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Quarterly Letter to Clients 

October, 2019

Indices at quarter-end (September 30, 2019):

    Dow Jones Industrials:             26,916.83       3Q'19            +1.19%          YTD      +15.39%

    Standard & Poor's 500:             2,976.74        3Q'19            +1.19%          YTD      +18.75%

It’s been a strong market so far this year, so why am I filled with trepidation?

This summer we spent a weekend in NYC. I was struck by two things: first, the amount of new construction throughout the city. The desirable neighborhoods are always changing, of course, so to some extent, large construction projects are a more-or-less constant in Manhattan. But at this moment the quantity and scale of construction is mind-boggling.

We stayed at a hotel on 51st St. and Lex, and one day we walked north to 60th St. On that walk I was struck by something else: the number of vacant retail stores. I still can’t balance how much new space is being built with how much space is vacant. Either all of the merchants have moved to the new neighborhoods, or rents have priced them out, or there is something more ominous going on. Or perhaps it simply shows the damage that the internet has done to retailers.

We all know that malls are suffering. Long time clients know that I sometimes cite my “Bethel Index,” an eyeballing of the number of vacant stores in Bethel, CT. Bethel is a mid-level community, and at the moment there are almost no vacancies.

But in Westport, a decidedly upscale town, the main street is home to a large number of vacant stores, something that I have not seen before in the 30 years that we have been in the area. Here in Sarasota, too, I am noticing vacancies in the midst of a frenetic construction market.

Something similar is going on in the stock market, where I know that decent gains have been recorded in the year-to-date, but lots of stocks have been left behind. I feel like we are teetering on the edge. Employment continues to be full, but various indicators are flashing warning signs. The Fed has seen something troubling, and reacted, lowering rates. They have been forced to inject cash into the banking system, a move not taken since the last financial crisis a decade ago. Daily swings in the stock averages have been manic, driven principally by a storm of “Tweets” relating to trade with China. Tariffs loom as a dark cloud over the economy, one that will not easily disperse. We have done well so far this year, but the market and economic outlook is cloudy.

The more cautious (or fearful) investors have run to bonds, pushing bond prices to crazy levels (and pushing yields to ridiculous lows). But can this be said to be a “cautious” investment? The 30-year treasury bond yields around 2%. Will that even cover inflation? Who wants to put out money at 2% for thirty years? Not me. Especially when we are racking up trillion-dollar deficits every year. When (not if) rates rise, the collapse in bond prices will be nauseating.

How do we position ourselves in this environment? That is a question for which I have no good answer. It is my feeling that an investment account should generate income, even if your main thrust is toward growth. Thus, many of my accounts hold some allocation in bonds, and to a large degree, the stocks that I buy pay dividends.

I am fully aware that, if bought at these levels, bonds promise losses. At the higher-quality end of the spectrum, their yields probably will not cover inflation. In some parts of the world, bond yields are negative, guaranteeing losses.

Against this backdrop it should be no surprise that I am content to allow cash levels to build.

To protect against inflation and have some hope of capital growth though, the only direction left is to seek out dividend-paying stocks, and to try to ascertain which companies will thrive, and which companies will continue to pay, and perhaps even increase, their dividends regardless of the economic environment.

This is a tall order, but not an impossible dream. For thirty years (from roughly 1930 to 1960) stocks yielded more than bonds. The rationale was that you needed to be compensated for the risk inherent in stocks. For the next 50 years bonds paid more, at least partially (in theory) to compensate for the risk of inflation.

Today the relationship is once again changing. Stocks—at least those paying dividends—now often yield more than bonds. We might assume that means that stocks are viewed as the riskier investment, but I do not think that assumption is valid today. Nor do I think inflation is dead.

Our objective is to preserve and grow our capital. Prudent selection of vehicles to accomplish that end will not necessarily insure that we do not suffer losses along the way. Cash holdings will serve to insulate us at least a bit. We always need patience in order to attain our goals. Over the longer term I firmly believe we will prosper.


Jim Pappas

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