Opinions expressed are those of Ron Muhlenkamp
and are subject to change, are not guaranteed, and should not be considered
a recommendation to buy or sell any security.
Please consult your investment professional
and/or tax advisor for advice concerning your particular circumstances and
for any tax advice. Neither the Fund nor any of its representatives may give
legal or tax advice.
At our winter seminar on December 4, 2003, Ron Muhlenkamp
presented Investing: Where to Look, What to Pay to an audience of
clients, shareholders and prospective investors. Afterwards, Ron Muhlenkamp entertained questions from the
audience. The following is a sampling
of the “Q&R” session.
Federal Budget Deficit
As the federal deficit increases, won’t it
cause inflation?
Folks, we went through
that argument in the 1980s. When Reagan
said that he was going to cut taxes in the early 1980s all the economists hit
the fan. They said that if you cut
taxes you’ll have deficits, the government will have to borrow a whole lot of
money -- and that will drive up interest rates, squeeze out private borrowers,
and the economy will tank. In fact, the
economy boomed.
Thirty years ago, textbooks used to talk about inflation
being cost-push and demand-pull. What
Paul Volcker proved is that inflation is monetary. The economics I was taught was all nonsense. The last 30 years has proved it. But if you are a tenured professor, or an
economist, or have a PhD, it’s kind of hard to agree with that.
In mid-1991, Connie (my wife) and I were at a reunion at
MIT. I caught up with an old classmate,
who is the chief economist at DRI, (Data Resources, Inc.). They own Standard & Poor’s and other
things. At the time, treasury bonds
were at 9%, and he argued that with the deficit, interest rates had to go
up. I said, “With the incentives that
are going on and with inflation coming down, interest rates will come
down.” In June of ’91, treasury
interest rates were at 9%, and by year-end of ’93, they were at 6%.
Let’s bring it home.
Connie and I have been married 40 years. We’ve had deficit spending 18 of the 40 years. Five years when I was in school, eight
years when the kids were in school, three years when we bought houses, two
years when I started the company. I
don’t regret borrowing money for any of those purposes. But I will not borrow money to buy a new
car. I will not borrow money to take a
vacation. Every now and then I will
borrow money for an investment, but I will not borrow money for things I think
will depreciate. In your own lives,
it’s not whether you borrow money -- it’s what you use it for.
Ronald Reagan borrowed money to get the economy moving
again. It boomed. We had 20 years of prosperity. And he borrowed money to end the cold
war. Most economists will agree that
when you are in a recession, you should borrow money; there should be a
deficit. You should have surpluses when
you are in boom times. And I think
we’ll probably get there in a few years.
The problem isn’t whether you borrow money -- it’s what you do with
it. That’s true for you
personally. That’s true for our government. The deficit itself is not the key. We went through this argument 20 years
ago! And the economists still haven’t
learned. They’re making the same
arguments that they made in the early 1980s.
What are your thoughts on the deficit in
relation to taxes?
The timing of the tax cut was useful in that we are in the
aftermath of a recession -- which is when you should have some deficit
spending. But I’ve argued that we
needed the cut in tax rates to keep people working three, five, ten years from
now. Obviously there are folks that
want a job and want to work, but you also need someone who is willing to hire
them. Who’s more likely to hire your
kids: somebody in the top tax bracket, or someone in the bottom tax
bracket? The answer: those in the top
tax bracket. They’re only going to hire
them if they see the rates low enough that it pays them to do so.
We wrote an essay about three years ago called Prosperity
in which we argued that, in the U.S. today, in both the spending level and in
the earnings level, at the margin, things are discretionary. Some of you have been through the thought
process. Suppose you work a 5-day
week. What you earn on Monday, you pay
10% in taxes. What you earn on Tuesday,
you pay 20%. What you earn on
Wednesday, you pay 30%, and on Thursday you pay 40%. Whatever you earn on Friday you pay 50% in taxes. How many of you would come to work on
Friday?
As you get more prosperous, the rate at which you will
continue working comes down, which is why I believe this recent cut in taxes
was necessary. If you are hungry, if
you are starving, you’ll work at a 95% rate, right? That’s called slavery; but even slaves will work to get fed. But as you get more prosperous that number
comes down.
What effect will budget deficits have on
interest rates and capital spending?
Long-term rates reflect inflation. Long-term rates should be, and historically
are, 3% above inflation. Long-term
rates, we think, are fair today.
Short-term rates swing all over the place. Right now, short-term rates are below where
they should be. If inflation is 1½,
short-term rates should be 1½ -2%. The
reason they are so low is that for the past three years the Fed has been trying
to goose the economy up. Before that
short-term rates were high.
You’ve got to watch the interplay between the two. You can’t just read one and not the
other. Capital spending always lags the
consumer. As you’ve seen in the last
3-6 months, capital spending is now picking up.
Trade Deficit
What are your thoughts on the trade deficit?
