Winter 2002

He who lives on an island, must not make an enemy of the sea.

14 January 2002


...the market comment

We remain risk averse and our outsized gain for the year has given us the luxury of maintaining a large cash position. Our activity has been hectic at times, but that is our style and it has worked well for us the last three years. Moreover, these are confusing times. The USA is going to survive all the turmoil and the long trend has always been up. But periods of consolidation and even retrenchment are part of economic history and we may be in just such a time. The real question is how much negative economic news the ever-optimistic American investor is willing to absorb before heading for and/or staying on the sidelines. Our guess is that we are at or approaching the limit. Even with 1% or less interest rates the Japanese investor has pretty much stayed on the sidelines for ten years. To be sure, there have been some very good rallies in the Japanese market over the last ten years. Unfortunately, the "buy and hold" crowd hasn’t done well since the Japanese market is back to its ten year low.

We are trying a new format with this letter. As we noted in the last letter, we have added a web site to our services. Since we spend many hours writing our daily comments, and because they coincide with buy and sell action in client accounts, we are going to use excerpts from the Lemley Letter Online to allow our non computer clients to share our thoughts over the previous three months. If you are a Lemley Letter Online reader you can relive these glorious passages or pass the letter on to a friend. Or use it to start a cozy fire if you wish.

1 January 2002

For the year the Model was up 21% while other benchmarks were S&P 500 (13.04%), DJIA (7.10%), NASDAQ (21.05%), NASDAQ 100 (32.65%), and Wilshire 5000 (12.06%). For the three and five year periods ending 12/31/2001 our Model portfolio has substantially outperformed the S&P 500 and many mutual funds.

Five Year Comparison
On 12/31/96 The Model Portfolio had a value of $200,666.
On 12/31/01 The Model Portfolio was valued at $429,804.
If in S&P 500 for same time period value would be $327,378.
That's a difference of $102,426. That's 50% on original amount.

Three Year Comparison
On 12/31/98 The Model Portfolio had a value of $245,951.
On 12/31/01 The Model Portfolio had a value of $429,804.
If in S&P 500 for same time period value would be $237,557.
That's a difference of $192,247. That's a lot of money.

Past Performance is no indication of future performance. See disclaimer at the end of the page.

5-6 January 2002

We did a bunch more selling yesterday of year-end purchases that had gained 15% to 30%. For nice short-term profits we sold Ciena at $16.30, Tellabs at $17.05, and Palm at $4.35. We also sold Broadwing at $10.02 for a loss in most accounts and reduced our Lucent position in accounts to a level where we can wait for recovery if we don't continue to get the New Year bounce. We sold the Broadwing, which is up 12% from year-end, because we have been taking profits and our discipline is to sell a loser or two at the same time we are taking profits. That way we don't wind up with a portfolio of losers at year-end. The telecom industry is in great flux and because we have had three years of outstanding performance we are taking a more cautious approach and bunting for singles rather than hitting away. We are aiming for a ten percent return in accounts this year and the move this week has most up 3% to 5% so we are off to a good start. As always we are loath to give anything back. We've had fun and profit trading Tellabs and Ciena but since we are in a New Year we will avoid them till next fall. Cisco gives us a bit more quality (in Wall Street eyes), as does Oracle. Both are ridiculously over priced, but we are trading anchovies now and so we want to own five star anchovies rather than three star ones.

Reviewing the stocks we own: AOL Time Warner is out of favor now. We own for the January bounce and will not own by March. Wireless phones are here to stay and while AT&T Wireless is not considered the best of the wireless stocks, it has the least debt. It's a worry free way to participate. Barnes& is a pure play and they have a simple business plan. BNBN sell books and discs. Burlington Resources has oil and natural gas reserves in North America. Down from $52, may get a pop on any Middle East war scare since it has a lot of North American reserves. Cisco , Oracle, and Sun Micro are our remaining year end tech plays. We own Hewlett Packard cause we like Carli, and because our late partner Don Yarling always liked it. But we own it for a trade this time. We switched Bristol Myers to J P Morgan Chase at year-end and the switch has given us a ten- percent gain so far. Looking for better news to keep us in the stock. Lucent is either a long-term recovery situation or a sell at $10 per share in the next month. Everyone loves Walgeens and hates Rite Aid, and with good reason. But Rite Aid is entering its second year under new management and same store sales are rising. RAD has a ton of debt and isn't out of the woods but we like it as a speculation. If it runs to $7 we'll sell half or more. SBC is one of the four remaining RBOCs and we own it for a boring trade to the mid $40s. We have been trading Schering Plough for the last year. In the "shoulda coulda woulda market," we shoulda sold SGP when it popped to $40 in December, and then we coulda bought it back now at $34. We woulda made a nice trade. Not. Charles Schwab has been acting well and "the street" has hopped on the buy Schwab wagon, so we'll be pigs and hold for more

