QUARTERLY LETTER
Published First Quarter 1996
Muhlenkamp
Memorandum 37
1995 has been a good year. Financially,
it has been a very good year. This fact alone has some people
nervous. The current headlines on the budget debate and Bosnia
enhance this nervousness. I have been getting some phone calls
from clients concerning what we see and think. As usual, I
will start with the big picture and work down.
Position Evaluation
Inflation in the United States is roughly
3%. Bonds are priced to return 6% and stocks are priced to
return 8-9%. Specifically, domestic stock and bonds prices
are fair, unlike a year ago when they were on sale for "20%
off". (See Muhlenkamp Memorandum
#33.)
Trends: The Long–Term Picture
- Thermonuclear war is unlikely.
- Much of the world, on all continents,
is moving toward freer economies and freer politics.
- Throughout the world, central banks
are disinflating. If anything, central banks have been overdoing
it. Japan flirted with a depression and Germany's money
supply is probably too tight. In 1994, the U.S. purposely
slowed the economy as a preventative measure. This is in
sharp contrast to the 1970s when we waited until major surgery
was required before battling inflation. Central banks, in
"emerging" countries, have learned that the first
requirement for "emerging" is that people, both
domestic and foreign, trust the value of their currency.
Thus, the big picture is very positive.
The Intermediate Picture — Basically the
3–5 Year Business Cycle
- The U.S. economy shows few excesses and
is likely to continue a gradual expansion. Americans have
become conservative spenders and aggressive savers. Our
politicians are arguing about how much to throttle back
spending, not whether or not to spend less. The Federal
Reserve has room to lower interest rates and their most
recent two moves have been downward.
- Japan appears to be backing away from
the brink of financial disaster in a rational fashion and
Germany appears to be loosening up a bit. Other European
governments are trying to come to grips with the welfare
state. They have a long, hard way to go (compare the budget
arguments in France to those in the U.S.), but the first
step is to identify the problem. The politics in Russia
seem to be backsliding toward the hard-liners, but no more
so than we expected.
Thus, the intermediate trends are quite
positive.
The Short–Term Picture
- You have been seeing the short-term factors
discussed on the news and on the front pages of your local
newspapers. Some are disasters waiting to happen. I believe
our troops in Bosnia are likely to be targets for the young
locals. (What would happen if we asked soldiers of a foreign
nation to police our streets?) After being ignored by the
U.S. news media, the Vince Foster/Whitewater affair has
suddenly become news and has plenty of potential for political
disaster.
- The budget debate is currently stalemated
in Washington, but that very fact is helping to stir debate
in the country. There are important philosophical and fiscal
issues at stake, and the pro-longed debate may well be a
plus. I believe less government spending is a move in the
right direction, but the Republican agenda may have gotten
ahead of broad public opinion.
- The value of prolonged debate was illustrated
by the recent yearlong discussion we had on healthcare.
I believe the debate served to give us not only a good outcome,
but one in which all interested parties felt they had input.
In a democracy, the "input" part may often be
nearly as important as the "outcome" part. Frankly,
the longer I watch free markets and the American democratic
experiment at work, the more impressed I become with the
capacity of both for healthy self-correction and positive
outcomes. In the 1980's we worked off inflationary excesses
with about as little pain as possible, and in the 1990s
we may be working off governmental excesses with as little
pain as possible.
- And of course, there is always the unforeseeable.
The point is that we always face short-term psychological
crosscurrents, and thus we always face the possibility of
a 5-10% "correction" in stock and bond prices.
We are probably in one now. Thus, the short-term trends
are choppy, but essentially neutral.
Conclusion
We conclude that stock and bond prices are
fair, the long and intermediate term trends are positive,
and the short-term trends are neutral.
Thus, we remain positive.
Additional Comments
We recently went through a dialogue with
the Securities and Exchange Commission concerning the format
and filing procedures for our mutual fund prospectus. If I
were to view the experience in a vacuum, I would be very discouraged.
It was a veritable case study of regulators following form
and procedure, oblivious to common sense. But when I look
around, I see the Justice Department suing Hooters for not
hiring male waiters along with the young females and the public
laughs at the Justice Department. At the same time, Philip
K. Howard's book, The Death of Common Sense, is on the bestseller
list. The book is a pretty good description of what we went
through and how government regulation evolved to its current
state. I suggest you read Mr. Howard's book. In our case,
the public's response to our experience was, "Oh, The
Government!" My point is that much governmental regulation
has lost the respect of the American people and is therefore
subject to being changed. The lag times are much longer then
we would like, just as they were for inflation and the federal
budget, but I am gaining in-creased confidence that when U.S.
economic and political trends reach absurd extremes, the public
reverses the trends back toward sensible levels.
A quote from This Week with David Brinkley,
December 5, 1993 - Sam Donaldson: "No one in this town
[Washington DC] tells the truth." David Brinkley: "That's
the truth. No one in this town tells the truth."
Read our quarterly newsletter, Muhlenkamp
Memorandum, for more by Ron Muhlenkamp.
|