Quarterly
Letter
First some background: Since WWII, the U.S. Federal Reserve Bank (the Fed) has purposely raised interest rates to slow the economy at least 12 times. Ten of those times it culminated in recession and once (1994) in a soft landing; i.e. a decline in the growth rate but no decline in GDP. In most cases the Fed raised interest rates until something broke, i.e., a sizable company went bankrupt. (In 1970, Penn Central went out of business; in 1984, it was Continental Illinois Bank.) In recent years, the Fed has taken a more gradual approach and has been quite open (transparent) about its intention. In 1994, the Fed engineered a soft landing. In 2001, it appeared on track to do so until the attacks of 9/11/2001 tipped the economy into a recession. In the current cycle, the Fed raised short-term rates to 5¼% over a two-year period and waited. We judged the squeeze to be insufficient to cause a recession and have been predicting a soft landing. We also expected a soft landing in the bond and stock markets. We missed on two counts. Although the Fed stopped raising rates in early 2006, participants in the mortgage and credit markets continued actions that only made sense during the ultra low, short-term rates of 2002-2004. Specifically, mortgage providers continued to write adjustable rate mortgages and as rates moved up, rather than writing fewer mortgages, they modified the terms to be able to keep writing mortgages until they broke the market and themselves in February-March 2007. Meanwhile, managers of leveraged buyout funds and hedge funds, which had great success in the period of ultra low short-term rates, attracted huge amounts of money which they attempted to put to work as the rates became much less attractive. In an attempt to continue prior good returns, many of them used greater leverage at a time and under conditions when they should have used less. They pushed their market until it broke in July-August 2007. While the point of maximum pressure appears to have passed in each of these markets, the fallout will go on for a couple of years in mortgages and possibly longer in the credit markets. We can never say for sure that some other market won’t break, or that an outside event like 9/11/01 won’t occur, but we don’t currently see additional likely candidates. We said late last year at our November 9 seminar that the first sign of the transition period coming to an end came in the spring of 2006 when long-term treasury rates peaked and rolled over; (see “Where to from Here?” on our website at www.muhlenkamp.com). Since then long-term treasury rates have remained in a range below that peak. The second sign that the transition period is coming to an end occurred in August 2007 when the Fed lowered short-term interest rates. Normally this is also a sign that the time is right to buy financial stocks. We’re about to find out. We are now observing that a soft landing tends to take longer than a recession and gives ample time for the uncertainties in the marketplace to drive stock prices lower much like a recession would do. This time it has been a split market. Some stocks and industries have done well while others have done poorly. Despite the focus of the media and the markets on the problems, several averages are doing very well and are near all-time highs. The question remains: If the above is apparent in hindsight, why didn’t we see it coming? Good question. My best answer is that my hindsight is better than my foresight. Bottom line: This transition has taken longer
than we expected, but the pattern is familiar. We find it interesting
that market participants alternate between despair and euphoria while
the economy marches on and major market averages near all-time highs.
We believe it’s a good time to put money to work.
