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Quarterly Letter to Clients 

January, 2010

Indices at quarter-end (Dec. 31, 2009):

    Dow Jones Industrials:            10,428.05       4Q'09        +7.37%          YTD      +18.83%

    Standard & Poor's 500:            1,115.10       4Q'09        +5.49%          YTD      +23.46%

Have you been following the nuclear disarmament talks?  They are of interest, though perhaps for an unexpected reason.  Here it is:  You may remember that in a recent letter I mentioned that around 20% of our nation’s electric supply is generated by nukes.  Well, it seems that approximately 45% of the fuel that American electric plants use in their nuclear reactors comes from decommissioned Russian atomic weapons.  I offer this tidbit with no further comment.

The markets continued their robust action during the quarter, and though the indices seemed to hit a bit of a ceiling in December, the year saw handsome gains in the area of 20-25%.  The NASDAQ average far outran the Dow and the S&P, gaining around 45% for the year.  Bonds were up almost as much as stocks, continuing a two-decade run over which they have been the asset class to beat.  Performance-wise it’s been a fabulous year. 

But as I look back at my best years I cannot help but notice that they generally follow years that had sharp declines.  This is a humbling fact, but enlightening as well. 

On a percentage basis I’ve had better years—1988 and 1989 for example.  Remember that back then we were coming off a crash year (1987), just as this year we came off a crash year (2008).  Also in 2003 we garnered strong returns, in that instance after coming off of three bad years in a row.  There’s a lesson in there:  you can make extraordinary returns if you are in the market after a cataclysm.  The trick, of course, is to not lose so much in the downdraft that there’s nothing left to come back with.

Another lesson is that it takes cojones to invest into the teeth of a raging decline, but that is when you can make the most money.  To extend this train of thought, you also need to have some cash on hand to make those gutsy investments; thus you need to have sold something when prices were high, or have a flow of funds available for investment.  Unfortunately, history does not give us any accurate hints as to whether next year will be equally as rewarding.

Bonds performed almost as well as stocks last year.  I tend to look at the very long picture as an investor, so I would like to point out the major moves in rates over the last hundred years or so:

                                                Long-Term Trends in Interest Rates

You can see that these are tectonic movements, long and slow, and while the pattern is evident, the variability of the time frames does not allow for any accurate assumptions going forward.  But even if you were unaware that rates were now essentially at zero, it is still obvious that, sometime within the next few years, they are due for an upswing.  And if rates go up, remember, bonds go down.  That is why in my bond accounts I have tended to shorter maturities.

The final lesson from the last few years is that it pays to be balanced, that is, to hold bonds as well as stocks.  I add this tentatively, as I am skeptical of its value in the near future.  Overall, and taken together, these observations reinforce my belief in riding out the storms that invariably crop up in the markets.

In mid-December came the news of the death of Paul Samuelson, 94, the Nobel-prize winning economist and advisor to presidents.  It was his textbook that sparked my interest in economics forty-odd years ago, and which nudged me into what was to become my life’s work.  I met Paul perhaps ten years ago; he was a tennis player and became a member of our local club.  I was (uncharacteristically) star-struck, for his work literally changed my life.  He had a sharp wit and always a twinkle in his eye.  He will be missed.

Jim Pappas

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