April 13, 2018
For the first three months of 2018 our average account was down -0.46%. After last year we will be pleased if this is all the tribute we need to give back to the investing Gods.
Since time out of mind there have been few sentences more dangerous to investors than, “This time it’s different.” Value investors in particular abhor the very thought. More people come a cropper from the idea behind this sentence than perhaps any other. Human nature does not change, and neither do the human emotions that drive the investment cycle. So it is with no small amount of raw fear that we have been contemplating how current times are so out of the known bounds as to be truly different. Love him or loathe him, President Trump is so out of the ordinary that he deserves special attention. He is not “extraordinary”, in that he is not much more of the same of anything we have known before. Mr. Trump is a complete outlier, on a different axis than any other figure of power. He is different.
What got us to thinking about this was rereading John Lukacs’ book, “Blood, Toil, Tears and Sweat”, an accounting of Winston Churchill’s first months in office as Prime Minister. It is a brilliant little book, mostly about Churchill’s most famous speech and its immediate consequences. Those days are the most closely chronicled in history, perhaps, and there are movies out right now that dramatically cover the same ground. Will it surprise you to know hardly any of them agree even on the facts, let alone the consequences? It was the time when radio first really came into its own as mass communication. It turns out when everyone could hear a speech at once everyone heard what he wanted to hear.
Television being what it is, few people are better known than Donald Trump. For most Americans they know the man from TV well. He has been in the public eye for over 40 years. He is a wildly successful businessman. Except that he isn’t. He is a brilliant negotiator who has mastered the art of the deal. Except he hasn’t. He is a towering financier with bankers at his beck and call. Except he doesn’t. Indeed perhaps on that last score what his television audience “knows” for a fact is most of out kilter with the actual facts. The bankers who have had the most to do with him over these last 40 years want the least to do with him now. They know that a Trump financing is at grievous risk of default from the moment of its first floating as a nascent idea to the last payment date. There is a reason why you always see foreign banks listed prominently as the likely partners in the next Trump organization project. The locals have been burnt too often. Even the New York legal establishment is on to him. In the days to come watch how hard President Trump struggles to come up with legal representation in the pending Mueller investigations. For many years Mr. Trump consigned his legal bills to the waste paper basket. Today, even if one lawyer would love the glory of representing him, that lawyer’s partners will have none of it. The glory comes on the courthouse steps to the one lawyer who speaks for him. But the bad receivable is born by an entire partnership.
We wonder how many investors who are racing to the “safety” of cash every other day realize that cash is an IOU from a fellow who has every intention of not paying you back anything like equal value to what you just gave him. And now we have a new Federal Reserve Chairperson who cannot be far away from learning that he has a title, but not much of a job. Interest rates will be what President Trump wants them to be. All that is left to discover is how much pain Jerome Powell is willing to pull down on his own head. President Trump will keep the Fed on the tightest of leashes when it comes to raising interest rates. Tuesday’s New York Times could not have been more illustrative of what we mean. A front page story went on at great length about the dangers of our exploding Federal deficits. The word inflation does not appear even once, as the Timesmen take you through every gory detail about what pain greater interest rates would wreck on our ever more indebted republic. Our last letters to you have been about how we fear inflation while the crowd does not.
The bond market caught the whiff of inflationary cordite in the air in the first quarter, but the Times was oblivious as ten year yields climbed 40 basis points. There may be a little more of that to come. But President Trump is likely to be a very bullish factor on equity prices in the long run. Not because he engenders confidence in a sunny future. With his terrifying twitter habit far from it. It is just that President Trump is an inflationist. It is in his self-interest. Stocks are an inflation hedge, while cash and bonds are inflation’s victims, as we told you in our last letter.
