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Quarterly Letter to Clients

October, 2016

Indices at quarter-end (September 30, 2016):

Dow Jones Industrials: 18,308.15 3Q'16 +2.11% YTD +5.07%

Standard & Poor's 500: 2,168.27 3Q'16 +3.31% YTD +6.08%

The only thing certain is change: it is a constant. It is exciting that technological advances can be destructive to various industries, while at the same time creating new industries.

Back in the late 1940’s-early 1950’s the advent of television, and it’s wide acceptance, were supposed to be the death knell of the movie business. It didn’t quite play out that way, but often a new development does mean the end of an older industry. Now television itself is coming under attack, as viewers find alternate means of consuming entertainment.

Fountain pens are mostly a relic now, replaced by the ballpoint or, lately, the stylus. The secretarial pool has been replaced by computers. Remember carbon paper? Typewriters? Hey, remember Fotomat? For that matter, when was the last time you used a real camera? Poor Kodak.

Disruptive technology is the term that we are using lately for developments that displace older industries. Take music: before Edison, it was sold as sheet music. Then came shellac and vinyl recordings, 8-tracks, cassettes, and CDs. Today most music is “streamed,” delivered over the internet or via satellite, changing and challenging traditional radio as well as conventional music distribution. There are no more than a handful of record stores left.

The advent of the computer, the internet and the cell phone, has meant, if not the demise, at least the diminution of conventional mail, newspapers, and books, and "e-commerce" now threatens brick-and-mortar retailers themselves.

Communication has been radically altered. A hundred years ago it was a marvel that we could talk to someone on the telephone; fifteen years ago we were already taking our new cell phones for granted. Our children and grandchildren no longer even talk on the phone, they text, and we all use the phone as our camera and as a hand-held computer. Instant information, right there in the palm of your hand. And a Verizon store on every corner, an Apple store in every mall.

Taxis now compete with ride-sharing services like Uber, and NYC medallion prices have halved. Soon, it is promised, cars will drive themselves. And be powered by electricity. Computing long ago left the giant refrigerated spaces that held mainframes, migrating to our desk tops, and now our data is "hosted" in the "cloud."

From finance to manufacturing to retail, there is hardly an industry that has not been changed by technology, generally for the better, and the pace of change is only accelerating.

Stock markets have also been subject to radical change. Trades are driven by algorithms and "black box" systems, executed in nanoseconds by traders who may hold those positions for only marginally longer than that. Giant pension funds may trade in "dark pools" to hide their actions; hedge funds hire people to monitor numerous esoteric things like weather patterns and retail store activity. News is disseminated at the speed of light.

The myriad new industries that have sprung up create many potential opportunities.

So it is a new world for everyone, but especially so for investors. We must be careful that the companies we have invested in, and sometimes held for many years, are not distressed by new technology, that they can adapt and be part of the new order. And we must be constantly on the watch for new industries to invest in. Change brings opportunity, but also danger. We cannot simply get comfortable with what worked in the past, nor can we blindly buy that which is new, as many will fall as quickly as they rose.

Technology aside, human behavior is remarkably resistant to change, and so markets continue to fluctuate wildly. The Fed continues to resist raising interest rates. Our quadrennial election cycles seem to descend ever-deeper into irrationality, as people continue to believe that a different politician will result in a different outcome.

As for me, I am a pragmatist; you must prove it to me. You may say that I am stuck in my old ways, resistant to change. But I would rather continue with methods that have proven successful over my lifetime, regardless of technological advances. Show me the numbers: I need to digest the balance sheet, I need to be comfortable with the valuation of the securities that I buy. I will happily watch a new business as it develops over time, but I am unlikely to be a buyer of such a company until it has proven itself to me. I repeat the mantra: quality companies held over long periods of time, that is the formula for success.

Jim Pappas