I was a registered Washington lobbyist, I’m a superb bridge player….
I can do a lot of other things.”
A mutual fund manager, quoted in the Wall Street Journal,
on why he does not fear a bear market.
With no false modesty, we would like to note that the talented fellow at Founders Asset Management quoted above neatly illustrates, with an eloquence we could never bring to it, the difference between our firm and a mutual fund. We have been, between us, a tank driver, a waiter, a crop duster and a sailing instructor. Sailing for pay is cold, wet, rotten work, and it is the best choice of our previous occupations. Too many of you know too well the extreme poverty we would be respectively thrown into were we to be forced to fall back on our golf or tennis games. In short, unlike our robust competitor above, we do not have a fall back position if Levy, Harkins & Co. doesn’t pan out. Since so many of you have the bulk of your life’s savings with us, we thought you might find a frank acknowledgment of our modest accomplishments a comfort, especially if you had seen on your own the newspaper article where this young man confidently prepares to leave the scene of an accident.
Levy, Harkins & Co. must succeed, or Harkins and Levy will begin to lose weight at a rather alarming pace. And to succeed we must survive. This is not the attitude of the typical mutual fund manager, who invariably owns no part of the management company he works for, has no investment in the fund he manages, and has no scruples about going to work for the firm down the block with a fatter pay envelope. More than once we have marveled at the savoir faire of fund managers taking corporate managements severely to task when the insider filings show a tiny reduction in management’s ownership, while the Wall Streeters themselves have no interests in the funds they manage except those directly at odds with the investors’. Indeed, the incentive system of the mutual fund decision-makers could scarcely be more perverse. They must lead the league standings for some period of time, and that period of excellence grows steadily shorter with every passing week of the bull market, in order to trumpet their achievement in the popular press. The number one manager gets the lion’s share of the new money flows, number two gets enough to wax fat, and everyone else gets table scraps. How much risk are mutual fund managers willing to hazard with the money in their care in order to be number one? Let every man search his own soul for that answer.
The excesses in the mutual fund bubble have badly skewed valuations within the stock market. “Story stocks”, by which we mean issues with fabulous business plans and barely ticking businesses, now regularly command valuations in the billion dollar and more strata, when five years ago a fraud that sold at a hundred million dollars was noteworthy. At the same time, however, value in shares both here and abroad is not that hard to come by; now that we have mostly sold our very overextended oil drilling stocks, we can easily believe that our current portfolio might last us two or three years. In the midst of a stock market that sells for record high valuations, how can that be?
That the nation is in the grasp of a mutual fund mania is an obvious truth, but one that not so obviously obscures an even greater truth. Conditions have never been so bullish. The death of communism, an event that is still treated in the United States as a foreign policy issue, something that happened in Berlin with consequences for the Russians, has had profound knock-on effects in America, and they just keep on coming. Consider the devastation wrecked on the average West side liberal here in Manhattan, now that every form of collectivism stands in smoldering disrepute. We are ten months away from a New York mayoralty race, and the Democratic Party cannot find a candidate in the home of radical liberalism. Rudy Giuliani has cut welfare roles by five percent, fired free spending school chancellors, held government spending flat for four years, and may be presiding over the end of fifty years of rent control. Yet the city’s liberal establishment can’t seem to start a fight with him. Why not?
In New York, when we say collectivism’s death is a home issue we suddenly find we mean it quite literally. Rent control, surely the wackiest form of income re distribution ever devised, is under serious attack for no better reason than that it hurts the city’s tax base, harm’s the city’s housing stock, and is generally unjust. That this has been true for every one of the fifty years of the “Temporary Housing Emergency Acts” existence is, of course, true, and has never had even the slightest role to play in the debate previously.
