QUARTERLY LETTER

Published Second Quarter 1992
Muhlenkamp Memorandum 22

The First Quarter of 1992 witnessed alternating signs of winter and spring, both weather wise and economically. The net result is unmistakable; spring is coming and the economy is beginning to expand. The financial markets have responded with a move up in long-term interest rates and strength in those stocks expected to benefit as the expansion takes hold. This was accompanied by corrections in many of the favorite stocks of the past few years. The net result has been a sideways movement in the DJIA since January, but one that masked corrections of 4-8% in nearly all other averages. So we feel pretty good about being up modestly for the quarter.

Meanwhile, the Japanese market continues to slide, and still has the potential for disrupting other world markets including ours. The Tokyo stock market is down more than 50% from its peak of three years ago. The good news is that Japan's troubles have just made the cover of Business Week, normally a sign that a move is near completion. Many commentators have pointed out the tendency for trends to hit the cover pages of popular media near their peak, and have concluded that the media are simply poor investors. I think the explanation is a step subtler. Business Week is not in the investment business; it is in the publishing business. It is very successful because if reflects the knowledge and opinion of its reading public. As Bob Braun says, "The public is usually right except at the turns." (Remember how upset the American public was that Japanese investors bought American real estate right at the top?) As investors, we seek to exploit the knowledge and opinion of the public, which is why this newsletter will never have a wide distribution.

Domestically, we are being entertained by politicians who, like spoiled children who have finally reached the limit of their parent's patience, are realizing that the rules have changed, but they really don't understand why. Their problem of figuring out what the public wants is compounded by a public that, without any major external threat, doesn't know either. To a portfolio manager, the advantage of an election year is that ideas are floated on the front pages and many of them are given direct votes, yea or nay, by the populace. So the mood of the voting (and investing) public can be measured directly rather than being viewed through the filter of the media.

The interest paying public does know it wants to pay down its debt. Mortgage refinancing remains heavy and consumer installment debt as a percentage of disposable income has fallen 10% since mid-'89. In response, credit card rates are now falling. Citicorp just cut its rate from 19.8% to 14.9% for its cardholders with a clean credit history.

The interest receiving public knows it wants rates higher than the 4% now available on CD's. The financial community, banks, savings & loans, insurance companies and brokers are happily selling them a variety of securities that promise higher returns. Unfortunately, many of the people selling these securities don't understand them, and the risks inherent in these securities aren't being discussed. We repeat our advice of one year ago. If you want a good return on your money for a period of time greater than three years and cannot get comfortable with common stocks or equity mutual funds, buy long-term Treasury Bonds.

Meanwhile, inflation remains under control and the stock market is fairly priced. From current levels, we expect the stocks of companies that do well to do well. We expect the stocks of companies that disappoint to disappoint. We are spending our time trying to find these differences in time to be useful. Short-term emotional swings can move prices 5-10% in either direction, but that is always true. Frankly, we'd welcome a decline in prices.

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