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| July 10, 2006 |
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| Dear Client,
For the first 6 months of 2006 our average account gained approximately +1.30%. For the first six years of the new century, our investment returns were far better than average experience. For the last year and a half we have been utterly ordinary, meaning our returns are right in line with stock market averages. These last six years have also seen the least turnover in our portfolios that we have ever known, even less than the already languid pace we had known in the twenty years before. This begs the question then, if the lineup is slumping, why not change the players? This is a completely legitimate question and we are not setting it up as a straw man. Obviously we will get antsy too if bland performance goes on long enough. But we also grew up reading Benjamin Graham, and he said Mr. Market is a manic-depressive, and the key to successful investing is to accommodate him, not anticipate him. When he wants to buy from you at a wonderfully high price, accommodate him. When he wants to sell out on the cheap, let him. However, what do you do when the companies whose shares you own keep gaining value rapidly, and Mr. Market pays no mind at all? That is our predicament at the moment. Over the last two years Nike has seen its profit rise by 21%, and the earnings per share rise by 24%, because of an aggressive share buyback scheme. The margins are marvelous and the brand name gets better and better. Mr. Market doesn’t care. Echostar has seen its profit go up 68% in two years, paid off $1.5 billion in debt, and increased customers count by 2.5 million. Mr. Market yawns. Bear Stearns and Countrywide Financial have shown phenomenal growth, and Market rewards them with single digit multiples. To be sure, Mr. Market has his reasons for why his mind might be elsewhere. We have a new Federal Reserve chairman, we may be having new Congressional leadership, and we unfortunately have the same old Iran and North Korea. These are weighty matters all, and we do not claim to have any particular talent in handicapping any of them. Still, because these issues so dominate the headlines perhaps you will give us a few minutes and we will share what we think. Paul Volker was a giant who led the markets where he wanted to go. Where he wanted to go was the highlands of no inflation, and the markets came along only after quite a tussle. Alan Greenspan followed markets, and the markets found him a much more congenial soul, so much so that he has acquired a reputation much greater than his achievements. Ben Bernanke was likely to generate uncertainty whatever he did, and a few stray comments of his own haven’t helped. However, we doubt very much that Mr. Bernanke will push over any apple carts. He has no mandate to, and he simply doesn’t look like the type. Indeed, his greatest problem is that his Board doesn’t seem to show him much deference. The governors of yesteryear followed Chairmen tamely. This lot seems to see themselves more like Supreme Court judges, empowered to disagree and firing off opinions all the time. The noise makes the markets nervous, but we doubt it has any lasting impact. Congress is another matter. They are always noisy, but the change of just six seats in the Senate or fifteen in the House could mean a new noise with a different intent. As just an example, Charles Rangel stands in line to be the next Chairman of the Ways and Means Committee if the Democrats gain control of the House. Those of us who have followed his career closely here in New York know that cannot possibly be good for the monied classes. The rest of the country, never having heard of him, is in for an earful. This may never come to pass, of course, but there is no denying its unsettling effect today. The simultaneous showdowns with Iran and North Korea, while war rages in Iraq, produce almost every day more column inches than all other domestic news combined. Stock prices have long correlated closely with presidential popularity, and if there is a popularity enhancing outcome to any of these three crises it is evading us. All three problems are long in the making and seem likely to be bedeviling presidents long after this one. For investors, that is the salient point; these problems are just not going away. There is always an endless supply of troubles in the world, and those of your own time always seem the most intractable. There is never, though, more than a small supply of very good businesses selling at attractive prices. Businesses that produce real cash, with managers who have the shareholders interest at heart, and which have protective moats around them from competitors, do not come along every day. When you own a collection of them, they grow, and the growth grows unrewarded, you can get kind of testy about it. In the midst of a very hot summer, that is about how we are right now. Sincerely, Edwin A. Levy Michael J. Harkins James B. Lebenthal |