QUARTERLY LETTER

Published Third Quarter 1993
Muhlenkamp Memorandum 27

The trends we have been observing and discussing over the past few years continued in the first half of 1993. The net effect was a continuing decline in long-term interest rates (which drives bond prices up) and a positive change in the average stock price, but "the average stock price" is a misnomer. Some companies and their stocks are doing well while others are doing poorly. Of a broad list of 5000 stocks, over 35% have corrected 20% or more from their highs earlier this year. To those commentators and investors among you who are looking for a significant correction, we would argue that we are already halfway through it. In many respects, the pattern is similar to 1992 when the market spent the summer months digesting the sizable gains of the prior winter.

Today, I'm often asked, "Where's the market going?" I think this is the wrong question. When I entered this business in 1968, inflation, the dollar, interest rates and P/E ratios had been stable for 15 years. If a company's earnings went up, the stock would also go up. Consequently, no one asked, "Which way is the market going?" Instead, people asked, "What do you own?"

During the 1970s, rapidly increasing inflation and interest rates overwhelmed the efforts of individual companies, driving P/Es and "the market" down. During the 1980s, decreasing inflation and interest rates drove P/E's and "the market" back up. Today, inflation has been stable for ten years. The dollar has been fairly stable for four years. Interest rates are returning to "normal" levels, and P/Es are likely to stabilize at current levels, which are fair. Therefore, the relevant question once again is not, "Which way is the market going?" but rather "What do you own?" If it is of any help to you, Warren Buffett and Peter Lynch both maintain that this is the only question relevant to successful investing.

The second question we get is, "What do you think of Clinton's programs?" One of our financial maxims is: "When they change the rules a little, they change the game a lot." It is apparent that we are about to get a change in the rules, particularly in relation to taxes. We don't know any more about the content of the new rules than anyone else does, but we do know that there will be gainers and losers and that some people and businesses will adapt better than others.

We also know that when personal taxes are raised, people have less money to spend. We know that when business taxes are raised, fewer people will be hired. On the basis of the tax proposals we have seen so far, our judgment is that the economy will continue to expand, but just barely. Consequently, little or no progress will be made on the budget deficit or on unemployment. This will put continued pressure on our politicians to, in Winston Churchill's words, "...do the proper thing, but only as a last resort," which is to cut government spending.

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