“I hope in favour you will not Emit any more paper, till
what we have at least becomes more valuable.”
Abigail Adams in March, 1777
For the first quarter of 2005 our average account was down -6.39%.
When Mrs. Adams wrote the lines above to her husband John as he was working in the Continental Congress, the British navy was blockading her in Boston Harbor and he was on the run from the British Army in Baltimore, having just been hustled from Philadelphia. None of that carried any weight with Mrs. A. She knew exactly what was causing the tumultuous rise in inflation then causing the dollar not to be worth a “Continental damn”, she knew exactly what ought to be done about it, and she wanted her husband to do it. “Stop the Presses” might have been her command in a less decorous age. Mrs. Adams had a formal education typical for a woman of her time, which is to say precisely none, and yet she put her finger on the issue of monetary incontinence that has bedeviled central bankers ever since.* Adam Smith was just then inventing the science of “Oeconomics”, as Mrs. Adams spelled it, in Aberdeen, Scotland. She had never heard of him, but she still knew that inflation was caused by too much money, and every other excuse was poppycock. She was right.
Alan Greenspan earned a bachelors, a masters, and a doctor’s degree in economics from New York University. He has honorary degrees from Harvard, Yale, Penn, Notre Dame, Wake Forest and Leuven, that last somewhere in Belgium. Yet he always affects not to know that he has anything to do with the prices sky-rocketing around him. If Abigail Adams wasn’t willing to put up with such nonsense from her beloved husband it is hard to see how the American public has been so long hoodwinked by Mr. Greenspan, and suddenly, in mid-February of this year, it was not. Investors who had paid no mind to inflation at the year’s beginning have thought about little else for the last six weeks.
The public’s change of heart is mortifying for us, first because we lost you some money, but next we have been writing you for time out of mind that something like this would happen. When suddenly it did, we weren’t very well prepared for it, now were we? We will be brief in making our excuses, but part of our problem has been that we were both warned in early manhood about central bankers, “Watch what they do, not what they say.” Around the world and at all times central bankers claim to be arch-foes of inflation. A handful of them are, but most are all talk. What Mr. Greenspan is doing now is instructive on this point. He is pegging rates at a very low rate, raising them very slowly and decrying price rises. This practice used to be known as “jawboning”, and it was thoroughly discredited in the Ford Administration as worse than useless. To see why, you might re-read the speech Mr. Greenspan wrote for President Ford on October 8, 1974 as the nation faced its last big inflation. Gerald Ford wore before the Joint Congress assembled a WIN button, for “Whip Inflation Now”. He urged farmers to grow more, he urged Americans to do more sharing, and, we are not making this up, he urged Americans to write lists of 10 ways to fight inflation and to exchange the lists with their neighbors, and to send him copies. The speech runs to eight densely typed pages and nowhere is hard money mentioned. No mention of interest rates or monetary policy is made at all. Luckily for President Ford Mrs. Adams was in no position to write him a letter; it likely would have stung. For six years after his speech inflation raged. Then came Paul Volker, who said virtually nothing but raised the prime rate to 22 percent. That was the end of inflation.
We take you through this thirty year retrospective of Mr. Greenspan’s career not to attack him, but only to speak candidly about how unlikely we think it is that with nine months left in his public life he will suddenly change a lifetime’s habits and go on a hard money tear. His successor, whoever that is, will need time to grow into the job. That means we are at least a year away from any strong action, and a year with negative real interest rates is likely to seem a very long time indeed to today’s holders of long term bonds. The public never seems to grasp how real the losses are when you receive a 4% yield in an 8% inflation, and until there is some enlightenment on that score, monetary policy is likely to remain behindhand and tepid. Consequently, we would rather own shares of businesses that have some pricing power rather than dollars with scarcely any yield. The occasional scary sell off is what we have to live through.
For the quarter we are generally quite pleased with the business results of our holdings, but something has gone on over the last year that we want to crow about. Three times in the last twelve months one of our holdings has spontaneously decided to pay us a special dividend. First Ethan Allen decided last May that it had excess capital and mailed us checks for $3 a share. Then Echostar decided a quirk in the tax law could be utilized to give us a tax free $1 a share. Last but best, Fidelity National decided that it had told the market one time too many that its shares were cheap without result, so it found two sophisticated buyers to purchase one quarter of a subsidiary that Fidelity thought was under appreciated, and sent us a whopping $10 special dividend, which was almost a quarter of the then stock price.
This behavior is really unusual. In less than a year about 15% of our holdings sent us cash out of the blue in dividends that were in no way expected or obligatory. Only businesses that spit out real cash earnings can do this, and they must have managers that treat their stockholders as fellow partners, and not as shills to be gulled, which is unfortunately the all too common practice. This is great stuff, and Farooq Kathwari, Charlie Ergen, and William Foley are to be commended for their values as well as their acumen.
We write frequently that we can tell a good business from a bad one, we know something about the right price to pay for them, and that we need sound managers with the right attitudes towards business and shareholders. That is all we do, in that we do not try to time economic cycles or anticipate sweeping changes in technology or cultural movements. Timing markets is too hard, while evaluating businesses and managers is too straight forward, for us to do anything else. Every now and then we get even this wrong however, and when we do it is time to fess up. Late last year we sold our shares in our long time holding of AIG when Hank Greenberg was first making headlines in an alleged bid rigging scheme with his two sons. The sons were running two of AIG’s biggest brokers, and they were accused of telling customers that AIG had won business in an honest competitive situation when in fact no other bids had been sought, or other bids were in fact actively suppressed. When the allegation was not instantly and forcefully denied, we sold. Without trampling on anyone’s given right to be presumed innocent before trial, what has been revealed in the hundred days since our sales of these shares has proved embarrassing to us. We should have seen that this was a once great business culture that had ossified around a single man. Hank Greenberg is a giant in the insurance field, but AIG is stark proof that a system of checks and balances on power in a corporate setting is every bit as necessary and utilitarian as it is in a government setting. We were slow to see what was obvious and we are taking it to heart.
Even taking our mistakes into account, we are particularly pleased we are just about right in the middle of our fairway; we own shares in great businesses and they are back to being good value. Countrywide Credit sells at eight times this year’s estimate and its chief executive, Angelo Mozzilo, has been voted one of the nations most admired business leaders. With his record, that is as it should be. Fidelity National sells at eight times earnings even after paying us that swinging big dividend in March, and it has done nothing to jeopardize its 34% market share in the title insurance business. When you can pay out big sums and you have not hurt your competitive position, then you know you have a great business.
Echostar announced in March that in 2004 it had added almost 1.5 million new customers on a 9.5 million subscriber base, proving that its growth goes on as vigorously as ever. This is particularly impressive, since it means the gross addition of subscribers before churn took its toll was greater than any year previous. This is something to mull over as the cable companies continue to extol the benefits of bundling. If everyone wants to buy television, internet access and phone service from one provider, how is it that both satellite companies show such vigorous growth? Even better, Echostar joined the list of plain vanilla earnings per share concerns, so that while we still think its earnings are severely understated relative to its increase in intrinsic value, that hardly matters anymore. A media company selling at 17 times this year’s stated earnings strikes us as just a cheap investment.
We now have plenty of those, and so long as the gathering inflation doesn’t get too out of hand, that should stand us all in good stead going forward.
Sincerely yours,
Edwin A. Levy
Michael J. Harkins