The completely changed set of assumptions about the proper role of government, assumptions that scarcely ever undergo examination, and yet are at the heart of what makes the last few years of this century so very different from all the rest of it, are also the motive force driving share values beyond levels known in this century. James Grant, in his imminently readable new history of the century’s finances, The Trouble With Prosperity, observes that the government bond market in the second half of the century was called on to finance, with becoming ease, “World War II, the GI Bill, the Marshall Plan, the Berlin airlift and the containment of Soviet power in Europe.” He might also have noted, the War On Poverty, the Interstate Highway System, the TVA, Aid to Families with Dependant Children, and Space Exploration, all government efforts, each of them profitless, financed out of the public market for funds, and for the most part it seemed without particular cost. Can any of us imagine a clarion call for a space race today? Indeed, were Catalina Island unexplored territory today, it is doubtful whether any level of government could summon the will, the money, or the know-how to find out what was on it.
We see now the hidden costs in tapping the public markets for all of these past programs, most of them misbegotten, in part by observing how robust financial markets are now that they are gone. And, or course, the greatest change isn’t simply that government has stopped competing for funds.
Imagine, for a moment, that we awake one morning to a nationwide report that reading scores amongst Chicago primary school students have plunged. It is completely predictable that after a panel of notables is hastily called together to discuss the matter, nothing will be done about it; certainly nothing that costs money. Now imagine instead that one of the Japanese banks so long teetering on the edge of insolvency finally succumbs, closes its doors of a Sunday night, and its demise leads to a threatened chaotic share opening in New York Monday morning. The Federal Reserve and Treasury officials who meet with the President before the start of trading will give no thought to the budgetary implications of whatever actions they decide on, and Congress will be approached as an afterthought for whatever authorizations are necessary.
If there is never such a collapse, and indeed nothing worse than a Mexican bailout is ever again in the cards, it does not in any way lessen the bullish implications behind the profoundly changed assumptions. Stocks have long been known to be greatly superior investments to confiscatory bonds, particularly in times like these, when an inflation soon on the boil is being suppressed mostly by wishful thinking. The rub was stocks could go down, and the quotational loss over a year or two could scare the wits out of anyone. How much more valuable are equities if government impulse provides no competition for equities in good times, and society’s most trustworthy safety net is sure to be extended to them in bad times?
Every month stock market historians point out that stocks have never sold at such scant value to dividends, book values, earnings and bond equivalents. Their unstated, but linch-pin assumption, is that the last hundred years closely resembles the next ten. Yet every month we are all taken by surprise by some ancient social compact under fresh and bewildering assault. Two months ago a Democratic President eliminated means-tested welfare in the middle of a landslide electoral triumph. Last month the inflation rate was treated by Professor Boskin like a back dated check, the government informing you that what you had long thought you’d lost, you unknowingly had gained. This month comes a proposal for Social Security reform, one that threatens to turn men and women untalented in the financial arts out into the street, should they not meet the performance bogey on an account they had thought for a lifetime was guaranteed.
When social changes grow as predictable as this, and all of them in the same direction, we no longer have the right to record them as surprises. Obviously the 80% of humanity that have joined the capitalist world in the last decade are a great story; far less appreciated is the profound change in Western society too.
To miss out on the golden age of capitalism, especially in the face of a gathering inflation with such evident power, would be an error hard to make up. A decade of good decisions in ordinary times is not likely to match the more than 60% gains we have made in the last two years. Still, we mean to be plenty alert should the government and officialdom fall, even just a little bit, out of love with the market and its ways. As one friend says, this is a delightful party, and it’s best to dance nearest to the door.
Wishing you and yours the best in the New Year, we are,
Sincerely yours,
Edwin A. Levy
Michael J. Harkins
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In 1996 our average account gained +27.3% from all sources, inclusive of all fees.
The statistics below are also from 1996:
*GDP Price Deflator…………………………..…+1.8%
*Consumer Price Index………………………..…+3.3%
Average Treasury Bill Rate……………………....+5.1%
Standards and Poor 500 Appreciation………......+20.3%
Dow Jones Industrial Price Appreciation……….+26.0%
Investor’s Daily Mutual Fund Index…………….+12.9%
*Source: Bloomberg
Note: The figures above represent the composite performance of all fully discretionary, balanced accounts. These figures exclude accounts managed for less than 6 months, accounts using short selling and accounts consisting only of fixed income investments, to more accurately reflect the past performance of fully discretionary, balanced accounts. However, past performance is no guarantee of future results.