The reason we have a trade deficit is that our population
is quite prosperous and we’re buying all this stuff. And we’re buying it at the cheapest price we can get. So while we’re buying goods from China and
Japan, they’re buying our Treasury bonds.
So we have a trade deficit and a T-bond surplus, if you will. I had a question from a shareholder a couple
of days ago asking “But isn’t the trade deficit terrible and isn’t it terrible
that the dollar is falling?” Folks, our
producers want the dollar to fall so that they can sell things cheaper
overseas. Frankly, our consumers would
like a stronger dollar. There is no
free lunch. How do you find the
balance? Right now we’re seeing the
dollar coming down a little and that will help our trade deficit. And, incidentally, all the stuff we’re
hearing about China, we heard the same stuff about Japan, thirty years
ago.
When Tony (Muhlenkamp) was in Korea he wrote home to say
“Dad, these people work sixty hours a week and live in rabbit hutches!” My father was willing to work an unlimited
number of hours and to live cheaply to make things better for his kids. I don’t have quite that same drive. My kids have always been well fed. But if you’ve been through the depression in
this country or the war in Japan or the war in Korea, that population is
willing to work unlimited hours and to live cheaply and thirty years later, the
young folks living in Japan have always taken food, clothing and shelter for
granted and they are not willing to work those hours. So Japan today has the same problems that we do. So now we say, isn’t China out-competing
us? As a consumer you welcome people
who are willing to work hard and cheaply.
They are selling you goods that are cheap.
Inflation
Media/economists talk about the weak dollar
producing inflation: What is wrong with
this? Why is the dollar falling?
Six months ago we were hearing fears of deflation and I
told you it wasn’t a problem. Inflation
could be. We’ve been printing money for
the last year and a half and the Fed has done so because we want to get the
economy going. They have been printing
money at a rate that, if they don’t start sopping it up, it will become
inflationary. Frankly, the printing of
the money has slowed down over the past three to six months and they have been
sopping some of this up.
What people forget is that the slowdown was on
purpose. This time we did it for fear
of inflation that hadn’t picked up yet.
Whereas in 1950 the population feared depression, six years ago we all
feared inflation. We slowed this
economy down and suffered a recession for fear of inflation that hadn’t picked
up. If anything, we’re too sensitive to
inflation, which is why we haven’t experienced it.
Other than the depression, we muddle through pretty well
in this country. It never gets too far
out of whack. We were told in the 1970s
that stagflation was inevitable and then we changed policies and the economy
kept growing. Folks, it’s when there
are no problems that you should worry.
What problems did we have in 1999?
People couldn’t find any problems so they paid twice what stocks were
worth. When people send me a list of
problems, then, as investors, we’re in good shape.
Employment
You say we are willing to work longer hours to
earn more -- but businesses are taking jobs off shore! How can we create new,
good-paying jobs?
There is no unemployment among the Amish. My grandfather was a farmer, which means he
farmed with horses. He was never
unemployed and he didn’t have time to worry about it. My father worked in a foundry for twenty years to pay for a
farm. He never told me that if I lived
clean and worked hard I too could work in a foundry. I don’t want my grandfather’s job and I don’t want my father’s
job.
A month ago I was on an airplane sitting next to a
guy who works for Oracle and he was worried about software jobs going to
India. I said: “How is that any different from thirty years
ago when we worried about steel jobs going to Japan?” He said: “I don’t work in the steel industry.” What we would like to have is our job
disappears the day we retire. It
doesn’t quite work that way.
We’re producing more goods and we’re doing it with fewer
people. We produce the same tons of
steel that we did in 1960. We do it
with about a sixth of the people. How
many of you have kids that want to work in the steel mill? So, whose kids do you want to work in the
steel mill? Now the guys that are
there, they’d like their job to disappear the day they retire. We do a terrible job of the transition. We do a good job of creating jobs, and if
you look at the turnover as opposed to the net gain in employment or
unemployment, what we do is a terrible job of is the transition. I don’t have an answer for that. But when you tell me that you’ve got
children that want to work in a steel mill, then I’ll change my opinion.
Presidential Election
With 2004 being a presidential election year,
is there any significant impact on the stock market?
Historically that’s been a good year. We think things are in place. This time around we actually cut taxes at
the bottom of the recession. We think
the economy looks pretty good next year.
For politics, it’s still “the economy, stupid.”
Frankly, I think Bush is playing more politics than he has
to. I think things are going to look
pretty good for him. If we listed how
many presidents we’ve had (forty-eight), how many of you could tell me which
ones were two-term presidents and which ones were one-term presidents? It seems to me that a guy gets elected
president and he’s kind of relaxed and he wants to do good things. But the people around him… If Bush ends up
being a one-term president, then he’s in the history books. But all his aides, if he’s a one-term
president, what are they going to do a year and a half from now? So, I think you get all these folks around
the president whose incentive is to do whatever… (And Republicans aren’t much better than the Democrats because
they think they get elected to spend our money and to promise us stuff.)
