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Quarterly Letter to Clients

October, 2002

Indices at quarter-end (September 30, 2002):

Dow Jones Industrials:  7,591.93    3rd Q'02   -17.87%     YTD: -24.24%

Standard & Poor's 500:    815.28    3rd Q'02   -17.63%    YTD:  -28.99%

For awhile there, the financial channels were looking very much like Court TV.  Lately that has tapered off.  As the wrongdoers are brought to justice, perhaps this very dark chapter of American business history will fade into the recesses of memory.  But for now the level of distrust of corporate management and Wall Street research is at its nadir.

This, along with deteriorating conditions in business and the economy, has led to a “flight to quality”, meaning a shift from stocks to bonds, and causing a very strong bond market, especially in government issues.

The ten-year Treasury note is selling at a yield not seen in 40 years.  Can you imagine investing in ten-year bonds for a return of 3.77%?  Or in five-year notes at 2.8%?  (Hey, maybe we should just spend the money.)  Fifteen year mortgage rates are hovering around 5%.  I can certainly imagine borrowing at that rate.


As for the stock market, bad goes to worse.  Greed turns to fear.  Fear becomes panic.

It is in times like these that I recall the old axiom:  wealth always returns to its rightful owners.  Its rightful owners are most certainly not those who skated close to the edge during the dot-com mania.  They are not the day-traders or the high-tech braggarts who could not tell you what the companies that they owned did.  They are, rather, those intelligent investors who sheltered their assets through the speculative explosion and the ensuing collapse.  They kept, and continue to keep, a percentage of their funds in safe-harbor items like bonds.

Someday, when stocks become anathema, when no one wants to talk about them, much less buy them, when people won’t return their broker’s phone calls, then, in the darkest part of the investors night, the rightful owners of wealth will begin buying.  PE’s might be in the single digits or the low double digits.  The outlook for business and the economy will be bleak.  The conventional wisdom will be to avoid equities like the plague.

At that point there will be no risk left in the market.

Most people will learn of the opportunity only after the fact.  Wealth’s rightful owners will have gradually shifted money from their bond holdings into stocks, and be poised to reap the maximum returns. The lower stocks go, the brighter their future.  The opposite is also true, but most people missed this corollary when stocks were soaring.

Wealth’s rightful owners did not necessarily sell out at the top; that is an almost impossible feat.  But they were likely to have increased their bond holdings and gradually reduced their stock holdings on the way up.  Wealth’s rightful owners were certainly damaged in the severe market drop we have just lived through.  But they were not decimated.  I have a quote on my web site:   “Capital is to a money manager as plant and equipment is to a manufacturer.  If there’s a fire at the factory you want to have something set aside in order to rebuild.”  That something set aside in this case is money in bonds, cash, anything other than stocks.

Yes, I have been battered by the bear.  While the S&P has declined more than 40% over the last three years, I am heartened that my equity losses over that span are significantly less.  But to me this is hardly a silver lining.  There is an old saying in this business, “you can’t eat relative performance”.  So if the market is down 40% and you are down “only” 10%, you have outperformed the market by a wide margin.  But you are still down 10%.

I have always invested conservatively, and I will continue to do so.  I ask your patience through this period of turmoil in the markets and in the economy.  I cannot say when, but there will be brighter days. 

Jim Pappas

copyright © 2002 JPIC