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Quarterly Letter to Clients

October, 2021

Indices at quarter-end (September 30, 2021):

Dow Jones Industrials: 33,843.92 3Q'21 -1.91% YTD +10.58%

Standard & Poor's 500: 4,307.54 3Q'21 +0.23% YTD +14.68%

Someone told me that first comes the price movement, later comes the explanation. Then they said that the explanation may be right or it may be wrong, but if accepted, the explanation would come to be considered market wisdom and history.

Stocks rose during the first half of the quarter, but then ran into some selling, to close out the period flat to slightly lower. Although ending more than 1000 Dow points off the August high, we still show a very nice gain for the year-to-date.

If the softness turns out to be something more we will see what reasons will be ascribed. There are always several floating around—CNBC has air time to fill. Whatever the reason, if prices fall enough, I am likely to be a buyer of select issues.

There is a sharp divide between the performance of stocks and bonds this year, which leads me to reflect on how I run my business. You should know that, whenever possible, I invest your funds in the same manner, and generally in the same issues, that I buy for my personal accounts.

When I was younger, all my assets went into stocks. 1987 taught me that I should diversify; I was just seeing the light at the end of the tunnel when my progress was very rudely interrupted. Because of that, I then changed my approach; I began a program whereby whenever I took a profit in a stock, I would take some percentage of that profit, generally 30-50%, and put it into bonds. Eventually my personal accounts became roughly 50% stocks and 50% bonds, which was my goal, and have stayed that way ever since. Until recently.

My clientele is diverse, and each one of you has unique needs and desires, and a different risk tolerance. Thus, for some people, an all-bond approach has been appropriate, while for others, an all-stock account is right; for a large contingent, some mix of stocks and bonds has been the best option.

Historically, the function of bonds in a portfolio has been to provide income and diversification; and to insulate against the blows that the stock market occasionally inflicts, thus smoothing performance.

Here is where I point out that for the period that began after the 1987 crash, bonds carried a yield of 8% or so, and have performed pretty much just as well as stocks over the intervening period, as rates fell and bond prices rose. Bond holdings did their job plus.

But now I must point out that rates are almost certain to rise in the future, and bonds are almost certain to underperform. This may not happen immediately, but looking forward, it is hard to imagine that the ten-year Treasury bond will not be yielding more; even after a relatively big jump, that benchmark now yields only 1.5%. Bonds in general will be priced lower. Bond holdings will eat away at your portfolio.

Top quality stocks can be had today to yield nearly double the rate of that 10-year Treasury. If we factor in inflation, it seems to me that such stocks should be supplanting bonds in any portfolio.

So it should be no surprise that I have not bought any bonds for quite some time. This is a reversal of strategy, as I am allowing bonds to mature or be called, with plans to redeploy the funds so generated into high-quality dividend-paying stocks. This is simply a continuation of my method of doing for my clients exactly what I do for myself.

I have telegraphed this change in several recent quarterly letters, and, of course, it does not apply to my equity-only accounts. But I want to be certain that my clients that own bonds know that I will almost certainly not be buying bonds for the foreseeable future, and that I will be looking to use monies originally earmarked for bonds to buy stocks.

If you are used to the relatively smooth performance of a bond account, you may find that equities can be a little more volatile. But I am confident that, given time, this is the right move.

Many of you will notice that cash levels in your accounts are high, as bonds have matured or been called, and have not been replaced. I am a cautious buyer, and it will take me some time to re-invest that cash. I reiterate that the same is true in my personal accounts. Stocks are not cheap, and that fact alone makes me more even more cautious.

Investing in securities is a “long game,” and I am pleased and proud of my performance over the 33-plus years that I have been in private practice. I hope to be able to continue to generate market-beating returns going forward.

Jim Pappas