Long Bond Yield
|1-Jan-03 to 30-Sep-03
|52 weeks prior to 30-Sep-03
|Estimated FY 2003 P/E
|Estimated FY 2004 P/E
What Were They Thinking?
Is it possible that Bill Gross, Warren Buffet and Jeremy Grantham could
know a thing or two about investing? Or are they are getting old? Becoming
wealthy and complacent, loosing the vigor for taking the risk inherent in
investing? Well, it is true that the prospect of poverty, when one has
some assets, may serve as a determining motivation.
What these three investment sages of respectively Pimco, Berkshire
Hathaway, and Grantham MayoVanOtterloo, with their combined successful
investing experience exceeding 90 years, and stewardship of over $100
billion are saying is, that there is nothing they like at the moment.
Stocks, bonds, REITS, commodities, they say, all look
pricey, and taut with the risk of excessive valuation. Warren Buffet,
whose firm has $6 billion in cash, said in an interview that he's seen
similar environments, and while it is a challenge, he has the patience to
wait out current (high) valuations, for more reasonably priced investment
Capital Market Review - First Three Quarters
Stocks started the year at near all time high valuations based on
earnings. That was before the year-to-date run-up in prices of
approximately 13.25% for the S&P500. Earnings have increased, but not
nearly 25%. The earnings growth has been due largely to cost control
-read, layoffs. This is one of the great things about America. Few
countries would tolerate dismissing millions of workers, and the havoc
wrested on the lives of these individuals and their families.
Other driving forces of increasing corporate earnings are new money
from consumers re-financing their houses, tax cuts and the wealth-affect
of home owner's increased spending. The importance of housing can not be
underestimated. Lester Thurow was kind enough to send us a copy of his
seminal new work, Fortune Favors the Bold. Lester states, "For 90 percent
of American families, the value of their home is at least three times as
important as the value of their stock market portfolios."
None of these factors: lay-offs, re-financing, tax cuts will sustain
growing sales and earnings which are essential for investment and a
growing economy. It does appear, however, that economic activity is
We've always heard, and believed, that the most reliable leading
economic indicator is the stock market. The stock market is up, earnings
are increasing, job prospects may be brightening, housing stays strong,
mergers and acquisitions increase. When Saks 5th Ave. has a four-fold
profit increase reportedly based on increased sales of women's evening
dresses and hand bags, one thinks there are more parties to attend, and
more money to carry around.
What Does It Mean
Standard & Poors ranks stocks in three groups based on credit quality:
A, B, and C. A companies have strong balance sheets. C companies have weak
credit ratings, but are not in bankruptcy. B are between. For the first
three quarters of 2003 the stock market value of A firms increased 5%, B
firms increased 15%, and C firms increased 25%. The weaker a firms credit
quality, the more its stock price increased during the first
three-quarters of 2003.
One interpretation of the A, B, C phenomena, is that the markets have
become more speculative. Reflect on the recent bubble. Stocks which
appreciated most were those with the riskiest earnings prospects, and
greatest losses. As a measure of the near insanity, our friend, Dr. Larry
Pholman, Research Director at PanAgora, reminds us that in 1999 companies
were valued on 'clicks'. During this bubble epoch, old-line like firms,
like Proctor & Gamble, Pfizer, and Berkshire Hathaway, declined in value.
The other interpretation of the A, B, C's is that investors sense a
genuine economic improvement. Earnings will increase the credit quality of
C companies. C companies will have the opportunity to become B rated. As
their earnings and credit quality rise, share prices will increase doubly
compared to A firms, and C companies will represent greater long term
Which interpretation is correct; how much do you want to bet on the
second scenario, and at what stage of the stock price curve?
A Great Investment Opportunity, Getting In At The Beginning?
A Long Term Investor In The Japan Stock Market Lost 80%
Current Investment Perspective
Does it sound like we at Davidge & Co, along with the
great investment sages, are pessimistic? The answer is yes, guardedly
so. We consider the positive signs in contrast to many negative factors: the potential for rising interest rates, the exceedingly high valuations
in virtually every investment sector, tepid job creation, contraction of
the money supply, the large current account deficit, low factory
utilization, the 'China' factor.
The investment environment has become markedly more challenging from
the beginning of the year to the present. We have been fortunate to have
performed most of our re-balancing toward the beginning of the year.
What Has Been Working?
|Master Limited Partnerships MLP
We invested heavily in these starting 18 months ago. Yields based on
purchase price have risen to an average of 9%, and the unit prices
have appreciated approximately 23% which yields a total return of
12 to 18 months ago, after a terrific run-up while the market was
collapsing, we felt the underlying economic trend was dodgy for
office space, apartments, shopping centers. We reduced holdings. The
total return in the first 3/4's was 24.5%. Reducing REITS was
mitigated by the movement into MLP's
We have stuck to municipal bonds with maturities of mid-term or
less, and the middle of the credit range. This has provided nice
yields in the 5 - 7% range, while limiting interest rate risk.
|Some Equity Purchases
Our purchases of Verizon and SBC have declined modestly. The fact
that these represent defensive holdings, backed-up by substantial
assets, income generating ability, and a nearly 5% dividend,
|Most Equity Purchases
Our value oriented equity purchases have done well, some doubling or
tripling. Most also provide a yield in the 2-4% range. The selection
criteria follow our standard criteria, outlined in the Summer
We continue to find opportunities in mid-term
municipal and corporate bonds, where we try to keep funds available should
there be a market correction. Most of our clients have substantial equity
portfolio's. We have continued to lighten-up on equities as Stock-Bond-MLP-REIT-Foreign-Commodity
ratio's have exceeded the targets for individuals.
If you would like to discuss a
complimentary portfolio evaluation, please contact John Davidge at