For the first half of 1997, our average account gained approximately +7.12%.
In our last letter to you, we extolled the investment merits of Guinness PLC. Then we promptly sold it. We had meant to hold it for the long term. So you might reach for a pinch of salt whenever you are reading any investment advice that gets produced every ninety days, including ours.
Guinness was a pleasure, in that we made a fine profit in a short amount of time: and a disappointment, since the proposed merger between Grand Metropolitan and Guinness is exactly the sort of “empire building” combination likely to rob both companies of their full potential. Blessed with fabulous brand names, the likes of Pillsbury, Green Giant, and Smirnoff for Grand Met, and Dewar’s, Johnnie Walker and Guinness Stout for Guinness, neither company has been run as though it had an overwhelming urge to make its shareholders proud. Indeed, why should either giant take any of the unpleasant steps sometimes necessary to turn sleeping giants into vigorous multi-nationals when neither George Bull nor Tony Greener, the respective chairmen, stand to benefit in any significant personal way from the effort? The City of London culture, where generous options packages are seen as American crassness and aggressive re-structurings are just not done, almost guarantees that this merger will disappoint a few years down the road. Hence our exit.
Left to find another fine branded goods company, outside America, at an attractive price and with a disgruntled shareholder list, we have been really hard pressed. As you can see in your account, so far nothing has come to mind as an acceptable replacement. If you are a money manager determined to stick to a value discipline, and we are, this is a time when all sorts of sales, some “accidental” like Guinness, and others driven by overvaluation, are going to happen. You are likely to see us raising considerable amounts of cash in your account by the fall, and it will have very little to do with any global “bearish” statement. Prices are just very high.
However, our Guinness experience has also given us a fresh appreciation of the bull market in America. The shares that have gone up the most in the U.S., and made keeping up with the averages so extraordinarily difficult, are also American brand name companies that are the class of their field. Of course, they sell today at prices never seen before, prices that turn value buyers like ourselves stone cold. Much of this has been attributed, perhaps too cynically, to the buyers of index mutual funds and their know-nothingism when it comes to the historical perils of common stock ownership. There is much in that, but it is not the whole story.
Amongst its other hideous flaws, communism was an enormous barrier to free trade, in the obvious sense that Russians could not frequent McDonald’s. But the death of collectivism as an ideal has had the more subtle but profound impact on the previously non-communist states. Consider that the Indian government casually but effectively outlawed Coca-Cola to 1/6 of humanity with nary a peep from their own population or from the giant’s lair in Atlanta. To be a multi-national just ten years ago was to be identified as fundamentally evil, and to prohibit the expansion of worldwide brand names was seen as a blow for justice. Today, anyone in the world further than a block from a Nike store believes his fundamental human rights have been abridged, and redress is demanded. Interestingly, no U.N. commission ever met and no non-aligned summit meeting was ever held to bring about this astonishing change. Attitudes changed, and that was enough around the world. But it has redounded overwhelmingly to the benefit of American firms. Americans are natural proselytizers, who can scarcely be imagined going through the fits of self-induced identity agony a company like Mercedes felt necessary to subject itself to before opening a foreign facility. Two decades of diversity training also mean we do not give a thought to foreign born executives running subsidiaries, or indeed parent companies. This proved an overwhelming barrier to Japanese efforts at globalization a decade ago, and they have scarcely made any progress since.
Our business organizations are English speaking, and run by people who think of stock options as more important than salary, which is sometimes an opportunity for abuse but always an incentive for growth. We are far better off than any of our major trade competitors to take advantage of the homogenization of world consumer markets as the leading American brand name companies.
That the bourgeoisie of the world have united, and wish to shop in all the same chains wherever they are in the world, is a topic much on our minds these days. Were you to take a stroll down the Fauborg Saint Honore, and then Bond Street, the Kurferstendam, Madison Avenue or Rodeo Drive, and chop the second floor off of every building as you passed, you would have almost no visual clues to tell you where you were, because the store names are all the same. The world’s major shopping thoroughfares, wildly disparate ten and twenty years ago, have a cookie-cutter uniformity to them today. This is a trend coming to a suburb near everyone soon. It is also what has drawn us to McDonald’s. We are aware that competitive pressure in America have for the moment made same store comparisons rotten. All the same, McDonald’s stores outside of America average 50% greater volumes than domestic locations, and sometime next year there will be more there than here. Big Mac can afford price wars here far better than their less international fellows, resembling, we hope, Coca-Cola of fifteen years ago when price wars broke out with Pepsi. We all know how that turned out.
What would otherwise be a delightful year has been taken hostage in recent weeks by our gold share holdings. They are modest in size and immoderate in agony. Gold has every reason but one to go up, as the world currently consumes forty percent more gold than it mines. Unfortunately, that one contrary reason, that central banks are disgorging gold, is animating every newspaper editor in the world. The level of gloom, a measurable thing in commodities, is at record levels. We have been wrong about the extent of central bank selling, but in our defense some of their actions have also reached the nonsensical. In the last week, the central bank of Australia has touched off a fresh round of despair, aggressively selling two thirds of its holdings while simultaneously discomfiting the country’s second largest exporter. The resulting damage to an industry that employs 40,000 Australians appears to leave the Bank of Australia untroubled, although it has occasioned a friend to observe there may be a few more sheep down under than he had previously realized.
Two things should be born in mind about our gold investments. First, we would not have made many of the other investments we did make had we not owned it. The world is priced for perfection, and gold is a refuge when things go wrong. We have understood why the world should pay much higher prices than were ever previously accorded to equities, but that is not to gainsay that higher entry prices in and of themselves guarantee greater risk should anything go substantially wrong. Secondly, gold is in an unsustainable imbalance between supply and demand, and while long suppressed cyclical investments can be a trial to work through, they are immensely rewarding in the end. Think about our commitment to drilling rig companies three years ago. A very modest increase in the underlying energy prices created an astonishing rise in the shares of rig companies. You will recall there was not one rig on order anywhere in the world when we started, implying a depreciable life for the rig fleet of 540 years. This seemed a touch unrealistic. Wall Street is prone to these immense mood swings, perhaps because it is so male dominated. Women, on the other hand, always like gold. They will triumph in the end.
Sincerely yours,
Edwin A. Levy
Michael J. Harkins