Portfolio manager’s Letter July 2001
First, the good news. This continues to be a good year for Losch Management Company. Losch Management Company’s net composite return for the last 12 months was + 36.95%. For the same period the S&P 500 was a -15.83% and the broader Wilshire 5000 Index was off 16.24%. So Losch Management Company’s average gain beat the Wilshire by 53%. Since I consider any year that we manage a gain while the market as a whole is down to be a great year. I hardly know how to deal with the above figures.
How are Mutual Funds Doing? Check out this table:
|Name of Fund||1 year Net Change|
|Fidelity Aggressive growth||-51.70%|
|John Hancock Large cap Growth||-45.42%|
|John Hancock Small cap growth||-30.94%|
|Vanguard Growth and Income||-12.41%|
Particularly at I time like this, I think that it important to understand that one-year is a very short span in which to judge investment results. Fortunately Losch Management Company’s long term results while not nearly so spectacular are still quite satisfying. I wish I could say that the above results would continue for a long period or that they were solely the product of our superior intellect, but I can not. On one point I can be quite definite, enjoy this while you can because the results will get worse, probably soon.
As most of you have probably already figured out I have a totally irrational addiction to speculating on the impact of FED policy and other such economic nonsense. So forgive me: I can not help myself.
After just 15 months of correction the NASDAQ has been reduced to a pile of rubble. This phenomenon has become so alarming that the FED has reacted by lowering short-term rates six times in just six months. This is the fastest ease ever.
Back in 1991 and 1992, after our last recession the economy was very slow to recover and the FED took a lot heat from people who do not like slow recoveries. Perhaps, it is this memory that has caused the FED to be so aggressive in its easing this year, or perhaps they see some economic danger threatening, that is not yet apparent to the rest of us.
I know that rapid and aggressive easing is politically popular and that a lot of the walking wounded from Wall Street are screaming “faster”, “faster”. Greenspan is famous for being the rescuer of economies, but I wonder if he has not become too fond of this role. Just as with other agents of the government, the Federal Reserve has always been capable of doing harm equal to or greater than the good they do.
It is after all the Fed that we have to thank for the depression of the thirties. Greenspan eased aggressively in 1998 and 1999, to deal with a real crisis in the emerging markets, and an imaginary one that was supposed to appear on December 31, 1999. The net effect was a flood of cash that created the Great Tech Bubble.
Yes, there is a lot of pain out there already (can anyone say Telecom?). Some degree of ease was certainly necessary. But there is still a lot of cash sloshing around in the system. The rubble at NASDAQ still has PE of about 50. Big Al won a long and valiant struggle by successfully puncturing bubble number one, but is he now pumping like crazy on start of bubble number two?
In the seventies the Fed had to deal with a runaway inflation of basic commodities. The battle took several bear markets over a period that lasted from 1966 to 1982. Each time the Fed would tighten until the pain was acute, and widespread, and then reverse course, but before the economy could get up a good head of steam, inflation would start to reappear and the Fed would have to tighten again. The result was a series of bear markets that left the Dow Jones at about the same level in 1982 that had first reached in sixteen years earlier.
So, as we come out of the current correction and the market begins to recover, is this the beginning of a prolonged recovery like the early nineties or are we just moving from one leg of the roller-coaster to the next, like in the seventies?
I assure you I do not have the answer to this riddle: (My Crystal Ball froze up last week after predicting that Anna Kurnikova would defeat Serena Williams in the finals at Wimbledon. Fortunately as I was about to call my bookie my daughter informed me that Anna was not even entered, something about being too busy negotiating a new contract with Charles Schwab).
But Warren’s 1999 Fortune article and the size of the cash pile in Omaha have me thinking about the seventies. It is time to watch for bubble number two. The appearance of speculation early in the next recovery will be a strong hint that we are back on the roller-coaster and we best find a way to enjoy the ride. If the FED has been too aggressive in lowering rates, the patterns of the past two years will start to reappear quickly.
The next bubble probably will not show up in the same spot (tech stocks) but it will have similar technical characteristics (money pouring into mutual funds, managers chasing momentum stocks, and outrageous evaluations placed on individual stocks within whatever sectors are chosen to lead the rally).
A rapid inflation of a new bubble will force a response from the fed, and quick return to monetary restraint. This is likely to keep bull markets short and prevent the averages from achieving new all time highs.
The speed of the recovery is critical, Fast is Bad, Slow is good. My guess is that things will go badly, the Fed will be too aggressive and a new bubble will appear quickly. On the other hand market action like we saw last week is encouraging because it retards bubble development, indicates a bigger economic correction and a slower recovery than the market was expecting a month or so ago.