For the first quarter ending March 31, 1998, our average account gained +7.74%.
The investment climate was sunny and warm in the first quarter; just perfect in every way. Forecasts for the second quarter are for a sharp improvement. It is this latter fact that gives us an occasional sleepless afternoon, the more so since the relentless increase in corporate earnings has slowed so dramatically that the charming increases in share prices occasionally look a bit unhinged to us. Growth in profits has long outstripped growth in revenues, and one brilliant and rich friend frequently observes that earnings aren’t going to outstrip sales no matter what accounting legerdemain next prevails. So if shares are to have much further buoyancy, the economy must accelerate or a decline in interest rates must justify higher multiples. As it turns out, this may not be so hard to do, since American interest rates are completely out of sync with what is going on in the rest of the world. They look to be too high against almost all European alternatives, and compared to Japan, where all rates are 1.5% or lower, our 5.5% Treasury rates are about triple where an efficient market ought to put them.
The quarter was also noteworthy for the number of collectivist pillars that were chopped down, in silence, it seems to us, but fallen just the same. As long term readers of these letters know, we believe much of the multiple expansion in recent years is due to the end-of-communism theme that continues to reverberate in this country as in no other. In California, Al Checchi continues to lead the field for the Democratic gubernatorial nomination. Mr. Checchi, you may recall, has spent the last decade impoverishing airline workers for his own gain and amusement. Were Milton Friedman elected the next head of the Teamsters, it could not seem odder to us, but any incongruity in the American labor party endorsing Mr. Checchi is wholly unnoticed east of the San Gabriel mountains. That Mr. Checchi is even considered by the Democratic Party for the second most powerful post in the country is bullish; if he wins, we are not sure the market will be able to contain itself.
There was another coup for capitalism in this quarter at Disney, and it also occurred in an unlistening forest. An institutional shareholder with not quite 1% of the outstanding shares opposed the slate of directors at what is widely held to be a well managed company. The objection was that the existing board was much too close to the management, which is undoubtedly true, but seems akin to a complaint that August is too hot. It was ever thus. Except that in this case, when the dust settled, 35% of the shareholders agreed with the dissidents, leaving us to wonder if the much anticipated revolution in corporate democracy hasn’t gained an outstanding victory.
And Daniel Patrick Moynihan, liberal grandee for 40 years and rightly acknowledged saviour of the existing Social Security System, went to Harvard and casually observed that placing an eighth of the incoming receipts from the payroll tax into the stock market would make an excellent cure for the problems likely to plague Social Security 25 years hence. The Wall Street Journal editorial page promptly declared 7/8ths much stronger medicine, and the argument is now to be fought out on a line that we think is already a capitulation to imprudence. Over the long term stocks are marvelous investments, but this proposal is proof there can be too much of a good thing. Amongst its flaws, this proposal is a dagger at the heart of sound monetary policy. Americans are going to put all their eggs in one basket, and then calmly watch a Fed chairman scramble that basket with higher rates the next time the labor market overheats or the dollar takes a tumble? You don’t have to be Dick Morris to see rate hikes will never fly with an electorate using their Social Security accounts as margin money. This is a destabilizing temptation in the extreme, and while it doubtless aids the stock market today, we will be amazed if there is no adverse fallout in the dollar market as this proposal comes closer to being made policy.
Closer to home, we hope capitalism has had its little triumphs with two of the shareholdings Levy, Harkins has been able to acquire. You bought an exciting way to watch television in Echostar Communications this quarter. DISH, as the symbol so winningly makes clear, is a direct broadcast-from-satellite company with two interesting innovations. The dish antennas are tiny, about the size of a pizza, making upscale suburban planning boards sigh in relief. And unlike its other two competitors, Echostar can deliver your local over-the-air TV stations. You would be amazed how many people are apparently addicted to the local snowstorm closing reports, or mudslide alerts, or something. They will not be tempted by the 180 other channels without those local news anchors, and now Echostar delivers them. It will also deliver astonishing cash flow if it continues to sign up nearly a million customers a year, at monthly rates much better than the cable companies, we might note, since the satellite works no harder and costs not one penny more if it beams the signal at 2 million customers than the one million they have now.
We have also bought Brazil, in the form of Telebras, which by itself accounts for 52% of the Brazilian stock market’s value. Telebras is an AT%T breakup story all over again, with two interesting twists. For one, as soon as the company is broken up into 9 state Baby Bells and three cellular phone companies, foreign telecoms have been promised a level playing field for taking them over. Alliances have already been formed amongst the world’s communications giants, and some of the bidding could get spirited for the fastest growing large telephone market in the world. The surviving Telebras companies are also likely to be world beaters, at least for a few years, as they will be given free reign to rationalize their work forces. For fifty years the federal government has treated Telebras as an employer of last resort for whichever faction was then in power. Government’s dead hand will be removed from the till shortly after June 30, and we could be treated to the heartening sight of fewer but motivated workers finally putting a dent in the multi-year period it takes to get a phone line. At less than ten times earnings, an investment in Telebras has numerous roads to prosperity. This stock was violently battered in last fall’s Asian shakeout, an event it was half a world away from, of course. Yet when global mutual funds have to sell, they sell what they can, not what they should. We think Telebras will prove a neat demonstration of how an ill wind in the strange world of mutual funds can blow us some good.
Sincerely yours,
Edwin A. Levy
Michael J. Harkins