QUARTERLY LETTER

Published Second Quarter 1988
Muhlenkamp Memorandum 4

It's working better folks! Several of the trends we detected in January carried through the quarter. The stocks of companies' with good balance sheets and strong earnings out performed those companies doing poorly. A smaller trade deficit allowed bonds to rally in January, carrying the interest-rate related stocks along with them. Although a few takeover rumors dominated the headlines, a broad array of companies and their stocks are doing very well.

Year-end fears of recession have dissipated, only to be replaced by concern that the economy might grow too strongly, reviving inflation. This in turn has renewed fears of a weaker dollar and higher interest rates. We claim no expertise at predicting the value of the dollar, but we believe the trade deficit is in the process of fixing itself, and this should bolster the dollar. We also see no signs that inflation will be worse than 4 or 5%. In fact, it looks to us like it may trend below 4%. Inflation is monetary, and the Fed is simply not printing money at rates that cause high inflation.

On the political side, the demise of Richard Gephardt's campaign for President is a hopeful sign of a lack of public support for protectionist trade legislation. If we are correct that the trade deficit is resolving itself, the federal budget deficit is the remaining major negative for the U.S. economy and the dollar. The accompanying article indicates that this problem is not insurmountable, but no one still running for President seems to want to tackle it.

So where are we? We've had a good quarter. Many of the cheap prices we saw at year-end have been bid upward. We sold some stocks that ran up nicely, primarily chemicals, and some whose earnings estimates were lowered, primarily insurance. In general, the stock market is once again hostage to the bond market, which in turn is hostage to the international value of the dollar. In coming months, the economic numbers will help clarify business and economic trends, and November should help clarify the politics. In the meantime we are focusing, as usual, on those individual companies which are doing well and whose shares are modestly priced.

Read our quarterly newsletter, Muhlenkamp Memorandum, for more by Ron Muhlenkamp.