QUARTERLY LETTER

Published Fourth Quarter 1991
Muhlenkamp Memorandum 20

The Third Shoe Dropped...and Disappeared

In 1990 two giant shoes- war and recession - dropped, taking a heavy toll on the psyche of spenders and investors. Last winter, in searching for other potential major negatives that could drive the markets still lower, we mentioned the possibility of a hard-line reaction in the Soviet Union. It happened during the third quarter of 1991. It lasted four days, and merely affirmed that social and economic changes in Eastern Europe are backed by the masses, and therefore long lasting in character.

Economic freedom in Eastern Europe, as well as in major areas in South America, is a long-term economic positive of overwhelming proportions. In looking for long-term negatives, we find only two remaining: First government at all levels spends too much money. This is nothing new. Second (also not new and easily remedied at election time) is the moral bankruptcy of many of our national representatives. From the Keating Five to "Kite-gate" to Ted Kennedy's moralizing on sexual harassment, the Beltway mob lurches from one lurid mess to another with no regard to the taxpayer.

On the positive side, the recession will come to an end just as all others have before it. The U.S. Federal Reserve has made it clear that it will continue cutting interest rates until the American public finds spending irresistible. Other major countries are lowering their rates as well. With the decline in Japanese rates since June, Germany is alone in keeping rates high. We expect that German rates will join the others within a few months. These declining rates cause bond and stock prices to increase, with stocks subject to individual disappointments.

As investors, it remains a tricky time for security selection, with a major focus on avoiding surprise disappointments in earnings. (The trade calls them torpedoes because they can sink a stock without warning.) Despite suffering from some torpedoes ourselves we are having a superb year. We are doing so because we positioned ourselves to benefit from the explosion of the "Time Bomb" which we warned about two years ago. We own many names that benefit in a declining interest rate environment. At some point it will also pay to invest in cyclical companies, which do well when the economy strengthens. Meanwhile, we prefer long-term treasuries to Certificates of Deposit for the reasons given in our previous newsletter.

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