|January 9, 2012|
In a year full of gruesome news and wild volatility we produced a loss, but only a small loss, which is the only comely thing one can say about losses.
The news continues to be Eurocentric. Bailout scheme after bailout plan comes, is debated, is briefly celebrated and quickly dies, now in monthly intervals. A little over a week ago the new European Central Bank President Mario Draghi unveiled a new twist, suddenly lending €490 billion to banks on three year terms against all sorts of collateral. To put that amount in perspective, it represents about 78% of the entire size of the U.S. Federal Reserve on January 1st, 2008. He says he is coming back for another round on February 29th, of indeterminate size. No one knows if this is to be an every other month thing. All Mr. Draghi will let on is that this mustn’t be seen as an outright purchase. There is something Lehmanesque in this denial, but it seems to be acceptable to the German public mind, at which it was of course aimed.
Gideon Gono has been quoted in the Financial Times as saying this is all too much. The Federal Reserve, the ECB, and the Bank of England are courting disastrous inflation, and he would like to start putting his countries reserves in China’s renmimbi. Mr. Gono, as you no doubt remember, is the President of the Central Bank of Zimbabwe, and he has been since 2003. He is also, therefore, the creator of the 10 billion Zimbabwean dollar utterly worthless banknote, now trading in the aftermarket at about 10 American cents. Considering the 10 billion dollar note was introduced on August 1st, 2008, it is safe to say Mr. Gono knows from inflation. Paul Krugman says Mr. Gono’s worries are nonsense, that the world isn’t printing and borrowing fast enough. Mr. Krugman has a Nobel prize, a bi-weekly New York Times column, and a Princeton professorship. We think Mr. Gono’s worries should be heeded, and the adoration of the Princeton undergraduates dismissed out of hand. In creating inflation, one of these guys has hands on experience, and it isn’t Professor Krugman. Mr. Gono can see into the minds of his fellow central bankers better than we know.
The whither inflation debate affects everyone on Earth, but paradoxically the rich even more than the poor. Inflations are an awful tax on the poor, because it is almost unheard of for wages to go up as fast as prices, but at least the poor are unsullied by miserable decisions. There is nothing really they can do about it. The rich on the other hand can make awful decisions, and find themselves joining the 99% faster than ever they imagined. The face of this conundrum was on the cover of Friday’s Financial Times, as they reported that $92 billion had gone into money market funds in the last two months, the fastest pace ever. The yields are miniscule, typically less than 0.01%. The answer to, “What are these people thinking?” is, “Fearful people don’t think.”
The extreme volatility of the year, along with this odd neologism “risk on-risk off”, has made it easy for people to throw up their hands in surrender and enter the no fixed income market. The political process hasn’t helped, as the August debacle of the debt limit increase has made America look like the New York of the 1970’s; ungovernable, and no Rudy Giuliani in sight. Quite a lot of damage was done even after the foreordained outcome came about.
Our already jaundiced view of the authorities and their interaction with inflation got nothing but worse as the year went past. Joseph Stalin famously observed that it never mattered who voted or how, what mattered was who counted the votes, and that was all important. Watching highway tolls go up by 30 to 45% in New Jersey last week got us to thinking about this, and not in a kindly way. Those toll increases will never be computed in any consumer price increase, and come to an $88 a week difference to one of the affected victims the New York Times quoted. Think an annual $4,000 increase in tax matters to a working man? Indeed, the current period of “financial repression”, as James Grant has taken to calling Fed policy, that promises savers nothing but misery as far as the eye can see, is affecting New Jersey citizens in a far larger way than most will ever know. New Jersey is the state with the largest unfunded pension costs per capita in the nation. It also has assumed rates of return on its existing, woefully underfunded assets, of around 8%. Conventional investing is extremely unlikely to make this bogey, let alone make up for past misses in funding state workers’ pensions. So the average New Jersey Jane and Joe is in a hole not on their own making, and it is being dug deeper, while their own retirement worries loom. The panacea Wall Street has been prescribing is “private equity investment”, one of the dubious advantages of which is that the client gets to pay fees he rarely ever sees. That is not a comforting thought to anyone who has spent a lifetime around Wall Street.
We go on about the dangers of inflation at this length because our fears that it could get out of hand are our workaday worry, but also because everyone has an assumed rate of return in his mind’s eye, whether he has made a conscious decision or not. At some point everyone thinks, “If I have $X, I can live to Y years, spend r dollars annually, and still leave money behind.” If you are on the board of a school or a hospital, you should be having that discussion once a month. But underlying that thought process is the linchpin assumption that the money will retain its value, and one wonders at this more and more. Inflation is no longer a prediction, it is an observation. It is greater than 5% in Britain right now, greater than 6% in China, and higher still in Brazil, India, and the fast growing third world. Indeed, with the notable exception of Japan, prices are rising just about everywhere, and observers are failing to see it.
Closer to home your portfolio continued to prosper with a news background that was decidedly punk. Indeed, tonight is the beginning of earnings season and it is thought S&P earnings will be up about 15% for the year, this with the economy growing less than 2%. If our own hopes are realized, our holdings may do even a little bit better than that. It is hard being a young American graduate looking for a job, but it is fun being a shareholder in Cognizant Technologies and watching revenues go up 35% as Indian outsourcing starts to catch on in Europe, and the company takes market share from its larger competitors. Cognizant is a beneficiary of globalization that sells at a reasonable price. What else could we want?
And so it goes up and down our lineup. No company is inflation proof, if for no other reason than the income tax is sure to tax phantom profits from us all. Yet we own the crème de la crème of multinational leaders because the prices are compelling. American Express sells for about 11 times what we think they will earn in the year we’ve just entered. It is a great cash generating property, meaning it really is legitimate in thinking of its price as a near 9% yield, and it grows. How can that value co-exist with a 2% ten year Treasury yield? Only very uneasily, with a constant drum beat of doom in the newshole of every surviving newspaper. To be sure some of this unease is caused by exactly what we are writing about. No one would have thought Boeing could set a record in plane deliveries and profits with airlines in the shape they are in. Truly the rich are doing better than the poor. But our job is not to lament the fate of the 99%, but to make sure we all stay in that other percentile. With values where they are, we like our chances.
Wishing you and yours all the best in the New Year, we are,
Edwin A. Levy
Michael J. Harkins
Levy Harkins Rates of Return
Since Inception 1980
Rates are Compounded Rates of Return After Fees
15 Years Ended 12/31/11…….…….+10.07%
10 Years Ended 12/31/11……..……..+6.52%
5 Years Ended 12/31/11……………..+1.28%
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.