Back to Quarterly Letters

Back to Quarterly Letters || Previous Letter || Next Letter

Quarterly Letter to Clients

July, 2014

Indices at quarter-end (June 30, 2014):

Dow Jones Industrials: 16,826.60 2Q'14 +2.24% YTD +1.50%

Standard & Poor's 500: 1,960.23 2Q'14 +4.69% YTD +6.06%

Recently, after a sharp sell-off, a friend asked me if the market was in correction mode. Two days prior the averages had hit new all-time highs. I told him that if the market was correcting he wouldn’t have to ask, but that particular knowledge might not be apparent two days after the highs. Since that conversation the market has continued edging up into new high territory.

Stocks have gained ground slowly, grudgingly, marginally, but steadily this year. No matter how it has happened, following the outsize gains of last year, any incremental gain is welcome. In fact, we have added a nice handful of percentage points, and to be at this level at the half-way point is very encouraging.

Out of necessity I recently found myself in the waiting room of a tire shop, and I turned the TV to the financial channel. As people came through, a series of short conversations ensued about stocks and markets. While it was obviously a small sampling, it appeared to me that there were two camps, both involved in the market in one way or another. One group seemed blithe, unfazed by the levels of stocks, bonds, commodities. That group gave the impression of being inclined to gamble. The second group appeared to be fiscally more conservative, and while pleased with the gains of the last few years, seemed uncomfortable, on edge, maybe even a little frightened.

I have often said that if you were not worried you were not involved. While I am never really frightened, I am always wary about the markets, and I would characterize myself as being a bit uncomfortable right now. Yes, I, too, am pleased with the increase in our net worth over the last several years. But I know that markets fluctuate and that declines are part of the business, and in fact, offer the best buying opportunities. That is where my small amount of discomfort lies: while I do not anticipate a meaningful decline in stocks or a rise in rates, I am aware that the bull market is long in the tooth. And I recognize the unforeseen possibilities. If, for example, the Fed should bump rates up, stocks would tumble along with bonds.

I would very much prefer to be a buyer at lower levels rather than at the full valuations we are seeing right now. Thus the conundrum: having cash on hand is necessary if you want to buy when stocks are cheap, but not having that cash invested hurts performance as the market continues to rise. You know by now that I am not a gambler; I am by nature in the fiscally conservative camp. I try to balance holdings of cash and securities and I will continue to be a careful buyer, hopefully on those inevitable dips.

The economy continues a recovery that is now five years along. It is not the sharp, strong recovery that we might have seen decades ago, when we were young, but it is nevertheless positive for almost all areas of business. Barring the unexpected I see no real reason for any meaningful setback in the economy.

The stock market, mirroring the economy, has now advanced for five-and-a-half years, and that is probably the root of some people’s nervousness. There is a general feeling that the natural order calls for a few years of gains to be balanced out by a decline. It is a pattern that usually holds true. We know that stocks can dip at any time, for any reason, and often do so for no apparent reason. But a long period of gains is not unprecedented: from 1991 to 1999 we had nine consecutive positive years. Perhaps the amount of nervousness that one feels is proportional to the amount one has at risk and is less related to the level of the market.

The Fed has been tapering, reducing it’s buying of bonds. The bond market, shrugging off what should be a negative, is in it’s own world, exhibiting strength for reasons hard to justify. European economies seem to be recovering, and the sovereign bonds of some of the weaker European sisters have recovered dramatically. A dozen years ago I opined that we (meaning the United States) might be in for a multi-decade period of very low rates, a la Japan from the late 80’s on. That seems to be a call that was more prescient than I imagined when I originally put the thought to paper. More recently, my opinion that rates should rise has been an error of several years duration. It is a humbling business.

If one has a forty or fifty year career, sprinkled with a handful of good ideas, offset by only minor errors in judgment, it might lead one to be considered wise, perhaps even revered. I am well aware, though, that it is not really wisdom, but more a matter of consistency and conservative investment mentality that form the true underpinnings of investment success. A distaste for losing money also helps.

Jim Pappas