7 January 2002

Last Friday a friend called and asked us to speak to one of his clients who was retiring. His client had created a portfolio of growth mutual funds and preferred stocks yielding 7% and felt that the portfolio he had created would serve him well for the next twenty-five years. These calls are always difficult because folks who have spent a lot of time and thought preparing for retirement are in the mood to have their plan confirmed, not questioned.

On the other hand, since we are not involved emotionally or financially, we can give an objective opinion. The retiree we were talking with expects a return of 6% a year from his investment and has enough capital to generate $90,000 per year at that rate.

Our first question was what the rate of return was for 2001. He told us it was a negative 6%, but that for the preceding four years it had been over 10% annualized. Our response was that the preceding four years during the boom were the most vibrant and rewarding investing years in our thirty-five years in the business. Even our staid old stock trading and large cash position had not kept us from realizing excellent returns.

Since the retiree had not taken any disbursements in 2001 his capital had only dropped 6% and he saw no reason to worry. We suggested that if he had been retired and in 2001 had taken the 6% he was planning, his capital would be down 12%. He agreed but opined that 2001 was an unusual year and the second down year in a row. We agreed that two down years in succession had not occurred since 1974-75 so one wouldn’t expect a third.

But we felt compelled to point out that his investments this year, assuming he had drawn money in 2001 would have to grow by 18% to get his principal back to where it was at year-end 2000. (6% down in 2001 plus two 6% withdrawals in 2001 and 2002). We have always assumed an 8% withdrawal over time for retirees whose funds we manage, but we have never locked our investments into preferred stocks to obtain that return. And we certainly don’t rule out another down year in the near future.

Our reason for disliking preferred stocks goes back to the interest rate rise in the early 1980s when short term rates went to 20% and preferred stocks dropped in value by 50% to 75% depending on the quality of the issuing corporation. And that drop occurred even though at that time there was a built in demand for preferred stocks by corporations with excess cash who could avoid 85% tax on preferred stock dividends. That exemption no longer exists for most preferreds and with it the demand by corporations is gone.

With Treasury bonds, even long term Treasury bonds, an investor can be assured that he/she will eventually get the invested principal back at maturity. We prefer Treasury bonds because we don’t have to worry about the credit quality of the issuing corporation or country.

With preferred stocks there is no maturity and so no guarantee of eventual return of principal. In attractive interest rate environments like now, this worry about return of principal may seem overdone. But remember our retiree plans on holding these stocks for twenty-five years. Just think of the market turmoil that has occurred over the last twenty-five years.

Interest rates are currently at forty-year lows, which mean that prices are at all time highs. It is no coincidence that preferred stocks are currently being marketed to individual investors. Wall Street has a way of giving the investor just what she/he doesn’t need. Wall Street profits from individual investors depend on the naivete of folks who need yield to live on but are not asking the right questions. The question to ask is: If preferred stocks yielding 7% are so great why are banks selling their own newly issued preferred stock to me? Why aren’t they going to the Fed and borrowing money at 1.75% and using that money to buy the 7% preferred stock of other companies and banks and locking in a risk free 5% return? The answer is that these stocks are not risk free. As long as interest rates stay low, the preferred stocks being sold today will not drop in value. The odds on their increasing in value are minimal since interest rates are as low as they can go without a Japan style economy. If that happens our retiree’s growth stock mutual funds are going to continue to lose value to a greater degree than the yield from the preferred stock can replace.

