QUARTERLY LETTER

Published Second Quarter 1990
Muhlenkamp Memorandum 13

The story of the first quarter of 1990 was not in the net return, which was slightly negative, but in the pressures absorbed by the U. S. stock market with so little effect. Chief among these pressures was an increase in long-term interest rates. Rates on U.S. Treasury bonds climbed from 8% to 8.6% during the quarter, puffed upward by increased rates in Europe and Japan.

In Europe, rates increased in anticipation of an East German capital shortage, pending reunification with West Germany. The rise in Japanese rates appears to be in response to somewhat higher consumer inflation in that country, as well as highly inflated real estate and stock prices.

Higher Japanese rates in turn triggered a 30% drop in Japanese stock prices, from three times the world average price/earnings ratio to two times. This was the second major negative absorbed during the quarter by the U.S. market. We, along with many others in the U.S., view the Japanese market decline as a positive, and long overdue. We cannot be sure; however, that the fear it engendered will not spread over here. So far, it hasn't.

Another short-term negative during the quarter was the long expected and widely advertised slowdown in the U.S. economy, which knocked earnings for many companies below year ago levels. The slower economy surprises no one, but weak earnings and higher interest rates combine to create pockets of panic selling in (suddenly) overvalued individual issues. This "earnings mine field" should culminate with the results of the first quarter, which are being reported now. We are trying to avoid the mines and search out firms with good earnings that are reasonably priced.

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