As we send this letter we are on vacation with our family and will be taking the first three weeks of August to spend with them. We’ll be in and out of the office and Kathy and Lauren will be able to reach us if we are needed. We expect stocks to trade in a range and/or begin sliding lower into the September/October correction period. We don’t rule out a push by the DJIA to 10000 as the fast money moves from the overbought momentum NASDAQ stocks to the more staid stocks of the DJIA. But while a move to 10000 on the DJIA would be 10% higher we can’t game it enough to want to assume the risk. Moreover, we don’t think the NASDAQ or the S&P 500 will match that move since they are already outperforming the DJIA. And the momentum stocks are what have powered the latter two measures higher at the expense of the former.

The Model Portfolio on July 23 had a value of $519,378 was 100% cash and was up 12.8% for the year. Very conservative accounts are up about 5%, but most accounts are up about 8% to 15% for the most aggressive. Those returns on the back of client money being up 60% to 100% over the past five years are our reason for not taking chances at this time. We want to build on our gains and we think the autumn will offer the opportunity to add another 5% to 10% to performance for the year.

And our performance over the last five years - which is no guarantee of future performance as we all know - is one of the reasons we have been slow to take on new accounts. That’s because most folks who are interested in switching to us have had lousy performance over the past three years and are intent on making back the profits they surrendered. Since we did not surrender but actually added profits to accounts we have a different approach to the current market. And that approach is one of limiting risk until we understand the full implications of the continuing crisis in Iraq and the potential disaster for the economy arising from misguided tax breaks that won’t accomplish the goal desired.

So while we may engage in a little trading in our aggressive accounts, we presume that we will be lethargic in our stock trading until after Labor Day.

            Review of the past three months of The Lemley Letter Online

And in keeping with past practice we now share bon mots from our website postings of the past three months. We would first like to begin with a poem celebrating our summer vacation with our family:

        August at the farm

And so it begins.
Andy Kathy Rob and Lisa
And Michael Amy and Michael
Come to the farm and Water World
Then the Powwow and a Cubs game and then
Tyler's birthday Dave and Lisa' anniversary Viterbo Reunion,
Neighbor pot luck birthday party riding Skeeter Abigail walking
Luna and Cubby and Pooper and playing house with Bernadette and Norah
Silly Seamus and Talkative Tyler riding bikes Dave and Tyler
Cleaning the spring Kelle speaking French and riding
Her bike 100 miles with Katie while Bud and Jackie sit on the porch
Then Rich and Jay and Katie and Ally and Richie and Patrick and
Number 5 plus maybe Barb and Big Rich and we all
Go to the Crawford County Fair to see the cows and sheep
And pigs and goats and corn and eat the blueberry pie and
Then pick blackberries and get mosquito bites and all wet in the creek
And then grandpa and grandma get to rest.

All these thoughts filled our mind
As we walked to the office this morning
Smelling the new mown hay.


        Haying

The chicory's up and black caps turning
So yesterday we mowed the hay
The sweet smell fills the summer air
And suggests the visit of those we care

We mow the grasses late each year
To give the bobs and meadowlarks
A chance to raise their hungry brood
And not become coyote food.

For when the rake combines the rows
To dry in sun for evening bale
Coyotes from the woods arrive
To eat any chicks still alive

Gruesome as all nature seems
The food chain does its purpose serve
There is no hapless killing here
Only food to live the year

The windrows wait in ordered lines
The hay rake circling metal tines
The swallows fly above the dust
Catching bugs for babies' sust

These few days of warmth and work
Are for putting rations by
Soon grandkids whoops will fill the air
And we will know our summer's here.

We make the hay in big round bales
And row them on the road near hill
So grandkids for the rest of year
Have a playground free and near.

And we will sit upon the porch
Rocking as our kids deploy
All is well in our small world
At least for now we can enjoy

We all should steal some time for fun
So serious we've all become
Relish now our love and luck
With family in our pick up truck.

Across the fields we slowly roll
Laughter wringing out the droll
Another year of watching deer 
And sharing time with those most dear. 

                    BL 7/03

2 June 2003 7:03am and we said we were looking forward to an interesting week because in bear and bull markets we always trade from the long side, never having mastered the art of selling short. And as that "ole" bullish feeling sweeps the marketplace trading long side opportunities should be easier.

