by Ron Muhlenkamp   

A shareholder recently asked, “In light of last year’s performance, do you intend to take any action to modify the current investments in the Fund?” My response was (is) “Do you really want me to change a philosophy and discipline that’s worked well for 40 years because we could have done better in a transition year like 2006?”

Folks, we’ve looked dumb before: the years 1994 (soft landing); 1998-99 (bubble); and 2002 (recession aftermath) are the most recent precursors to 2006. Each time we found that monitoring the economy and relying on the values of companies was the proper response. To that end:

The economy continues to expand.

The rate of expansion is a bit below 3% which is what the Fed was seeking, so the Fed remains on hold. We continue to believe that Q3/06 will prove to have been the slowest quarter of GDP growth in this business cycle, although the current pattern may be shallow (saucer shaped), rather than deep and quick (cup shaped).

The news is full of the repercussions of the Fed’s tightening; this time it is focused on the sub-prime mortgage area.

Folks, when the Fed tightens, it’s because an area of the economy got overdone and their actions are meant to cause pain in that area. A number of weaker firms go out of business and the stronger firms gain market share and go on to prosper. Because of the time lags in the system, the maximum pain for these firms is often 3-4 quarters after the time of maximum squeeze. For an investor, this becomes the ideal time to buy the good companies cheap.

At this point, we believe that we’re getting a chance to do it again. To the extent that the economy is cyclical, investors get a new chance every cycle (sort of like gardening or farming). Meanwhile, the markets remain quite volatile on a day-to-day basis; this will continue.