The preservation of our client’s capital is our first objective.

Greetings: September 10, 2002

We thought we should get our Summer Lemley Letter off before summer ends. We have been busy the past few months and we our late with this letter. We spend a great deal of time on our website comments which we post every day. And so we encourage our clients to visit the website at if they wish to know what we are thinking and doing.

On September 4, 2002, the Model Portfolio was entirely cash and had a value of $429,810. The Model Portfolio was unchanged for the year. On that date the DJIA was down 17%, the S&P 500 was down 23%, and the NASDAQ was down 34%. We expect to be reinvesting a good deal of the cash in the next two months if the markets continue to sell off. For the rest of this Letter we present selections from our posts over the last few months.

Dear D:

You asked what percentage of liquid assets should be in stocks at our age? First of all, we don't run money for folks based on age. We manage money for our clients based on market risk. Our oldest client is 101 and he owns the same stocks and has the same market exposure as our grandson who is 5. Since we tend to error on the side of caution we have on average been less than 50% invested in stocks for many years. But there are times of the year, usually year end when we will raise exposure to 100% if we think the risk reward ratio justifies that posture. Our philosophy presumes active management and the willingness to take losses and realize short term gains. Most folks don't like the activity involved in this approach but we find it works for us and our record gives credence. We can't tell you how much you should invest on your own because we don't know with whom you are investing and what their philosophy and objectives are. We used to try and answer the question and suggest percentages. Now we have reached the point where we say, give us all your liquid assets and let us do the worrying. We will take the responsibility and we don't know anyone who will do better than we. Nor do we wish to vouch for another's investment expertise. Finally your question reminds us of two questions we asked early on in our former life when we were actively engaged in farming. The first question was our asking a farmer how often one should trim a horse's feet. The answer was obvious, "as often as the horse needs it". Our second question was when we were digging a foundation for a chimney for our wood stove and that question was how deep to dig the foundation and the answer was, of course, "deep enough." Hope we have been of some help.

Spreads on bonds

We've been reading about the closing of the spreads between corporate bonds and Treasuries. The spread is the difference in the yield an investor receives from buying a corporate bond of a certain maturity-say ten years-versus the yield the investor would receive if he/she purchased a Treasury bond maturing in ten years. For example the ten year Treasury is currently yielding 4.13%. So if an investor bought a corporate bond due in ten years yielding 7.13% we would say the spread was 300 basis points or 3% over Treasuries. Those spreads have been narrowing recently, say from 300 basis points on single A rated bonds to 250 basis points. Some analysts are saying that the closing of the spread is the result of investors having more confidence in an economic recovery. Our take is that folks our panic buying higher yielding bond funds, since Treasuries don't yield what they are accustomed to or what they need to live on. Investors buy mutual funds that invest in lower quality bonds because those funds have the higher yield and that inflow of investment money causes the bond funds to buy in the open market and the demand lowers the yield and thus shrinks the spread. We have repeatedly warned that individuals chasing yield by buying lower quality funds is going to create the same gnashing of teeth and bitter recriminations as the stock bubble bursting has, when interest rates begin to move higher as economic recovery occurs.

Package of Telecom stocks

Several folks have asked about a package of sold out telecom stocks to buy. The idea is that an investor buys six or seven stocks with the hope that over the next few years as the telecom fiasco works out only one or two go bankrupt, one or two go up/down ten percent, and one or two rise five to ten times in value. In a year like this such a package seems reasonable. We just think it is too early to construct or buy one. We know that NT is selling at $1 and LU at $1.73 but they both could go to fifty cents in the next big down move. By the way, we are using NT an LU as examples, we would probably not pick them. For now, we are waiting and watching and making a list.

Why we try, why we buy and sell

A client wrote and suggested that Footlocker and AT&T Wireless and Fleming should not be considered investments. Fleming shouldn't be considered one because it pays no dividend, AT&T Wireless because it has no earnings and Footlocker because it sells at 18 times earnings.

To us an investment is what we own in the portfolio. It may not work out, but as long as we own a stock, it is an investment. We make no claim that the stocks we own are going to change the world. We own stocks for the purpose of earning a return over the short or long term. In volatile times such as these we sometimes wonder why we try. It would be easier to sit on cash and go to the beach. But we are paid to use our judgment. And it's our belief as we try to pick and chose in the next few months, that non nifty fifty issues will offer the best reward since they are being kicked out of portfolios with abandon. These issues are more volatile but we are sticking with stocks we know and have traded over the years. Hopefully a year from now, with hindsight, our purchases will make some sense.

