Former Fed Chairman Greenspan may be correct in asserting
that Central Bankers cannot manage financial Bubbles (a
“Remarkably Irrigated”
I was seduced by his physique, his charm and his intelligence. He has
five or six brains, which are remarkably irrigated. – Carla Bruni on her
new husband, French President Nicholas Sarkozy.
This quote in the Post caught our eye for reasons beyond another
stunning photo of the supermodel / pop singer turned first lady
of France.
Such a lovely turn of phrase! We should all hope our partners
chose us for our multiple, irrigated minds. Now, what keeps
the quote with us is the image of avidity and redundancy.
As investors, we must adopt several perspectives, honing each
vision and balancing it with the demands of the others. We
strive to position for the certain, manage for the likely, and be
mindful of the uncertain.
An example: we are certain that consumption of fossil fuels will
continue to grow, and it is likely there will be consequent
climate change. What is uncertain is the impact this will have
on Agriculture, Resort Property, or the renaissance of Atomic
Energy.
We are certain there will be a new occupant of the White House
next January, and it is likely he will be compelled to address the
fiscal carnage of the past eight years. What is uncertain is the
impact those policies will have on taxes, inflation and exchange
rates.
It is also certain that most of us will have less earned income as
we move into what the French call our “Third Age,” retirement.
It is likely that, with discipline, our pensions and retirement
savings can offset this decline. What is uncertain is how well
we will succeed at this task.
We at Farragut spend our days focused on these troikas, for
ourselves and for our clients. While you may have a career
which demands more of your time than your family may prefer,
or manage a business where your decisions set the welfare of
many families, be confident that you have a dedicated,
independent advisor, one who looks after your financial interests
diligently. The collective mind of our clients, interpreted by us,
your advisor, is immensely more powerful than that of one
going it alone. Many minds indeed, remarkably irrigated.
The Markets
The past twelve months have seen a convergence of trends
which have been forming in the clouds for the past decade.
Whack-a-Mole capital allocation on a Global scale, first seen in
the piling into Technology, Media and Telecom shares in the
late ‘90s, was amplified through the leverage of the Banking
System to create an unprecedented loosening of lending
standards for home buyers. As the current excesses unwind,
the same River of Capital which brought us AOL, Enron, and
the Miami Condo Boom is now streaming into the Commodities
Complex.
Copyright 2008, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific
investment strategy or the purchase of securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol
Securities Management, Inc. Investment advisory services and brokerage provided through Capitol Securities Management, Inc, Member FINRA/SIPC.
debatable stance), but investors are compelled to manage their
exposure to the certain consequences of excess.
The likelihood of an investment trend persisting forever is
remote. When and how the reversal occurs is uncertain, just ask
our friends at Bear Stearns. Trends are running their course
ever more quickly. Mohammad El Erian of Pimco, and the
former head of the Harvard Endowment notes :
“Under a “Just in Time risk management mindset, people waited for the
turn before taking risk off the table. Hubris took over. People believed
these new derivative products would allow you to reposition your
portfolio after the turn as opposed to preemptively. But that wasn’t
possible with credit products and subprime, and losses were huge.
People misinterpreted what these instruments do, and didn’t retool
significantly. – Barrons June 1, 2008.
Our Value
We have been investing other peoples money since 1997. These
12 years have been characterized as “dog years” for a traditional
Investments Career. Having learned to count in eighths and
sixteenths, a practice dating back to the Spanish Main, our
quotes are now decimalized. While the days of “Wiring New
York for a Price” were gone long before our arrival, the
explosion of investor information is perhaps the second most
ubiquitous consequence of the internet browser.
If precision, information, and execution are free and readily
available, why isn’t everyone running a hedge fund? No need
to punch a clock. Flip on CNBC and trade Cramer’s picks.
Foremost, because life is too short to be spent in the counting
house. Take a walk. Play with your son, granddaughter, or a
neighbor’s dog. Have you read any good books lately?
With a disciplined approach to managing risk, capitalizing on
opportunities, and a mindful respect for the Uncertainty of Life,
we strive daily for you to have fewer things to worry about.
Your Portfolio
Hard Assets continue to dominate the Market Chatter. Gold
stalled at $1,000, as the decline of the Dollar paused. We
continue to hold Gold, via funds and ETFs. As we advised
clients five and more years ago, we don’t want Gold to go up,
because its rise means something else is very wrong.
Oil is being bid by the confluence of rapid demand growth in the
developing world, mostly political supply constraints, and vast
amounts of speculative capital. The first two factors are enough
for us to maintain a bullish stance. Our recent emphasis has
been on the Oil Services group, although the Integrated Majors
are relatively underappreciated, and considerably less volatile.