 Having an automatic investment plan (AIP) can be a very important practice (VIP) when it comes to building wealth. An automatic investment plan is an automated method of investing fixed amounts of money at regular time intervals; e.g. $50 on the 15th of every month. Automatic investment plans are available at many brokerage firms and mutual fund companies. Whether you are saving and investing for retirement, a child’s education, or your dream house, an AIP is a powerful way to make your financial goals happen. It creates a habitual and disciplined combined savings and investment plan that occurs methodically over time. For those investors who intend to invest money periodically, an AIP makes sense because so often good intentions don’t happen. Good intentions often don’t happen because: • Activities that seem to require immediate attention
often take precedence over activities that will impact us in twenty
to thirty years. Many times such distractions cause investors to postpone
the time needed to manage their finances. An AIP can help take the guesswork out of when to invest and makes saving and investing easier and convenient. Saving even a small amount each month, quarter, or year may not seem that impressive, but it has the potential to lead to significant wealth over longer periods thanks to the power of compounding returns (i.e. earning money on earnings you made in prior periods). When I speak to high school students, many are unaware that they have a huge advantage as investors over me and my associates at Muhlenkamp & Company. Many are not aware, just as I was not aware at their age, that their advantage is youth – simply having more time to allow compounding to work to their benefit. In the classroom, we create a hypothetical situation in which one student upon graduation would invest $2,000 each year for three years and then quits their disciplined savings and investment strategy. We then compare the student to me at age 34, hypothetically starting a similar plan investing $2,000 each year. However, I stay the course -- and remain disciplined and committed for the next 26 years -- until retiring at age 60. Assuming both the student and I each find a good long-term investment that can return 10% a year on average, I ask: Who will have more money when they reach age 60? To the surprise of many of the students, it is not even close! The student would amass $329,578, and I would reach $266,420. Even small amounts of money saved and invested properly can have a significant impact on your wealth. Most of us could find an extra $50 a month to save. The hypothetical table below illustrates what saving an extra $50 per month can do when compounded at 10% per year over long periods. Years Future Value If you are not saving and investing something each month, now is a great time to start. If you already have an AIP, do your best to maximize what you contribute. If you know of someone that has a time advantage and they aren’t aware of it, you can do them a tremendous favor by encouraging them to begin an automatic investment plan, ASAP. Setting up an AIP can be simple. You just need to create a link between a bank account or money market and your chosen investment. Once this link is established, you can request your investment firm to withdraw money from your banking account periodically and transfer funds into your chosen investment. This will continue to happen automatically until you request it to be stopped. An AIP can be established in the Muhlenkamp Fund: 1. Initially, when you establish your account. New
account applications have an AIP section. Automatic Investment Plans do not assure a profit and do not protect against a loss in declining markets. The hypothetical example does not intend to imply any future performance.
During that call, we usually ask why the account is being closed. Frequently, we hear that shareholders want to consolidate investments in one place, finding it cumbersome to deal with statements from various companies. What we also learn is that many folks are not aware it might be possible to transfer Muhlenkamp shares to a brokerage account -- and not have to redeem them. If a shareholder wants to consolidate all investments at a brokerage firm, the procedure is as follows: • Check with either the brokerage firm or our office
to determine if that particular firm has an agreement with the Muhlenkamp
Fund. If we do, then a transfer of the shares is possible. As you can see, it is a simple thing to combine all of your investments at one brokerage firm.
2007 Distribution As you know, we invest your money with an eye to taxes which is currently an interesting topic for two reasons. One is that we’ve been able to defer paying taxes on capital gains since 2000, despite appreciation in NAV of over 70%. The second is that the capital gains tax rates may increase after the elections in 2008. As always, the main reason to take gains is because a stock is likely to go down or we have a better use of the funds; but if tax rates are likely to go up, it may also make financial sense to pay the tax early at the lower rate. We do believe that the current maximum rate of 15% (less in the lower tax brackets) is as low as it will be anytime soon. Stay tuned. Maintenance Fees Traditional,
Roth, SEP and SIMPLE IRA annual maintenance fee $15.00* * Capped at $30.00 per social security number; for any direct registered shareholder of the Fund having an IRA account balance exceeding $50,000, the amount of the IRA maintenance fee will be a Fund expense. IRA Account Maintenance
Fee Muhlenkamp Fund Minimum Balance
Maintenance To avoid having this fee deducted from your account, you may choose to either submit a check to raise your balance above $1500, enroll in the automatic investment plan (AIP) or close your account. If you close your account you may be subject to capital gains taxes or other taxes and charges. If you choose one of these options, your request must be processed by November 15th to avoid having the fee deducted from your account. 2007 Forbes Honor
Roll *Forbes magazine’s rating criteria for earning a place on the Forbes Mutual Fund Honor Roll include: 1. Strong relative performance in up and
down markets;
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Whenever
a shareholder chooses to close a direct account with the Muhlenkamp
Fund, our Client
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