Our answer to the retiree’s question is that there is no way to lock in a strategy for the next twenty-five years. Investing has become hard work and investments need constant reevaluation. And preferred stocks are Wall Streets latest fad/rip off of the ordinary investor. Preferred stocks yielding 7% when two-year Treasuries yield 3% tell you there is risk in the preferred stocks. Our suggestion was to sit on cash for a while or to place part of the funds in the two-year Treasuries at 3% and wait for interest rates to get back to the 5% level on the two year Treasury over the next few years. We expect yields to rise as the budget deficits balloon, and the worry of the disappearance of the Treasury Bond Market for lack of new bond sales becomes a fond memory of those crazy Clinton years, when the FBI spent its time looking for unmentionables in the Oval Office rather than terrorists in caves in Afghanistan.


21 November 2001

A comment on farmers, red and black steers, and trading stock.

Farmer Pete, as my grandson Tyler calls him, lives down the road a piece from us. At one mile he is our nearest neighbor which suits us all just fine. Can't even see his security light. For those of you who don't know, security lights are bright globes that come on automatically at dusk and shine brightly all night, illuminating the barnyard and half the countryside. Why they are called security lights is beyond us, since their brightness provides thieves the light needed to see their way around the farm. Whatever, city folks who move to the country rarely have security lights because one of the reasons they moved to the country is to get away from bright lights.

Anyway, Farmer Pete runs cattle on our farm. Each fall he sells his steers and bull calves, which he did last week. A few days after he shipped them we asked how he did on price. Without revealing too much, which of course is the country way, he allowed as he got 82 cents a pound for the black ones and 76 cents for the red ones. We asked why he got different prices since all the cattle were in good shape and about the same except for the color. His response was that the cattle buyers usually prefer black ones and so they usually pay more for them. We then asked him why he didn't raise all black ones, since he'd get a higher price for them. His response was simply, "I like red ones better."

Makes sense to us since that is usually our response when folks ask why we trade certain stocks when other stocks sometimes move better. As traders we have to own stocks with which we are comfortable. A good example of this philosophy was our catastrophic Barnes & Noble trade last week. We lost a good piece of change on the trade and this week the stock is back to our purchase price where we could get out even if we still had it. We have learned over the years that when a trade goes against us and we hold to get out even, our mind tends to focus on the bad trade to the exclusion of other opportunities. In this case, having taken our lumps and moved on, our accounts are back to their pre-Barnes & Noble trade value and our mind has been clear to focus on other more comfortable opportunities.

...Sri Lanka kids

We also would like to thank all those folks who donated to our Sri Lanka kids. We raised $20,000 and so Godwin Pieres who runs the orphanage with his wife and son send his thanks and the blessings and best wishes of all the children. With the new government in Sri Lanka the rebels have declared a cease fire. So hopefully………


The market value of the Model Portfolio is net of advisory fees, brokerage commissions and other related expenses. Model Portfolio results reflect reinvestment of dividends and other earnings. The Model Portfolio column is the overall return of the portfolio for the period shown. The S & P 500 is an unmanaged S & P composite of 500 stocks widely regarded as representative of the stock market in general. Unless otherwise indicated, index results include reinvested dividends and do not reflect sales charges.

Past performance is not indicative of future results. Other methods may produce different results for individual portfolios and for different periods and may vary depending on market conditions and the composition of an individual portfolio. Care should be used when comparing these results to those published by other investment advisors, other investment vehicles and unmanaged indices due to possible differences in calculation methods. A list of all recommendations made by Lemley, Yarling Management Co. for the preceding one year period is available to advisory clients upon request


Winter 2002
Autumn 2001
Summer 2001
Spring 2001
Winter 2001
The factual statements herein have been taken from sources we believe to be reliable but such statements are made without any representation as to accuracy or completeness or otherwise. From time to time the Lemley Letter, or one or more of its officers or employees, may buy and sell as agent the securities referred to herein or options relating thereto, and may have a long or short position in such securities or options. This report should not be construed as a solicitation or offer of the purchase or sale of securities. Prices shown are approximate. Past performance is no indication of future performance.