Current Letter

April 5, 2017


Dear Client,

For the first quarter of 2017, our average account gained approximately +5.55%.

It was the first quarter of the Trump Presidency, and he did not bore us for a moment, morning, noon, or very early morning.  He has an opinion on every conceivable topic, seemingly without ever the need for sleep, and all of which the press can’t wait to pounce on.  His twitter habit is such a burr under their saddles.  What has gone almost unremarked is how very slowly the process of staffing up the government is going.  Cabinet appointments have been made, but witnesses say Treasury, State, and the other departments are acres of empty space at the moment.  This matters particularly to us because with the scandal scarred resignation of Federal Reserve official Jeffrey Lacker yesterday the Fed’s policy making Open Market Committee will have an additional empty seat come January that Lacker was in line to fill.  And three of the seven Governor’s seats are now empty.  Plus Chair Janet Yellen and Vice-Chairman Stanley Fischer are likely to be replaced come January.  In our last letter to you we said Mr. Trump was likely to strong arm Mrs. Yellen to have his way.  He won’t have to now.  Very shortly he will have all the votes to do whatever he wants, legitimately.  Makes us marvel why anyone is scrutinizing the Fed minutes out today.  What a waste of ink.  Monetary policy will be whatever Mr. Trump tweets it to be, likely in the middle of the night.  Fed watchers are the lighthouse keepers of our time.  Their time is over, they just don’t know it yet.  Monetary policy will be whatever President Trump says it will be, the opinions of the current Fed Governors be damned.

In our last letter we also said, “Donald Trump is a man who has never known limits,” and that obvious fact just can’t seem to be grasped by the markets.  The ten year American Treasury bond yields 2.31%, slightly lower than when we last wrote, and the zany Austrian 70 year bond that so outraged us at year-end rallied 2 points.  Still down 9% from its issue price and still only yielding 1.71%, but making us marvel, “Does anybody read the papers anymore?”  Stated inflation is already above 2% in both dollar and euro zones, it looks to be climbing quickly, and it still understates the price increases going on in all of our lives.  This last point was forcefully brought home to us by reading a new book called, “No More Champagne: Churchill and His Money.”  David Lough, the author, has a satirical turn of mind which he proves in the title.  Do not worry yourself.  Churchill never went a day from puberty onward without having his champagne, including in war zones.  But the author has gone through Sir Winston’s monthly statements, his victualer’s snarlingly insistent bills, and his own correspondence to his banker, his book sellers, and his mother, always hoping for a further advance.  He may have been the man of the century, but he went through most of it astonishingly broke.  Because he lived to age 90, only dying in 1965, his accounts are a remarkable testimony to what inflation can do over a long lifetime.  This is from page 8, explaining what then money looks like now.  “A British reader who wishes to convert Churchill’s losses in the Wall Street crash of 1929–$75,000—should use the chapter’s exchange rate (5 dollars to the pound) to convert the sum to £15,000, then multiply by the chapter’s UK inflation factor (x50) to reach £750,000 as the modern equivalent.”  Think about that for a moment, particularly if you are good with scientific notation.  It takes all the brain power you can bring to it to work out, “How much money is that really?”  Then consider the pound is worth about $1.25 as we write, not $5 as then, and Britain floated 50 year debt in the last quarter at 1 ½%.  Apparently Mr. Market doesn’t read books either.  The book has 32 chapters, each with its own exchange rate, and never an uptick in the lot.  Our point is that bonds remain absurdly overpriced, and stocks by comparison remain a good deal.  And they provide a pretty decent hedge against that sort of catastrophic inflation.

If you are willing to go through 47 pages of transcript, Warren Buffett made just that point again and again in a February 27th interview on CNBC.  “Not even close” was his verdict, expressed at least three times, on whether he wants to own cash, bonds, or stocks.  He says that at 2.5% a bond is selling at 40 times earnings, has no inflation protection, and can’t compete with a stock market selling at 17 times.  Sounds simple enough, no?

Buffett then goes on to sing the praises of index funds, which annoys us no end.  He says it is too hard to identify in advance who will do better than average, but neglects to note that he did exactly that in 1984 in his Hermes magazine piece, “The Super Investors of Graham and Doddville,” which can be found online.  We updated that insight in our Levy, Harkins letter of January 7, 2005, and the groups he identified as on the right value investing path continued to outperform 20 years later.  You can read about that on our website.  But nobody we know of is taking heed on the silliness of exchange traded funds, all the rage at this moment.  ETFs are that rare breed, a hybrid that is the worst of everything.  ETFs allow you to pick and choose between industry groups, which you probably shouldn’t be doing, because it makes you focus on some economic forecast that you are unlikely ever to get right.  And then it uses your money to buy and sell stocks at prices that are likely to be the worst of the day, because their mandate is to accurately track their bogey daily.  This is short termism run completely amuck.  When a stock has a big move, up or down, in an ETF with say 50 holdings, that one stock will be the biggest mover of the funds value for the day.  So if it’s up, they buy a lot, and if it’s down, they sell ferociously.  Think the brokers don’t see these mullets coming from a mile away, and front run accordingly?  And this is legal.  Just how much useful price discovery can come out of markets where the major participants are determined to be know-nothings?

On a day to day basis the ETF craze does have one charming dividend for Gracy Fund Partners.  ETFs ignore small cap stocks, they just don’t buy them, which makes a fertile field even more attractive.  After all, maybe one day Orbcomm, Paypal, eBay, Dell, VMWare, or our other smaller holdings can grow up.  When they get big enough, maybe they can be bought by ETFs, who don’t know or care what they do for a living.  Every day more and more of our competition cares less and less about what they are buying.  That has to be good for us.


Michael J. Harkins