But we do think the major economic problems remain and while the recently signed tax bill has positive aspects for the markets, we don't know that it does all that much for the real economy. Maybe the stock markets have become the economy and if that is the case then we should be bullish.

In our readings over the weekend we noticed that reported unemployment in Japan is 4.5%. Now we don't know if that number is more understated than the U.S. unemployment number which is probably 4% higher than the 6% reported figure. But we did have the thought that even with only 4.5% unemployment Japan remains mired in a 14 year miasma. That doesn't mean that the Japanese stock markets haven't provided good trading opportunities during the fourteen years, for they have. There have been many 25% moves and even a few 50% moves for nimble traders to take advantage.

So even if our bearish scenario for the long term outlook of the U.S. economy occurs, we are not blind to the possibility of good long trading possibilities. And this current move may be one. But as the markets move further into overbought territory and the month of June the risk is increasing.

4 June 2003  8:25am and we are now over $521,000 in the Model Portfolio value and up 13% for the year and we want to play defense here.

12:46pm and we read that the Feds analyzed Martha Stewart's brokers ink to discover that he wrote "sell at 60" with a different pen than he wrote other items on a piece of paper. We wonder whether the Feds are using the same analyst who saw all those WMDs in Iraq.

The Martha Media Madness reminds of the Whitewater mania of the Clinton Years. That the FBI has spent over a year investigating this matter is ridiculous. The same thing happened with the Clintons. Talk about misplaced priorities. No wonder the Oklahoma City bombing and the World Trade Center bombings occurred. It's almost as if the media is running the FBI. Right now CNBC is showing a press conference in which 5 highly paid folks are talking about a $40,000 gain that was legal. The only argument is whether Martha got scared when the FBI questioned her and didn't follow her lawyer's advice.

5 June 2003 7:07am and many technical indicators are giving readings rarely seen. Some technicians are going back to the 1960s and 1970s to compare performance after the positive indicators currently manifesting themselves. The indicators are screaming that markets are overbought, but with the three year bear market taking many stocks to extremely low price levels versus the ridiculous levels at which they had been selling, it is not untoward to expect an overshooting bear market rally. .

9 June 2003 7:25am and we wish a happy 36th birthday yesterday to the mother of the prince and princess of Taylor Mill.

7:45am and last week the State of Illinois issued $10 billion of tax free bonds to make pension payments and to fund unfunded future pension liabilities. These pension payments should be coming from investments not made and tax revenues not raised. This financial legerdemain is similar to folks refinancing their home mortgages and taking the money out and spending it, or using the extra money to pay down credit card debt, so they can go out and spend with the credit cards again.

10 June 2003 9:05am and had we stayed more fully invested in the March to June rally we would be up about 25%. But that isn't our style. We have been too quick to sell these past four years and that action is why we have outperformed the S&P 500 by 100%. Until we see the economy stabilizing and can understand how the economy will grow its way out of recession we are going to remain tentative in our trading.

Airlines can't increase passenger traffic, hotel business is down, commercial real estate construction is dormant, manufacturing continues to shed high paying jobs as does the financial sector, and the tax cut will not stimulate the economy. Crude oil is back over $31 per barrel and Greenspan says natural gas prices aren't coming down soon.

20 June 2003 8:19am and in the tradition of the U.S. government, General Motors is going to issue $13 billion in various debt maturities to fund pension liabilities. And so the pension liability on their books will now become a debt liability. Hopefully the pension assets will grow faster than the interest paid. GM will be able to deduct its interest cost as an expense and so the U. S. taxpayer will pick up part of the tab. And the money borrowed will also be a deduction since it will be contributed to the pension plan and so the U.S. taxpayer will face a double whammy.

Of course GM will eventually have to earn an extra $13 billion to repay the loan but that's for future management to worry about the same as the rounds of tax cuts in the last two years are for our children and grandchildren to worry about paying, as we spend their inheritance.

In the good old days of corporate management, pensions were funded from surplus earnings just as tax cuts were funded from government surpluses. But then those were the good old days that everyone yearns for but no one wants to reprise.

23 June 2003 8:58am and last week we wrote a few words about GM borrowing $13 billion to fund pension liabilities. Since 1995 GM has paid out over $10 billion in dividends. Since 1995 GM has spent over $10 billion repurchasing stock outstanding. Now GM is going to the marketplace to borrow money to fund its pension liabilities after having spent $20 billion plus in earnings on other items. Moreover on the stock GM bought back it is showing a loss of at least 25%. With the help of investment bankers who are earning the fees selling the bonds and will earn continual fees managing the assets GM thinks that by playing the stock market with borrowed money it can earn enough to offset the interest expense and grow the pension assets to reduce future funding needs. In this case we hope past performance is not an indication of future performance.

