such an idea.)
Between 1962 and 1968 the stock markets went up 2 1/2 times in value.
The stock markets then went no higher (and actually crashed in
1974) for fourteen years. Between 1982 and 1987 the markets
went up five times in value. From the high in 1987 it took six
years for the markets to make a new high. Then from 1995 to
2000 the markets rose 2 1/2 times in value. Our point is that even
in roaring bull markets there are three to five year periods or
more when investment resolve can be severely tested. More so when
folks are living on the investments, or using the value of the investments
as a psychological spending backstop. More to the point - for the
markets to perform over the next thirty years like they have over
the last thirty, the DJIA would rise to 200,000, your house would
be valued at $7.5 million and Times Mirror/Cox would sell at $4000
per share so that the whole company would have a value of $3.4 trillion.
Long term growth stocks like Microsoft and Cisco are always priced
to perfection when they are in vogue. And so they have a long way
to fall when they fall from favor. Times Mirror/Cox may be a long
term growth stock but our view is more that its' price rise has
been part of the investment mania for media stocks of the past few
years. Investing is about paying a price for a company at which
one can expect a reasonable rate of return from earnings. No one
who was going to make their living from running a company and drawing
a salary would pay anywhere near the p/e multiples that are being
paid for growth stocks today. Growth stocks of today may be abandoned
next week as the next fad comes along. If we happen to run into
a period of four or five years when the Times Mirror/Cox type growth
stocks don't perform or underperform; and that time period coincides
with the time when you need to withdraw funds, it won't matter that
Times Mirror/Cox was known as a growth stock in the year 2001.
For several years we have been leery of the markets. The proposed
tax cut is a mistake and should the Congress go forward with it
we believe the long term results for the markets will be very negative.
For that reason we have a large cash position of over 60% in most
accounts. Periodically we attempt to catch rallies by investing
some reserve cash in short term trades. A few of the stocks we own
like Wild Oats are out of the mainstream and have the potential
to double or triple over the next year if we are wrong and the markets
move higher. The high return potential of these stocks coupled with
what we hope are judicious short term trades allows us to maintain
our large cash position, and still obtain a decent return over the
next year. If the markets move lower these stocks will suffer but
our large cash position will mitigate losses.
Again, let us reiterate that we will not trade in your account.
We appreciate your expression of philosophy and we wanted to share
ours with you.
...a final note
One final note. We are maintaining our cautious approach because
we believe a confluence of events this summer will rattle the markets.
First, once the tax cut passes, and the gurus personal tax cuts
are assured, those same gurus will discover the inflationary deficit
producing implications of the revenue give away. Secondly, the energy
crisis that is affecting California will spread through the country
with negative social and economic impact. Third, the unconscionable
acceptance of a permanent rise in the price of oil without suggesting
any conservation will inflict a tax on all the public with the resulting
drop in consumer confidence.
While this entire doom and gloom scenario may not occur, with our
good gains for the year versus the overall market we don't want
to let greed cloud our judgement. We have been successful the last
three years by being cautious, and we plan to continue in that vein.