April 16, 2012


Dear Client,

In the first quarter of 2012 our average account gained approximately +11.38%.

A little over a month ago the Federal Reserve released its Flow of Funds report for 2011.  It shows that the central bank bought 61% of all Treasury debt issued last year.  We would like to deliver a heartfelt apology to all of America’s village idiots, who we have repeatedly and falsely accused of running ten year Treasury rates to less than 2%.  They didn’t do it.  Turns out it was a collection of PhD’s from the New York Fed on Liberty Street who did this and we were unaware until Lawrence Goodman of the Center for Financial Stability alerted the world about this on March 28th in a lead editorial in the Wall Street Journal.  And then almost total silence descended.  The largest market in the world turns out to be rigged, and nobody much cares?  This is either insouciance or insanity, and we lean heavily toward the latter.

As Goodman aptly put it, “The conventional wisdom that nearly infinite demand exists for U.S. Treasury debt is flawed.”  We would add that the price mechanism is broken, and that is of fundamental importance because the ten year U.S. Treasury is what every other risk in the world is priced off.

We have spent the three weeks since we learned this pondering how the authorities climb down from here.  We admit to being flummoxed.  Who would ever willingly give up this intoxicating elixir and switch to ginger ale just because it’s good for you?  And what would make them start now?  With inflation hovering near 3% in all the major bench marks, their hands are hardly in the fire.  Markets are full of surprises, and we are hardly prepared to nail our colors to the mast with economic opinion, but it is awfully hard to see how this has a happy ending.  The authorities know just how hard to push this, and not go over an inflationary cliff?

Around the rest of the world, monetary improvidence may be even worse.  Mario Draghi has printed 500 billion fresh Euros since we last wrote you, and it hasn’t been enough to keep Spanish and Italian interest rates in line.  Today’s Financial Times says more bond buying with freshly printed money is to come.  And really, what else is Mr. Draghi to do?  He is an energetic and youthful 63 year old Tuscan, and he will find a way to bend the Bundesbank to his will, or he will be eating schnitzel in Frankfurt for the rest of his life.  It is often useful to remember that the authorities are just people in the end.
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We carry on about the danger of inflation for a number of reasons, but one of them is because it strikes at the very heart of our relationship with you.  We started running “balanced” money with bonds and stocks, and now we cannot because bonds come with outlandish risk.  But in not owning bonds and just owning stocks we have increased our short term volatility.  That is annoying, but so be it.  Bonds are too certain a loser.

And, some part of our reported returns is fictitious because it comes with no inflation adjustment, and in a well ordered world it would.  Finally, every client we have ever spoken to says their cost of living climbs far faster then the Consumer Price Index, and that has been true since we started in business.  The CPI describes the life of the Unabomber and hardly anyone else’s.

Meanwhile, the companies in your portfolio continue to do remarkably well, and are not much phased by our worries above.  Ask Rick Goings about the rising oil price hurting Tupperware and he rolls his eyes and laughs, so immaterial is the cost of resin to his overall result.  Outside of employees, Qualcomm, Google, Apple, Orbcomm, Cognizant, and EMC barely have a “costs of goods sold” line in their income statement.  We loved them for that before, and now even more so.  Our companies have brand names and pricing power, and they are going to need both in the days to come.

On a sunnier front, America’s march toward energy independence, for forty years a pipe dream, has, if anything, picked up pace from where we first mentioned it a few years ago.  American coal exports doubled last year, and with coal prices down 35% from their recent highs, this year is setting up gangbusters too.  All you need to know about natural gas is the price and you can guess at the eye opening quantities that have been found.  It burns cleaner than oil, sells for less than 1/5 the price, and powers busses up Madison Avenue outside our windows.  What a Godsend for America, and perhaps soon the world.  There is a lot of shale in the world, and hardly anyone has gone looking in it yet. 

We are off to a good start in 2012, and with a roster of world beating companies we like our chances going forward.  However, we have a near perfect attendance record because with monetary policy this flamboyant, something could go out of whack to surprise us.  After all, we are up about 28% since our September 30th letter, when the expression “double dip recession” seemed to make up 28% of every paper’s newshole.  The world doesn’t know a single thing more about the future than it did then, but market participants think they do, which is, if nothing else, intensely amusing.

Sincerely yours,



Edwin A. Levy



Michael J. Harkins