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Quarterly Letter to Clients

April, 2017

Indices at quarter-end (March 31, 2017):

Dow Jones Industrials: 20,663.22 1Q'17 +4.56% YTD +4.56%

Standard & Poor's 500: 2,362.72 1Q'17 +5.53% YTD +5.53%

Supply and demand, and their cousins, fear and greed, are themes that make frequent appearances in these scribblings. Today we are in the greed phase. Markets shrug off obvious threats and continue to power higher.

Ebullience rules. It may not be rational, but it is undeniable. At other points along the curve of time and price, the thought of successive interest rate boosts might have taken the wind out of stocks. Not today.

We know that greed will turn to fear, we know that markets will fall. We just don't know exactly when. But that little uneasiness in the pit of my stomach, currently overridden by the pleasure of the rising tide, will certainly grow to a discomfort that cannot be ignored. Admit it, you also feel a little uneasy at these levels.

Most of the time markets tend to exist in a reasonable balance, with a slight tendency toward the upside. Attractively-priced stocks and bonds can generally be found in most markets, while at the same time there are always investments that are priced "to perfection," meaning that there is no room for error. There have always been companies that I lusted to own, but I could not bring myself to pay the high multiples of earnings at which they were selling.

While balance generally prevails in the markets, on occasion we have sharp run-ups followed by dramatic, panicked declines. We all believe that we can take advantage of such moves, but it is much harder to do so than one might think. First of all, it is hard not to be fully invested during the strong bull market that generally precedes a fall, so we find that when stocks are most attractive we do not have cash available to buy. Second, it is at the bottom that fear is strongest.

And third, those great buying opportunities are spaced a decade or more apart, giving us time to become complacent. During my business career, the standout buying times were 1973-74, 1987, and 2008. If your emphasis was on tech companies, add 1999 to that list. The declines ran from 22% in 1987 to 45% in both 1974 and 2008. If life is a series of lessons, the great lesson of all of these panics is that the markets in general, and good companies in specific, always rebound.

Personally, during 1973-74 I didn't lose enough to hurt simply because I didn't have much to begin with. By 1987 I was getting a little comfortable, and that shock was probably the best lesson of my life. By 2008 I was able to buy into the storm, but, alas, I didn't have all that much cash available. Another lesson, but very difficult to adjust to: it's just as hard to sell at the top as it is to buy at the bottom. If you don't sell the highs there is no cash to buy the lows.

Notice the time span between cataclysms. If 1987 taught me to remain calm and buy into the panic, it was to be 21 years before I had another chance that good. I have had to comfort myself by looking to buy into the little squalls that develop in individual stocks.

One thing is certain, and that is that there are no screaming buys today. Recently, a company called Snap did an initial public offering (IPO). After opening the stock ran to a premium, giving the company a valuation of something close to 100 times it's sales. That metric was used, of course, because there are no earnings to measure up against. In fact, their loss is larger than their sales. Would you rather be a buyer or a seller at that level? I would call this an "Icarus trade."

It always comes down to price. We must buy and sell within the confines of this day's market. I am a cautious buyer and an even more cautious seller. It is easier for me to be a buyer in times of panic than it is to be a seller in times of extreme highs. That is one of my personal psychological shortcomings, though not one I am in any hurry to correct. Perhaps in another lifetime I can learn that lesson.

Jim Pappas