Winter 2003

Nothing succeeds like success

Winter GreetingsJanuary 30, 2003

The above quote applies to our satisfaction with the performance of our accounts over the past five years. The Model Portfolio has outperformed the S&P 500 by over 100% in that time period. We remind that past performance is not an indication of future performance and we are certain that our relative performance going forward will not match our record over the past five years. But we plan on giving it the old college try.

For the record the Model Portfolio finished 2002 up 7% for the year while the S&P 500 was down 22%. For the five year period ending 12/31/02 the total return of the Model Portfolio is plus 108%. The total return of the S&P 500 for the same five year period is minus 3%.

Weíve started this year with a nice pop and the Model Portfolio is up 6.9% and is 100% cash. We donít know what is going to happen with Iraq and we donít think the stimulus plan as proposed will accomplish its goal and so we have taken our profits from the year end bounce and retreated to the sidelines. Happily, all our accounts are positive for the 13 months ended January 30, 2003. Many accounts are up over 15% in that time period while the S&P 500 is down 20%. We are including the extra month because we usually get a nice bounce from our year end trades and we factor that bounce into our overall planning.

The only way the stock markets are going higher in the near term is if Saddam takes a hike. If he does the stock markets will stage a huge short covering "get me in" rally and we will miss it. But we will gladly miss such a rally if it is the result of avoiding war. And the reality is that as the rally occurs the same old economic problems will remain and the non stimulus stimulus package will still be on the table. So we would expect a strong two or three day short panic covering rally followed by an equally strong sell off when reality replaces euphoria.

We have no idea what this year will bring but we plan on continuing our rapid trading style that has evolved over the past five years and served us well. The stock markets could well be in a prolonged period of underperformance and until we think the bear market has ended we will be quick to raise cash when we perceive excessive external or internal market risk. Now is such a time.

As is our wont, we now present selections from our website from the past few months to share with our non-computer using clients some of our daily thoughts.

2 December 2002 6:44am and it must have been something in the Thanksgiving Turkey but all the talking heads and print media are sounding the all clear signal and speaking bullishly again. The rise in the prices of speculative stocks last week is an indication that the buy juices are flowing again and that maybe the individual investor is again beginning to feed at the trough. The manufacturing index is coming today and is expected to be slightly expansionary with a number at 51. Stocks are now up eight weeks in a row. We still think this may be a correction week, and we have enough cash and enough invested and enough gains that we are going to watch. We survived our travails with wireless stocks and made enough trading the tech area and so we plan on staying with our boring cyclical recovery plays for now.

3 December 2002 7:03am and we continue to believe that the tough White House talk on Iraq is setting the stage for Bush to claim the statesman's mantle of insuring that Saddam has no weapons. We are betting that December 8 will be a non event and that the inspections will continue.

The reversal yesterday has presented the pause that will refresh and inject doubt where it is needed. A lot of folks, except those short the markets, were becoming complacent with the gains of the past few months. Actually in the last three weeks the DJIA is only about 1% higher but a ton of low priced tech stocks were up 50% in that time period. We are happy with our cash position and continue to look for trading opportunities for the year end bounce.

4 December 2002 6:06am and Öthe talking heads on CNBC are discussing a Wall Street Journal article about hidden bombs arriving in Chicago and the subsequent wrecking of the global economy by terrorists so it's obvious that Monday's boom has become Wednesday's gloom.

Yesterday's call by Richard Bernstein, chief equity strategist at Merrill Lynch, to lower equity exposure by 5% to 45% had to have a negative effect given Merrill's large sales force. Also the Merrill analyst who recommended buying, selling and holding Merck all in one day set the one day record for a confusing analyst call. He was just trying to get ahead of the curve but instead was hit by the curve boomeranging.

Our current theme is that the year end tax selling, recent rally profit taking, and end of the world get me in cash time of year is now - and we have the cash to take advantage of the sell off. We may revisit some of the tech stocks we've traded in the past month but for now the QQQ are our main means of playing tech. We believe the risk/reward of trading stocks at this time of year after a three year downtrend favors owning stocks for a one to three week relief trading rally after yearend. There is always event risk but trading is about measuring risk and reward and making decisions to be in or out accordingly.

5 December 2002 8:29am and we were thinking that the rejection of the UAL loan by the folks in Washington is an example of the booboisie who are making economic policy now. As far as we can remember, assistance by Washington to large companies in financial trouble has paid economic and social dividends 100 times over. We think of Chrysler and Lockheed and the TVA and all the water projects in the west and all the other supposed giveaways that became huge financial and social successes. Contrasting the bailouts with the rape of electric and gas end-users over the past few years by Enron et al arising from deregulation of the utility industry and the gas and oil exploration fiasco and the savings and loan scandals in the 1980s arising from fooling around with tax rates and deregulation and we'll choose government help every time. But then we are liberals and believe that government is good and government workers are as capable as those in the private sector. Actually one would think conservatives would also think that way since folks like Dick Cheney and Paul O'Neill cut their teeth on government service as did Don Rumsfeld. They left government service to take over major corporations which we would think gives the lie to the worn and tattered bugaboo that government workers are lazy slackers. Or maybe not.

