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September 30, 2002

September 30, 2002

Hi, it’s September 30 and I’m writing to share our activity and to explain our outlook.

WHY WE ARE NOT WORRIED

We are holding cash, foreign currency bonds, gold shares and a small percent in U.S. Stocks with very low P/E ratios. We are not heavily invested, and what we do own are mostly contra-cyclical to U.S. stocks. We are currently 30 months into a major bear market in U.S. stocks. Many tech leaders of the 90’s are down over 90%, the NASDAQ is off 80%, the S&P 500 is off 45%. This 45% decline matches the ultimate 45% decline of 1973-1974 bear market. The duration of 30 months about matches the duration of the bear market of 1929-1932.

Psychological depression is spreading among market participants who have been fully invested all the way down. We, on the other hand, are not depressed. We see opportunity on the horizon. Many stocks, but not the market as a whole, are at the best values in 25 years. If the major averages fall another 10-15% we will be at the best values since the end of World War II.

LONG TERM ECONOMIC GROWTH IS THE KEY TO STOCK MARKET APPRECIATION

We believe that although psychology drives stock market prices in the short run, it is economic growth which determines long term stock market valuations. Today psychology is panicky, and fear is rampant. The corporate corruption which comes to light after every market bubble brings fear. Fear of a war is creating uncertainty about the availability of oil and uncertainty about the costs of the war. Fear of more losses perpetrated by 2 1?2 years of declining market, have created very low valuations for many stocks and a long bear market.

However, stocks represent ownership stakes in many different businesses. These businesses function well or poorly based upon economic activity. Today, economic data says we have growth. Economic growth, though slow or moderate, is still economic growth. The National Association of Business Economists expects six more quarters of modest economic growth of 2-4% per year. If the economy grows, businesses grow. Eventually the stock market becomes valued based upon the value of the underlying companies, many of which will be expanding.

MOST EVERYONE IS PESSIMISTIC

I am becoming more optimistic daily. I believe we are within a few weeks or months of a market bottom. My contrarian instincts are thrilled that I am hard pressed to find anyone who is bullish on U.S. stocks. Many are saying U.S. market will continue to fall for years to come. The same people who felt stocks at Dow 11,500 could double now see disaster ahead with Dow at 7,500. Having studied stock market history from the Railroad stock collapse of the 1870’s through today, and as a professional participant in markets from 1968 to the present, I can find no reason to be depressed or pessimistic.

THE HISTORIC FACTS ARGUE FOR OPTIMISM

Lets talk about the biggest bear market of my lifetime, the bear market of 1973-1974, which was second only
to the great depression of the 30’s in severity. At the bottom in October 1974 the market had fallen about the same percentage that it has this time. Today the S&P 500 is down 45%, speculative stocks are down 80%. In 1974 the economic background was much worse than it is today. We were in the worst recession since the great depression. It was being exacerbated by an oil embargo, replete with gasoline shortages and wage and price controls. Further, we were just in the process of losing major war in Vietnam and our national psychology was badly damaged by riots on college campuses, divisive arguments about the war and the impeachment and ultimate resignation of the U.S. President. To put it mildly, it was a difficult time for the country, for the U.S. national identity and for the markets. After the S&P 500 bottomed in October 1974 it went up over 80% within 2 years. Many stocks did even better than that.

It is true we have been fortunate to have been out or very lightly invested in the market for most of the last 2+ years. Our strategy has always been to (1) make money when its easy to make (in a rising market) (2) do not lose money when its easy to lose (in a falling market) (3) only enter the market after a bottom has been established (4) know your companies well and be able to anticipate the effects of demographic, economic, political, tax and other events on companies before we purchase them (5) cut losses or cut off profits if the fundamentals of the company deteriorate or if the management misrepresents company prospects.

ARE WE AT A MARKET BOTTOM?

We are close. I don’t know if the market will bottom in October 2002 or in a few months but should the markets fall another 10-15% they would be completely oversold and at a once every 50 years bargain prices. The only major risk that could delay a market bottom would be major interruption of energy flows from the Middle East caused by biological, nuclear or chemical warfare or destruction of the oil fields. Such a dislocation would cause a worldwide recession/depression and delay onset of a bull market. We give this a 10% possibility of occurring. More likely, a war in Middle East would be like the Kuwati war of 1991. Which would not cause long term economic hardship.

HOW ABOUT FOREIGN MARKETS?

Foreign markets depend upon U.S. market for leadership and upon U.S. orders for demand for their products. The U.S. is offering no leadership and we are consuming less goods from foreign companies. These trends spell bad time to buy foreign stocks. Foreign stocks will rally after U.S. stocks have rallied and U.S. economic growth expands.

WHAT IS GOLD DOING?

Gold is rising slowly as a result of a number of variables, increased demand, decreased supply, complexities of hedging, global political insecurities and a weakening U.S. dollar and Japanese yen.

CURRENCIES?

The U.S. currency should continue to slowly decline as U.S. and foreign governments pump their money supplies, possibly lower taxes and engage in bail outs of financial institutions (banks and insurance companies).

WHAT DO WE BELIEVE NEEDS TO BE DONE TO IMPROVE WORLD STOCK MARKETS?

Firstly, we should create confidence by expanding European, Japanese and U.S. money supplies at a 10% annual rate. Second, throw the resources of all governments into a program to stabilize major financial institutions. Let bad debts be written off in Japan, Europe and U.S. (but be sure to let only small banks fail). Large banks cannot fail without decimating investor confidence. Thirdly, lower interest rates in Europe, Japan and North America. And lastly cut taxes. This is the most problematic of all of the needs. Populist politicians want to raise taxes. Lower taxes are necessary to increase investor confidence and to make risk taking a rational alternative.

We expect to see a concentrated effort to accomplish these in the not so distant future. Then, the market should begin to rise.

HOW WE ARE POSITIONED NOW

Presently, we hold currencies mainly Euros or German government bonds denominated in Euros. We hold a small percent of our portfolios in very cheap U.S. companies. We hold 3% in gold stocks. This was 15% until we took some profits recently. We will buy gold shares on dips and sell them when they rally.

The main thing we are doing is holding cash and waiting for the market to find a bottom. We expect this to happen within the next few months. It has been a long bear market, longer than we had anticipated. However, because the market has fallen so much very good values are beginning to appear which will make the wait worthwhile.

For those accounts who can also sell short we will also be putting out trading shorts (not long term investment shorts) to benefit from the markets volatility.

SUMMARY

In the 38 years since I graduated, University tuitions have risen about 1200%, automobile prices are also up about 1200%. How does one keep up and maintain ones buying power in strong inflationary times such as we have had, and will have, in the future. Invest in stocks. Over the long term bonds yield 4% year. Stocks 8-9% per year. 7% compounded over 38 years gets you the 1,300% you would have needed to maintain your buying power over that period.