On a much sunnier note, springtime is annual report time. Our companies are handing us green shoots galore. Our largest holding is Boeing, and we will spare you bad puns about soaring results taking flight. We carried on about Boeing in our last letter and, if anything, prospects have grown ever so much brighter in just the last 91 days. But to prove a point by inversion, think about this. Boeing is by far America’s leading exporter. And despite the nasty trade spat that broke out with China this month and the threats and brickbats each side has thrown at the other you don’t hear a word about the Chinese cutting off Boeing. They can’t. They need the planes if they are to grow. That is a silent endorsement to be sure, but all the more powerful for that.
A few years ago we saw change a-coming, and sold our long held American Express and used the proceeds to buy PayPal. Would that we had done it sooner and bigger. Around the world, in South Korea and Scandinavia, and in wallets everywhere, the cashless society is upon us and blooming. In much of the developed world today paper money is fast becoming a barbarous relic. Your cellphone will be your wallet, and PayPal may be entrenched well enough to handle payments as big as a hedge fund manager’s tax obligations. Illegible handwriting on flimsy slips of paper is on the way out, and with PayPal we are on the way in.
To turn to a disappointment, Qualcomm remains one of our largest holdings and has been dead money for quite some time. But with a 4.5% yield and pure cash flow that cannot be surpassed we have no intentions of selling it. Value this precious will out itself in time through nature’s own way. But then again the President’s Twitter habit might put us back on the road to prosperity quickly if all else fails. Mr. Trump rails nightly against the Chinese prosperity for outright larceny of American intellectual property. The Chinese are so brazen they do not bother to deny it. And no one has been a bigger loser in missed royalty payments than Qualcomm. The smartphone in your pocket, no matter which brand we are talking about, runs on Qualcomm’s patented inventions. By dollar volume only about half of the proper royalty payments have made it to San Diego, even though Qualcomm has signed contracts with over 150 licensees. For this company’s earnings to explode all that has to happen is for President Trump to cajole President Xi to do the right thing. And the 5G revolution is coming, with the internet hooked up to just about every device that draws electricity. Qualcomm is the patent holder there too. One day this will matter.
As you may know on your own, late last quarter Jane Paik retired from Levy, Harkins. We have a generous early retirement package available to employees and Jane chose to take it. She was with us for 21 years and was a valued part of our success. We wish her well.
Jane answered many of your day to day questions; and for the last eleven years if she didn’t, Mary Yao did. Mary is ready to step up and continue our high level of service, and she is ably assisted in that by Emeline Perez. Call and just say hello if the spirit moves you.
I am also pleased to report that my dear friend of many years George Wyper has joined the firm as a consultant. He brings with him long history of success in the asset management business having been the Chief Investment Officer at Fireman’s Fund under the insurance legend Jacky Byrne, the co-head of the Asset Management business at Warburg Pincus and then, for twelve years, the head of his own firm. George will assist me in all areas of the firm and is a strong addition to the team. He is a graduate of the Wharton School and Yale School of Management.
The financial trauma of 2008 to 2010 did us a lot of good. It allowed us to buy the best of the best at reasonable prices. We have prospered mightily ever since. This does not stop us from being on the keen lookout for new things, but it is patent damn foolishness to sell something marvelous to buy something else just to be seen as active and alert. You can call here to find that out. We are here every day. And while some of what we own has gotten a tad pricey, what of it? If the earnings come through we will not be saying that this time next year. Indeed, to some extent that thought describes the stock market as a whole. At 16 ½ times this years’ estimated earnings stocks are the slightest bit more expensive than the last century’s experience. And interest rates defy 10 centuries of known experience. Makes all the palaver about when will we see the next stock market correction sound like debating the number of angels that can fit on the head of a pin.
We have waited until the end of this letter to address the question of the moment. Last year saw a stairway to heaven in stock prices, without a shred of volatility in sight. This year volatility is what we get every day, and even intraday. With President Trump’s Twitter habits confidence is shaken almost every night in the wee hours. But we own great value. Sleep through Mr. Trump’s nocturnal musings and you will be happier, healthier and wealthier.
Michael J. Harkins