6 December 2002 6:51am and the stock markets action this week has been less than encouraging to the bulls. Of course Lemley Letter Online folks expected this pull back since LLO had been forecasting an early December retreat for a month. Surprise or not, when the pull back does occur it is gut wrenching to see hard earned profits disappear in the blink of a trading day. But markets usually climb a wall of worry and when everyone turns bullish, Mr. Market has a tendency to bring everyone back down to earth.

For the same reason, as bearish and correction sentiment waxes and tax selling wanes we expect the year end rally to appear. Our theory is that we have two rally periods in the fall now. The first occurs toward the end of the mutual fund year end date of October 31, and the next occurs just as winter begins at the end of December or in early January.

The one negative to this scenario is the Iraq situation. That is a short term negative. And one of the longer term negatives is the looming bankruptcy of UAL and the disruption of hundreds of thousands of lives and the economy of Chicago. And as UAL sheds debt the pressures on Delta and AMR will build. There is also the matter of the economy recovering and the tax packages the Republicans are going to push through Congress. But those are long term considerations. The talking about the tax packages which will begin in earnest in early January will have a positive effect on stocks. Coupled with the relief of pressure from tax selling we continue to look for a decent rally.

11 December 2002 7:45am and the European bourses with the exception of Germany are higher while Japan was down overnight. US stock futures continue to indicate a slightly higher opening. Merrill Lynch is going to lay off 10% of its investment bankers. Merry Christmas. Merrill also sees higher earnings next year. That's the new mantra. Fire folks and thus improve productivity and earnings. Eventually there will be no one working who can buy your product but why worry about two years from now when Wall Street will price your stock and thus your bonus on next quarter's earnings.

The great expansion of the economy after WWII created jobs and raised living standards and in the process and as a result of the expansion the stocks markets rose. The bull market of the 1980s and 1990s resulted from higher earnings that were the result of eliminating high paying blue collar jobs by sending them overseas in the 1980s and then by eliminating high paying white collar jobs in the late 1990s. The bull markets of the last two decades had to do with job destruction not job creation. And that is what the problem is. The parallel is certainly Japan which had a glorious expansion from the 1970s to the late 1980s and then ran into a brick wall as job creation moved overseas for them.

The reality is that unbridled capitalism is a cruel taskmaster and good jobs will not return to the US until the standard of living is raised in all the third world countries. That is the reason to push for increases in living wages for folks in China and Sri Lanka. The African continent is the next area where jobs will flow as capitalism seeks the cheapest price. That flow of work to the cheapest producer has been going on since the industrial revolution began in Britain many centuries ago.

The markets were correct in the late 1990s that tech land and the Internet are the true frontiers for growth in this country until industrial jobs start returning in fifty or one hundred years. The only problem was that the euphoria of the times discounted any real growth by pricing stocks at levels of earnings that would not be achieved for twenty years. And that mania allowed hundreds of phony non productive shell imitators to raise oodles of cash from uninformed mutual fund and institutional investors (?). But in time capitalism cruelly corrected the problem as it did with the canals boom in the 1820s and the railroads in the 1850s and the automobile and the radio in the 1920s and the color TV craze of the 1960s. History does offer clues to avoid huge mistakes if one is willing to look for them.

31 December 02 7:47am and stock futures indicate a lower opening. North Korea is dominating the news but other than as a talking point and savior for a slow media week, the situation can be handled with good diplomacy. No matter what Rumsfeld says we arenít going to war with North Korea because South Korea and Japan Russia and China donít want war.

But the war talk is taking its toll on holiday cheer as well it should and the downer talk is also affecting the usual year end rally. With a down opening we'll bet on a higher close.

8:50am and the stock markets are meandering at lower levels with Treasury bonds rallying on the phony turmoil in foreign affairs.

The problems with Iraq, North Korea and even Venezuela are the result of menopausal men in the Bush administration who never fought a war needing to show their courage by sending other folks to fight a war they believe in just as these same folks did thirty years ago.

We believe that all three of these conflicts could be swiftly settled without bloodshed by some give on the part of the hawks in the Bush Administration. After all, we are the strongest country in the history of the world and we could bomb Iraq and North Korea back to the Stone Age in a matter of days. Of course, several million civilians would be killed but that is a price innocents have paid in the past.

Or we could continue to control the access and egress to North Korea and Iraq as we have for the past ten years with good results. Both these crisis are the result of a desire to test the leadership in Iraq and North Korea on the part of the Bush folks. Since most folks know that the leaders of both countries are dictators, unpredictable and reprehensible we don't know why the hawks want to test them. Usually governments only engage in tests of will when they know the eventual outcome. And the Venezuela oil crisis is being precipitated and directed by Otto Reich at the US State Department with the same game plan Reich used in Nicaragua to overthrow that government 20 years ago. Moreover we now are sending US Special Forces troops to guard oil pipelines in Columbia in the name of the war on terrorism. Will we soon be guarding oil pipelines in Indonesia for the same reason?

