Quarterly Letter to Clients

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Quarterly Letter to Clients

April, 2000

Indices at quarter-end (March 31, 2000):

Dow Jones Industrials: 10,921.92 1Q'00 -5.00% YTD -5.00%

Standard & Poor's 500: 1,498.58 1Q'00 +2.00% YTD +2.00%

Wow! If you want action, you've come to the right place. The Dow and the S&P were in correction territory--down around 20%--after the highs reached in mid-January. But in the third week of March, stocks sprang from the depths of despair to vault once again over the 11,000 mark in the Dow (though still negative year-to-date), and 1550 on the S&P (slightly positive Y-T-D). The NASDAQ rocketship bounced off the ceiling, retreating more than 20% off its high, and finally moved into negative numbers. Fear is showing in that arena, with valuations still at unbelievable, and in my opinion, unsustainable levels. The volatility today is incredible.

I am alarmed at the increase in margin debt. If the government was serious about dampening the stock market they would raise margin rates. Instead, we have a newly-minted army of traders incurring record levels of debt against their security positions. Are people taking out equity loans on their houses and using that money to invest in stocks, and perhaps then margining those positions? It is a frightening thought. The concept of risk seems to elude these folks.

I am left with generous amounts of cash in my equity accounts, and while I can identify compelling places to invest it, I believe that prices are likely to be more attractive in short order. You must understand that holding cash is an investment decision just like holding a stock or a bond. First, cash doesn't go down with the market, and second, it affords you the ability to invest when the opportunity is ripe. Buying well is half of the equation. Having the cash to do the buying is an essential part of the process.

In short, I am prepared for the bear. I am also prepared for the bull. Who knows which beast will show up?

While, to say the least, the equity markets have been wild this quarter, bonds have held steady, as intelligent cash sought out a haven. This is a relief, as bonds had a terrible year in 1999.

The Fed is raising interest rates and at the same time the Treasury is buying back bonds. I have to ask what it is that they're trying to accomplish here? My only conclusion is that perhaps they're trying to get someone elected.

Bonds are higher now (and yields lower) than they were at year-end, even though the mandated level of interest rates is higher. If the Fed's action was not offset by the Treasury, prices would certainly be lower.

The very public action of raising rates is obviously calculated to give the world at large a certain impression. But the relatively quiet repurchase by the Treasury of its bonds offsets that action. I take this to mean that the Fed does not really want rates to move much higher. After all, higher rates are inflationary. And given the price of oil and its products we do not need more inflation. We are already at the limits of governmentally-acceptable inflation, especially in an election year.

Philosophically I ask: What is the purpose of investing? It is very easy to say, "to make money", and that, of course, is the simplest answer. But then the question is, what is the purpose of making money? To come directly to the point, the end goal is to have an asset base large enough that it generates a certain flow of funds.

Just as the dream of every stockbroker is to become a client, I am saying that the ultimate goal of every stock investor is to become a bond investor. As your asset base grows, your "safe money", your reserve also grows.

It is with this thought in mind that my direction is, and always has been, to protect assets, to insulate from market swings, while still participating in the game. Prudent risk is my directive. I wish to grow my assets, but not via the craps table.

Jim Pappas