27 June 2003 7:10am and we were watching Charlie Rose last night and he had Floyd Norris of the NYT and Jim Glassman, chief economist at JP Morgan as his guests. The discussion was about the economy and the Fed rate cut. Norris opined that he thought the economy was showing nascent signs of recovery and Glassman is predicting 3% to 4% GDP growth by the 4th Quarter. They also talked about the housing boom and that discussion tweaked our brain a bit.

The latest figures showed a 6% gain in the sale of new housing and a 1.7% gain in the sale of existing housing. It is a given that housing has been the savior of the economy for the past two years, keeping it from rolling back into recession. We surmise that the difference in the sales figures is that existing housing is more expensive and that new housing usually has much better purchase terms. We have seen some new housing advertised with 5% down. The only difference between that type of purchase and a credit card purchase is the amount of money and interest rate. Both are very highly leveraged transactions and involve a degree of faith on the part of the lender. Any kind of slowdown in housing sales could easily wipe out the buyers equity.

Unlike the stock market though, as long as the homeowner continues to pay the “vigorish” he keeps the home. With stock folks are required to put up more money or they have their stock sold out from under them.

Another point the panelists made is that the rising stock market is foretelling an economic rebound since the stock market anticipates economic activity 6 months in advance. As Don Rumsfeld might say that is true when it is true and false when it is false and one does not know whether it is true or false until 6 months and many dollars plus or minus later.

7 July 2003 8:08am and the WSJ has a front page article on retirees who are trying to live on income from C/Ds now that interest rates are at all time lows. This is the story of savers who did what they were supposed to and refused to take risks and now they are paying the price of saving the economy. Many of them bought variable annuities at the banks they visited and those have been variable as the underlying equity mutual funds have tanked. They could have purchased ten-year Treasuries with a 6% or better yield but those didn't pay as much of a commission to the bankers who sold the annuities.

Our clients have averaged a 15% return over the last five years even with our usual large cash position and so they have been able to spend 6% to 8% of their money and still build up their principal. Past performance is not an indication of future performance.

We usually under perform roaring bull markets or bull spikes in long term bear markets because we maintain large cash or short term bond positions. But then we don't give much back in the bear phase.

8 July 2003 7:46am and the WSJ is reporting that the Treasury Department is going to change the pension rules to allow companies for a two year period to use the rate of return on 20 to 30 year corporate bonds to figure their pension requirement. The current requirement is that companies use the return on U.S. Treasuries but since the yields on Treasuries are so low the companies are required to put in twice the amount of money for pensions that they would have to if they used the corporate rate. This is called the Alice in Wonderland solution to lower interest rates.

On the one hand the Feds want lower interest rates to keep the house building growing and the interest expense on the national debt low. But by keeping interest rates artificially low they cause companies to under fund pensions, not to mention forcing savers to go to riskier reinvestments to attempt to obtain a higher return.

9 July 2003  6:50am and today is the 37th wedding anniversary of yours truly and the wonderful Katie. We've known each other since our college days back at Georgetown in 1961. The journey has not always been smooth but it has always been interesting. And we have two wonderful children and two fantastic grandchildren and what more can we ask from life.

14 July 2003 2:09pm and recently several of our clients have gone to banks for loans. Since many of our clients live on the monies we generate they show trading profits as income. Not a few of the bankers have asked for confirmation from us regarding the gains over the past five years because of all the horror stories about stock market experiences. We presume some of the bankers own portfolios may have suffered. Following is a letter we wrote for a client today:

Dear Mike:
Most of Ms. ….. income from the accounts managed by us comes from trading profits as the gains in the accounts for the last 5 years show. Below the gains are listed.

Ms. ….. regular account had a value of $850,000 on December 31, 1998. In December 2001, $335,000 was withdrawn. Other money has been withdrawn for various purposes over the years including $92,000 this year and as of July 11, 2003 the regular account had a value of $755,166. For your information, on December 31, 1998, the combined IRA accounts were worth $269,464. As of July 11, 2003 they had a value of $564,155. No monies were added.

Happy Summer!

Lemley Letter Model Portfolio Performance