At year end 2014 our average account appreciated approximately +4.85%.
We struggled last year. We were much too early in thinking that interest rates would have to rise, which is
to say we were dead wrong about it. And we watched a revolution eat its children, as the American oil boom
consumed the stock prices of every company involved, even the ones who created it. We should have better
anticipated the latter, but more on this in a moment.
The plunge in bond yields is a worldwide phenomenon and breath taking in its scope. Japanese 10 year
government bonds yield 3/10 of 1 percent, Germany’s are ½ of 1 percent and ours are at 1.96% as we write.
British yields have never been so low in 400 years of records. We do not take back a word of what we’ve said
about the riskiness of this to the buyers or the obvious war with arithmetic that will without doubt one day be lost
here. But it is what it is, and fighting it was foolish. There is one discount rate at a time, and Levy, Harkins must
accommodate ourselves to it, as must everyone else. In conceding this are we also denying that the rate is
obviously manipulated by quantitative easing and the other machinations of 21st century central bankers? Of
course not. But “consistency is the last refuge of the unimaginative,” as Oscar Wilde sagely observed long ago.
Oscar also died penniless in Paris, we would observe, which means we are going to keep up our perfect
attendance records and watch the central bankers like hawks. Ultra low rates have now gone on for so long as
to seem almost permanent. We wonder if one day that seeming stability isn’t seen for near madness.
Easy monetary policy is roaring along for yet another reason. The dollar is phenomenally strong, up last
year against all 32 major trading partners. In the 21st century this means something new and different. It means
monetary policy in every developing country, including most notably Mexico and Brazil to our immediate South,
just got much tighter. Third world countries borrow in dollars, and when those dollars are harder to get it means
trouble. Since so much of the world’s meager growth in recent years has come from the third world any policy
tighter than this is unwelcome in the extreme. Janet Yellen is more than an astute enough academic to know this,
and she can explain to the duller members of her crew that collapsing
commodity prices, including oil, are part and parcel of the strong dollar phenomenon. So if the scheduled
departure time for higher interest rates was meant to be this mid-year, look for bad weather to push that back.
So where are we now? Well, with stocks up about 10% in 2014 and earnings up about 5%, shares seem
to be dearer. But we doubt it ourselves, because a stock price, at least in theory, is meant to be two things at
once. The price of any asset is an expressed fraction, with the numerator the cash flows you are likely to get
from it through all time. That numerator is also a bit of a vamp, because she wiggles all the time and therefore
she gets all the boys’ attention. The other part of the fraction is the dowdy denominator, which is normally by
convention taken to be the ten year government yield, and that has gone from 3.03 the last day of 2013 to 1.96
today. If you take that much reduced denominator to heart, then stock prices have actually lagged by a good 30
to 40%. Is that likely to be caught up? That depends on a lot of things, including the state of confidence in all
things financial. But we surely can say the answer is a definite maybe, and that is a lot of money that might be
lying on the table.
Our other mistake last year was selling a modest amount of our oil service stocks when we ought to have
sold a major amount or, indeed, all of them. Partly we got swept up in how well the two individual businesses
are doing. The CEO of US Silica, Bryan Shinn was in Friday’s Wall Street Journal acknowledging that oil
companies will drill fewer wells this year, but noting they are greatly increasing the amount of sand they use per
well. Sounds like our last letter to you, doesn’t it? So Silica is still expecting to grow this year. When asked
about potential job cuts he says, “We’re not even talking about that. If anything we might be looking to add
jobs as opportunities arise.” At 10 times earnings and with explosive growth we just think we will exit at a far
As for Baker Hughes, it announced in mid-quarter that it was being acquired for a sizeable premium to its
then price, and by no less knowledgeable a buyer than the Halliburton Corporation. This is value investing at its
core. Ben Graham taught us to always be looking for stocks that are selling for much less than an informed
investor would pay for the whole company if he could. Who knows more about oil fields than Halliburton? But
Ben Graham couldn’t have foreseen exchange traded funds, which rule the roost these days. While Graham
wanted his acolytes to emulate the cognoscenti of the market place, ETFs celebrate know-nothingism to a fare
thee well. When a group is going up, and your stock is on their list, wheee! The ride is on. Same thing on the
way down, and damn the distinctions that might exist between the hundreds of stocks in any individual ETF. In
the short term is this ever exasperating. But in the long run it ought to benefit us greatly. When the other side isn’
t even trying, our odds of winning have got to go up.
With American shares flirting with new highs on a near weekly basis it’s only prudent to wonder where are
we now, or even why don’t many of the world’s manifest troubles express themselves in a more concrete way
with a sell-off? Well for one thing, the world’s troubles are only serving to better mark American
exceptionalism. Another quarter has gone past, and with the notable exception of our Canadian friends, only the
Americans are benefitting from the miracle of shale fracking. If we better accounted for our natural gas liquids
consumption and acknowledge our strong coal exports, the United States is on the cusp of energy
independence. If the current administration allows for crude exports we will be there shortly. It was only 5
short years ago when President Obama was asked about American exceptionalism and he replied he believed in
it, “the way Greeks believe in Greek exceptionalism.” How’s that judgment looking now? And American
exceptionalism does better than confront our enemies, it confounds them. After all, an expanded Navy costs
money and can set off an incident with the Russians. A boom in our energy production discomfits them and a
host of other miscreants besides, while lining our pockets in the doing. That is a rare success in life, and the
successes don’t stop there, or even just at an elevated GDP number. Can anyone believe that Apple made its
first cell phone just 7 years ago? Where is Nokia now? Or that Europe’s GSM dominated Qualcomm’s
CDMA less than a decade ago? GSM is a museum piece today. Indeed, so sclerotic are our European
competitors today that Tom Gaynor’s witticism from 2011 bears repeating today. “My problem with
quantitative easing is the dollar is just an IOU,” said the chief investment officer of Markel Insurance, “and the
Euro is just an IOU from who knows who.”
The flip side of Mr. Gaynor’s observation is watching real estate prices rise in Paris, London and New
York. No one can be paying these staggering sums because they are merely seeking shelter for their families
and their pets. $20 million aeries are at least as much a commentary on what they think a million dollar bill, or a
billion rubles, will be worth in ten years time as it is a need for an abode. It brings us back to our observation of
a few years ago. In 2009 we watched investors sell shares in sound companies out of abject fear. We wonder
if before this is all over we won’t see them buying shares in even greater terror.
With all our tribulations in 2014 we still like where we start out 2015. For one thing, if the earnings come
through then our oil field service problems will take care of themselves. As Halliburton proved, there is always
someone on the prowl for cheap. And then again, not making as much as we should have last year can be made
up quickly enough; at this level it could be as quick as a simple quarter. Outperforming in good times is not the
trick that leads to success in investing. Not getting pinned with big losses is. To that end we would note that a
dollar invested in Levy, Harkins on opening day, January 1, 1980, would be worth $61.50 at 4 P.M.,
December 31st, 2014. That’s 12.49% for 35 years. This is nothing like a guarantee as to what the next 35
years holds in store. Indeed, right about now no doubt we all would like a guarantee there will be another 35
years. Our point is just that long term value investing works, it works for just about every single soul who has
given it an honest try, and that with enough doggedness for long enough the results can be well and truly amazing.
Edwin A. Levy
Michael J. Harkins
Levy Harkins Rates of Return
Since Inception 1980
Rates are Compounded Rates of Return After Fees
Year End 2014……….…………….+4.85%
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. These numbers are after all fees. However, past performance is no guarantee
of future results.