You’ve heard me say this before: I don’t think it’s
Republicans versus Democrats, I think it’s politicians against taxpayers. And all the guys around the president think,
“Gee, if we just put on steel tariffs then we can get Pennsylvania’s
vote.” Well, if we’re that dumb, folks,
then we’re going to get the kind of politicians that we deserve. It looks to me as if the folks around the
president play politics more than does the president.
Malfeasance
Given the corporate scandals, when can the
independent investor trust the numbers and the CEO’s once again?
I learned coming out of the early 1970s (after the last
stock market fad) that 2–3% of management will lie to you. If you list 100 people that you know, 2–3%
are probably habitual liars. And
they’re probably rather entertaining at a party. But that doesn’t mean you want to give them your money.
In fact, most business managers are honest. You’ll find that as you go along. Of the ones that have been crooked, many of
them are going to jail. I believe that
people are gaining confidence and that it’s being solved in the normal process,
so we think that fear of malfeasance will dissipate. And we passed a law, Sarbanes-Oxley, which was a political
response to peoples’ fears.
What we try to do is make sure that the people we are
investing with, we trust. Nevertheless,
we are going to be wrong with 2–3% percent of them. But that’s why we diversify.
Terrorism
In the event of another 9/11 attack, do you
think we will show as much, or more, resilience?
Is there any way that another attack would be as
surprising as the last one was? If they
hit the Sears Tower tomorrow, would that be as big a surprise as 9/11? But whatever it is, it won’t surprise
anybody.
Were you more safe flying an airplane on September 12 than
on September 10? Yes, you were. Folks the reason we got hit on September 11
is that we had a dumb policy that said that if you are an airline crew, you
don’t resist hijackers. That’s a stupid
policy. Since then they’ve tightened up
on security. The hijackers followed all
the rules on security. We had a dumb
policy. The people over Pennsylvania
changed that policy within an hour. The
passengers changed the policy. Crews
have now changed the policy. We
haven’t heard it out of the FAA. In
fact Secretary Manetta, at one point said, “We will not allow pilots to carry
guns.” That’s a stupid statement. That’s like you and me going on nation-wide
TV and saying: “Oh I never lock my house and by the way, here’s my address.” Now, if he doesn’t want them to carry guns,
he should say, “We won’t let them carry guns unless they pass our
criteria.” And then you just set the
criteria so high that no one can pass
it. But you don’t tell the world that you don’t lock your house. That’s stupid.
We’ve got people
setting policy that don’t live in the real world. Well, the passengers changed the policy. How tough do you think it’s going to be to
hijack an airliner today? The
passengers changed the policy. That’s
the strength of this economy, and this country we live in. When people see something stupid they stand
up and do something about it. And we’re
a lot safer than we were on September 10.
Just knowing that there’s a risk does wondrous things for you.
World Markets
What about foreign stocks and bonds?
As the dollar has come down they’ve looked pretty
good. The key there is to pick and
choose. One of these days we need to
become a little more knowledgeable on China.
I have no interest in investing in France because they won’t allow
people to make money. Japan may or may
not be coming back a little bit. Part
of it is, folks, that we’ve found so much that’s good in the States.
Any time you go to
another country you take accounting risk, (and we have more accounting risk in
the U.S. than we thought we did), and you take currency risk. Now, currency in the last six months as the
dollar has come down has helped you.
Prior to that it hurt you. When
you look at foreign companies you have to get more than that 3% spread that we
were talking about. We need to see a
higher return to take into account the currency risk that we’re taking. So far we own a couple of things in Mexico. Beyond that, we haven’t gone much foreign
because we’ve found ample stuff here.
Do you see any impact of foreign held debt on
our financial markets?
Well, somebody asked
me this afternoon “What would happen if China decided to dump all their U.S.
Treasury bonds?” They would hurt us --
but they would kill themselves. The reason
they own our bonds is that they trust our economy and our accounting a little
better than other people’s. And the guy
says, “Well Saddam Hussein would cut off his nose to spite our face.” “Would he?”
These folks, whatever you think of their ethics, they’re not stupid. If China dumped our stuff it would hurt
them; it would hurt yes, yes, but it would hurt them more.
Look, I have a trade
deficit with the grocery store, I have a deficit with the gas station…I have
trade deficit with the tractor store, and some of you have a trade deficit with
us. We buy goods from China and Japan
and they buy our Treasury bonds. If you
lent me money, do you want to put me out of business? You’d have to be pretty dumb.
I castigated Clinton a couple of years ago for bashing the Japanese. Now we’re starting to bash the Chinese on
trade. They are our bankers! You’ve got a loan from the bank. It comes due next month. Are you going to go up and down the street
saying what a terrible guy your banker is?
Come on! Does it give people
something to write about? Yes. Go back in your magazines and take a look at
what people were worried about six months ago or three years ago. It all sounded good at the time. These people have to fill pages. That doesn’t mean it means anything. Why would our bankers try to put us out of
business?