October 2005: Extreme Weather
Katrina and Rita did incalculable damage to people’s existence in the Gulf Coast region; the disruptions from which will take years to recover and return to any sense of normalcy. Some people, whose lives were comfortably settled along the “energy coast” in southern climates, have been abruptly transported 1,500 miles north to Utah, Colorado, or Minnesota.
The weather metaphor has, of course, been used often by journalists as a motif for the financial markets. Parallels throughout the language of finance abound in meteorological terminology, and climatologists study long-term weather patterns which, as with the financial markets, never seem to repeat themselves and, given enough time, inevitably revert to the mean. Predicting the weather is just a little less hazardous than attempting to anticipate investor and/or investment market behavior.
During the quarter just ended on September 30, the world’s equity markets have endured just about anything the “weatherman” could conjure; subway bombings in London, rising energy prices, back-to-back hurricanes and a continuing diet of insurgency bombings in Iraq, Afghanistan, and most recently on the once peaceful island of Bali. And still one could ask, as we did in our July 13 letter, If The News Is So Bleak, Why Don’t The Investment Markets Reflect This?
For U.S.equities, the three months just concluded was the first similar period in seven years to end with a positive return. In the statistical record books, the third quarter usually ends in negative return territory. Yet the markets this summer were a calm sea reflecting very little of the surrounding turbulence. During this time, domestic common stock price volatility narrowed further from historic norms, the U.S. dollar rose in value elative to most other currencies and Mr. Greenspan’s Federal Reserve Bank continued to orchestrate a program of gradually rising short-term interest rates navigating back toward ‘normal’ levels. Today, the residential real estate bubble shows signs of topping out. Third quarter, and possibly fourth quarter GDP growth will be constrained by the impact of Katrina and Rita. Third quarter earnings, while ahead of last year’s levels, may disappoint. The congestion of all the above would usually signal pending economic recession, but investors as of now seem not to be concerned. Is this the calm before the storm, the eye of the hurricane, a new investment era in which risk management can be ignored?
Portfolio Strategy
Our interpretation of this apparent disconnect is that today’s threatening news environment is already discounted in stock prices. Investment markets currently appear to be marking time while earnings and company fundamentals catch up with valuations. Further, economic growth lost in the current quarter due to hurricane damage will merely be deferred into next year, and the massive Federal rebuilding program in the southern states, including new levees and the reopening of the Mississippi River Delta area, will provide a fiscal stimulus relegating Boston’s “Big Dig” to Category B status in the annals of public works projects. In the end, rather than driving the U.S. economy into recession, the outcome of Katrina and Rita may be to prolong the prospects for continued growth and rebirth for the South.
So, as was our focus last July, we are continuing to rebalance portfolios away from our previous small company bias and tilt toward value, and instead moving toward larger companies, as well as neglected growth stocks. A glance at the accompanying chart, “Getting Cheaper,” illustrates the improving case for the large company growth stock sector. Price/earnings ratios for this pre-2000 over-valued sector, are today near parity with small and large value stocks. A shift toward this large growth company segment seems to offer a reasonable probability of portfolio risk reduction, plus added upside potential.
Turgid Prose, Elegantly Simple Advice
Occasionally, as in many professions, a book appears which is destined to become a classic in the trade and which, if given time, changes the pattern of behavior among even well established practitioners. Unconventional Success, a “must read,” has recently become available and, although not exactly bedtime light reading, is laden with good advice for those wishing to avoid the mistakes repeatedly made by otherwise intelligent individual investors. The author, David Swensen, Chief Investment Officer of Yale University, began his effort expecting to provide individual investors with many of the portfolio management techniques he learned while running Yale’s now $14 billion endowment over the past 20 years. His remarkable record (16.1% per annum since 1985) was achieved through a skillful application of portfolio asset class structure, periodic sector rebalancing and utilization of marketable, as well as unconventional securities, some of which he designed himself.
As he describes it, while writing the book, the more he got into his subject, the more he realized how disadvantaged the average individual was when attempting to implement effective long-term investment programs. This was particularly so when it came to researching and selecting actively managed mutual funds which deliver consistent benchmark-plus value on an after-expense and after-tax basis, measures to which most individuals pay very little attention. Although our business isn’t reviewing and touting books, this one strikes us as insightful and well worth the time spent to absorb its useful practical advice. Of course, we would not recommend it if it didn’t comport with our thinking and approach, much of which you will recognize the author to be in lock-step with throughout.
Worried About Identify Theft?
Beginning September 1, 2005, residents of MA (in fact, all states now) are eligible for a free credit report from the three main credit agencies (Experian, TransUnion, Equifax) on an annual basis. By logging on to www.AnnualCreditReport.com and supplying personal information, one can link to the three agency websites and request a credit report online. The report can then be printed off immediately – these reports do not contain the FICO score that mortgage companies look at, but if that is desired, it can be purchased for $5 or $6 depending on the site.
We recommend that everyone review their own credit report periodically to ensure that all information is accurate and also that no one else has accessed your credit records. There is much talk in the news regarding identity theft and privacy issues, especially related to the frustrating (and potentially expensive) hassle that can ensue if someone does, in fact, steal your identity. Please review your credit report and if you find inaccuracies, report them to the individual agencies immediately.
Looking Ahead
Managing other people’s money is a business concerned with the future, trying to understand current relative values, assessing the probabilities of various outcomes. As we look forward, we see trends in our profession and amongst our competitors which appear to be opportunities for the firm. Our challenge is to take advantage of these openings, continue to provide attentive client service, maintain a creative investment process and deliver a useful result to those who have entrusted their financial planning and/or investment accounts to us. TFC is a growing enterprise (primarily through referrals), its staff and professionals are dedicated to maintaining a high level of competence and client service, justifying your continued confidence in our ability to deliver.
Changes are ahead of us. With this letter we are including a revised fund tracking report which reviews funds by rank order of performance, as well as asset class and market sector returns. The latter analysis is important to our portfolio structuring process, and we hope will supply a broader context for you to interpret performance results. Beyond this, probably in mid- or late-December, we anticipate moving into new space at 30 Federal Street, close to the Post Office Square underground garage. At this new location we will provide parking for clients coming into Boston for meetings.
Our new offices will also have facilities for clients to rendezvous with others and conference room space for our client non-profit boards wishing to hold downtown meetings. Our new website will also be on-line during the next few weeks, and early in 2006 a client portal will allow password-protected access to your investment portfolio information. We will also be distributing client quarterly review information through the website and/or as e-mail attachments to those who would prefer it. Probably next spring, web-based teleconferences with clients will be offered.
Finally, a few new officer title alignments have been implemented. Renée Kwok has been elected President; the writer becomes Chairman and Chief Executive Officer. These changes reflect Renée’s increasingly important role in the firm’s future. However, she will continue to work closely with many of you, supported by our team of professionals. As communicated with you in the past, we have made the strategic decision to remain an independent entity, a private firm without strings attached to any other institution. Our transition and succession plans, which will unfold in the years ahead, includes the assumption that we will promote from within and continue to develop the talent presently a part of the firm.
Please do not hesitate to call us if you have comments or questions.
Sincerely,
James L. Joslin
Chairman, CEO