These problems are not intractable and it is our belief that after the Bush folks get tired of posturing and prancing and projecting US force that domestic political reality will intervene and attention will be turned to domestic policies. While there may be a short war with Iraq there is not going to be a conflict with North Korea. And nobody cares about Venezuela as long as the oil starts flowing again so we presume the generals will eventually take power and rewrite that county's constitution.

On the domestic front the Bush folks realize that they only need 51% of the vote and so their policies are going to be directed towards that 51%. Thus we think there will be a market stimulating dividend tax cut coupled with a holiday on a portion of FICA taxes. These programs will be announced in January coupled with a speed up in raising the amount of the child tax credit.

Our thought is that the tax package talk and the end of tax loss selling season will allow the beaten down low priced stocks we own to bounce a dollar or two which represents a significant percentage gain. We plan on being in a cash raising mode beginning January 2 and hope that our scenario will unfold and allow us to profitably return to a 75% cash position by month end January.

9:36am and new home sales rose 5.6% in November which was better than expected. Continuing on our scenario for next year we would comment that some gurus are suggesting that the market action this year end is similar to the action at the end of 1990 when the US faced the prospect of a Golf War with a lot less certainty in the outcome. The uncertainty of this war is what terrorist attacks will occur because of it. That unknown is paralyzing investors before the fact. So there certainly is a similarity. And 1990 was the only down year for the Model Portfolio. That down occurred because we hadn't yet adopted the philosophy of going to cash at the first sign of trouble and then reinvesting as the markets bottomed. We were able to time our selling and buying better this year than 1990. And we are hoping that seasonality will allow us to sell before any big sell off in January as war talk increases.

9 January 2003 5:41am and Öback in the fall of last year we said we were buying to take part in a rally that would last through January and that we would sell in January since we still considered the stock markets to be in trouble because the economy shows no signs of improvement. In keeping with our scenario we have been selling the rally and The Model Portfolio is again a more comfortable 90% plus in cash. Since October the Model has gained about twenty percent and is up 14% for the one year and 9 days since 12/31/01. In the last nine days the portfolio has risen 7%. That's a good start to the year and since we still think we are in a bear market we have basically retreated to the sidelines to wait and watch. The value of The Model Portfolio including accrued dividends and after fees is $492,160. Nineteen years ago we started with $50,000.

17 January 2003 8:02am and the word from JP Morgan is to buy GM and short Ford Motor. Not now. You must wait till February to do this, or at least the end of January. Now that is the kind of advice that should be flushed or laughed at. The analyst thinks that GM will sell off at the end of January after running up this month. We don't really have a problem with that. That is a buy at lower levels suggestion. But why not short Ford now when it is up 30% from itís' lows. If GM is lower at the end of the month the odds are that Ford also will be lower. One buys stocks at lower levels, one shorts stocks at higher levels. Whatever!

The Big Bill Gates Giveaway

The 16 cents per share dividend that Microsoft is going to pay means $97 million tax free per year to Bill Gates if the Bushies pass their dividend plan. Now there is a fellow who really needs a tax cut. Remember that Bill Gates takes a very small salary and gets his income from selling MSFT stock. When he sells stock he is taxed at the maximum 20% tax rate and pays no FICA or even the 1.45% Medicare premium that all taxpayers pay no matter how high the income earned. We don't resent the money Gates has; we just think he should pay taxes like the rest of us.

Now the point can be made that Microsoft has already paid taxes on the money that Gates will receive in dividends. But MSFT's effective tax rate after adding back in depreciation and other offsets is about 18%. So the reality is that even if one makes the argument that Gates is paying his part of Microsoft's 18% rate a tax free dividend would still save him 20% off the top rate of 38% on earned income. That's a "kewl" 16 million in taxes. Not to mention all the free plane rides and Super Bowls and other goodies that corporate executives receive that Jane and Joe worker pay through the nose for if they could afford them.

You say Gates could sell stock and pay the same 20% rate since the maximum capital gains tax rate is 20%. True but then he would be giving up ownership and appreciation potential on the stock he sold. And with the Bushies plan to make the elimination of the estate tax permanent that part of the tax plan is worth $30 billion to the Gates family. Yes, the Gates family will save $30,000,000,000. And none of this stuff will stimulate the economy now, although we are sure it will stimulate multimillion dollar political donations. It's ludicrous that a couple of million dollars in donations can create such huge tax giveaways.








Winter Trees

This morning from the trees we hear

the pop of limbs and snort of deer

as winter again claims the land

and takes all firmly in its hand.

The horses hobble on icy hoof

as snow packed turns to ice,

the pigeons cling to barnyard roof

waiting for the sun to rise.

Frosted fields beckon us

to wander in the diamond land

since hunting season now is past

walk we will with staff in hand.

All the trees unclothed to show

the cuts and sores of seasons past,

some strong, some weak, some firmly

planted, others leaning on their last.

Up on the knoll where cutters came

the battlefield assaults our eyes

the stooped and scraggly underbrush

mourn the mighty trees demise.

How needed was the one new house

that came from maple strong and swell

progress is the calling card

of loggers seeking trees to fell.

Artists use the fallen log

They seldom take a living tree

They understand the pact they make

To create life from death and free.

BL 12/03/02




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 2003
Autumn 2002
Summer 2002
Spring 2002
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.