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Quarterly Letter to Clients
Indices at quarter-end (March 31, 1999):
Dow Jones Industrials: 9,786.16 1stQ'99: +6.59% YTD: +6.59%
Standard & Poor's 500: 1,286.37 1stQ'99: +4.65% YTD: +4.65%
While all the cocktail party chatter may be about the Dow reaching 10,000, most people are calling it a "stealth bear." Evidence: the average mutual fund gained only a fraction of one percent for the first quarter; bonds were negative by two percentage points; and fully 77% of all NYSE stocks are 20% or more below their highs.
In my last letter, I touched upon the fact that the market's advance was led by a very small number of stocks. In technical parlance, this is known as a "narrow" market, and the condition has persisted through the first quarter of 1999. In real life, it means that if you didn't own the handful of "dot-coms" or tech stocks that led the averages up, you didn't come close to those averages. A mere 21 stocks accounted for 100% of the S&P 500's gain (meaning that the other 479 did nothing).
I am like most managers in that we generally shun the high-PE (read high-risk) stocks that pulled the averages up. The noisy Jim Cramer of "theStreet.com" was up only 2% in 1998 and the famous George Soros was negative in his multi-billion dollar funds. Even the storied Warren Buffet is struggling. And this is indicative not only of last year; the relative under-performance (managers vs. indices) continued through the first quarter. My guess is that it will persist for another three to six months.
The reason is that what have historically been good gauges of value in the past no longer seem applicable: low P-E stocks stay that way; there is no premium for low debt companies; dividends are apparently a drag. And "dot-com" may be just a phrase, but, for now at least, it is an absurdly valuable one if added to a company's name.
And earnings? We know that ultimately the market will follow the earnings of its collective underlying companies. But it is also capable of placing an extraordinarily high--or low--multiple on those earnings for what may seem like irrationally long periods of time.
To the inexperienced hordes of people who have become "investors" in the last few years, historical valuation measures may seem as hopelessly outdated as a 286 computer. But there is an old saying on Wall Street that goes, "in a bear market, wealth returns to its rightful owners". Don't misunderstand: even the best will lose money in a bear market. Just remember that it's all relative, that losing 10% is not the same as losing 90%.
Please do not think that I am a bear. While I may sound overly cautious, it's my job to protect your assets (and mine), and a healthy dose of caution, seasoned with skepticism, seems appropriate at this point in the market. Valuations are high. Oil is making an attempt at a rally, its first in a very long time. Interest rates seem to have bottomed. And we as a nation are waging war in Eastern Europe and the Middle East. Is it not obvious that caution is warranted?
That being said, I am still able to find attractive investments, especially among convertible securities. Many promise returns of 9-11% per annum for the next four or five years regardless of what may happen to the stock market. And while lower risk may mean lower reward, it also means, well, lower risk. In that vein, bonds, too, are becoming more appealing. There are also common stocks that I believe have long-term value that is not being recognized. As has always been the case, it may take two to five years for those values to surface, and in the interim we will certainly experience downdrafts as well as upward climbs in each and every type of security.
The best opportunities--the best rewards--come from buying before a company's success is widely recognized. Such a strategy demands being early in your decisions, and that, in turn, often means holding a security for an extended period of time. As it happens, patience is my forte, my strongest suit in this game of markets.
copyright © 1999 JPIC