Two data points worth noting: first, the scale and growth of
energy demand from the Middle East is roughly equal to China’s;
and the US has the lowest Natural Gas prices of all the major
World markets.
Agricultural Commodities have gone bananas, with “Beans in
the ‘teens” for the first time in our professional memory. With
the relatively small size of these markets, speculative capital has
dwarfed industry demand (growers and processors). We have
token positions in an Agriculture ETF, and have recently added
exposure for some clients to the Livestock Index, a speculation
based on the wholesale culling of Southeastern herds during last
year’s drought.
Agriculturals are by definition a trading vehicle, and for most
clients we prefer to position for longer-term secular trends.
With Hillary out of the Presidential race, some of the negative
pressure on the Healthcare Stocks has abated. Nonetheless,
our overweight position in the sector, primarily through ETFs,
has been a drag on performance.
Rather than throw in the towel on the Health Stocks, we have
been migrating positions to an Equal-Weighted Healthcare ETF,
a vehicle less dependent on the performance of the Larger
Pharmaceutical and Device makers.
What a mess in Financials! A year ago we reduced our
exposure to this sector, as the mortgage problems began to spiral
out of control. We maintained token holdings (at the time
financial stocks were the largest sector of the market), in some
cases focusing on European Banks and Insurers. Selling out
was not enough. The correct stance for Financials last year was
to aggressively sell short.
While we avoided much of the carnage, very little worked in this
space. In considering the impact of the recent chaos, we are
mindful that the consequences reach far beyond Wall Street and
the Major Banks. As Mike Mayo of Deutsche Bank points out:
“The $100 billion hole between writedowns and capital raised so far
needs to be filled. If you don’t fill that hole, with the 20 to 1 leverage
existing on average out there, you need to de-lever $2 trillion of assets.
You can do that or raise more capital” Bloomberg, May 19, 2008
If the best time to borrow money from a bank is when you don’t
need it, what does it mean when your bank is desperate for fresh
capital? .
Income-Producing Real Estate, owned through REITs,
continues to be supported by the dividend yield. Our reduction
in US exposure last year proved timely, though International
REIT holdings declined as well. In addition to Foreign Real
Estate, we maintain speculative positions in two Storage Names
with attractive portfolios and compelling yields. While the
storage business is dependant on transaction volume in home
sales, it does not rely on the sales price going up.
Copyright 2008, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific
investment strategy or the purchase of securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol
Securities Management, Inc. Investment advisory services and brokerage provided through Capitol Securities Management, Inc, Member FINRA/SIPC.
Information Technology, as represented by the larger,
mainstream names, shows promise for several reasons. First,
much of their customer demand is innovation driven, and
implementation often yields improvements in customer
productivity. Further, the flagship firms in this sector tend to be
well-capitalized, often with a majority of their sales overseas.
The aggravatingly short product lifecycle also works in their
favor – those pallets of materiel ordered in the frenzied buildup
to Y2K are now obsolete.
In a softening economy, with negative real interest rates, and a
currency in secular transition, Fixed Income Obligations of any
sort are not compelling. When interest rates rise, their income
will be less prized, and our principal will be marked down.
As most investors seek income, we continue to buy discounted
closed-end funds, notably a preferred stock fund, as well as
foreign bonds. Municipals have compelling after-tax yields, in
particular those with lower ratings, as held by High Yield
Municipal Bond Funds.
Overseas Exposure continues to play an important role in
diversification, and our portfolios reflect this. Recent additions
include an International Small Cap ETF, as well as Russia and
Eastern Europe funds, a more speculative tack based on the
resources and stability of what will become Europe’s largest
retail market this year, and Europe’s largest automobile market
in two years.
To summarize, our portfolios continue to reflect the enterprising
caution we have maintained throughout our career. We are
certain that we will continue to live in what the Chinese call
“Interesting Times.” What seems sensible today will be refuted
tomorrow by the market’s caprice. It is likely that reversion to
the mean will continue to humble investors. What is uncertain is
where and when the best returns for investors will accrue.
As stewards and fiduciaries, both we and our clients will
continue to invest across industries, asset classes, and regions,
striving to maintain a garden where there’s always something in
bloom. While we cannot guarantee a certain outcome, you can
be confident your portfolios are positioned with care,
thoughtfully maintained, and remarkably irrigated.
Frank J. Ruffing CFP
McLean, Virginia, June 9, 2008
7918 Jones Branch Drive, Suite 800
McLean, VA 22102
Telephone 703-283-5220
www.farragut.us.com