Cans of worms and other thoughts

We raised a lot of cash the last two days and we are a bit ahead for our trading; by no means back to even for the year but this is a stingy market unlike the markets of a few years ago. Had we not had our brief unprofitable foray into the electric utility stocks, we would have had a better trading result. But hopefully we learn from our experiences. It's one thing to buy a can of worms to go fishing, and it's another to buy a can of worms as an investment. We know the difference, but sometimes we forget.

On this subject we were reading the New Yorker last night and came across an article by James Surieowki in which he wrote about the confidence that investors used to have in "white shoe" firms such as Goldman Sachs. He mentioned that investors formerly believed that if Goldman or Salomon or maybe even Merrill were placing their names on an IPO and vouching for the value represented that an investor could be reasonably assured that the company being offered was a real company. No longer is that the case. We mention this article because we learned that lesson back in the IPO boom of 1983 when we bought a company whose name we have long forgotten. It proceeded to head south with alacrity and we questioned our investment decision to buy, We remember thinking that the company must have some value since Salomon Bros., which was among the top firms back then, with Henry Kaufman as guru, had underwritten the company. Sorry to say we were mistaken and we received an expensive but long lasting lesson in the perfidy of the two sides of Wall Street. Actually that's why we quit being stockbrokers and became money managers. A stockbroker works for the firm that employs him/her. The stockbroker sells the products the firm says to sell and the stockbroker uses his/her clients acquired as a means of distribution of the firm's products. A stockbroker's earnings depend on the firm and his/her clients belong to the firm not the stockbroker.

A money manager works for his/her clients. The money manger's earnings come from the clients. If the money manager does not perform for the clients, the clients leave, and the money manager becomes a cab driver. This is Capitalism at work in its best form.

Realized losses and account values

Several clients have called expressing concern that their realized losses are quite large this year. Our response is that we never look at realized gains and losses till year-end and then we hope we have losses rather than profits to mitigate tax consequences. We are not being flip with this answer. The most important number to be aware of is the total equity figure, which is the overall value of the account. You'll notice that that is the only number we refer to when mention the performance of the Model Portfolio.

Thus if at the end of last year an account was worth $429,800 and it is currently worth $416,000 that account is down $13,800 or 3.2%. ($13.800 divided by $429.800). Another example is if an account was worth $1,400,000 at year-end and has taken out $85,000 we adjust year-end value by subtracting the $85,000 removed from the account from the value of $1,400.000. That would give the account an adjusted year end value of $1,315,000. If the account is now worth $1,275,000 it has lost $40,000 in value. $40,000 divided by $1,315,000 shows the account is now down 3% for the year. The actual realized losses for tax purposes may be greater than the $40,000 drop because some of the lost value may have occurred in prior years and thus the some of the loss would be accounted for in the year end value.

We would note further that an account down 3% that was up 18% in 2001, and 1% in 2000, and 42% in 1999 is performing better than 95% of all accounts being managed in the world. So while we don't like being in a loss position anytime, we are very proud of our long and short-term record.

UAL and other thoughts on interest rates

UAL Corp is at $4.50. The mini crash in October 1989 was caused by the collapse of the buyout of UAL, which was to be sold at a price of $189 per share. It's difficult to think that the economy can recover swiftly if the major airlines enter bankruptcy. But in the new age of financial planning, bankruptcy is the hoped for solution to all problems. Oops. For got to mention that shareholders lose all their investment but since management owns only options they don't care. They can just issue new options in the new company with less debt and new shareholders. The new shareholders are the former debt holders. That's how Iridium emerged from bankruptcy. Shareholders and some original bondholders lost $10 billion on that Motorola boondoggle but the new owners are making a handsome living. On that same note we mentioned the other day that the economy and stock market are being saved on the backs of savers. The US debt is $6 trillion. Interest rates are at least 2% lower than they would be without FED intervention. That is $120 billion per year not being added to the national debt. That number also equals the amount of tax benefits going to high bracket taxpayers on a yearly basis. So Mary Jones is earning 2% on her $50,000 life savings C/D so that Jack Welch's top tax bracket can be lowered from 39% to 35%.

Our Job

Our job is to try and earn a decent return on capital without taking too much risk for clients who entrust their money to us. We manage money for folks with the caveat that the more we are allowed to employ our thinking process without having to factor in client fears and foibles the more productive we will be. We mention this now because we have been struck by the absence of client calls of worry and we want to thank clients for their confidence. We know it helps that we have a great deal of cash on hand, and that we have well outperformed the popular measures for the last four years. But we think that client confidence in our investment approach is what allows us to stick with our philosophy in difficult times.


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


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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.