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Past Commentaries

Current Commentary, Review and Outlook
August 12th, 2005

To My Clients, Friends & Observers:

We've all heard the venerable and commonplace investment advice, "Buy good stocks and hold them." In a trying market, many investors retreat to this old saw, mostly, in my opinion, out of fear, or lack of alternatives. And in their defense it must be said that doing nothing, at the right time, is often the best solution to many a case study. Does buying and holding really work? Inspect the following list of stocks, certificates of which are carefully stored in the underwear drawers of thousands of buy & hold strategists across this great land.

Company Price Date
General Electric $34 Jan-99
Cisco Systems 18 Nov-98
H.J. Heinz 37 Nov-96
Coca Cola 41 Mar-96
Merck 31 Nov-95
Pfizer 27 Jan-98
Citigroup 42 Dec-99
J.P. Morgan 34 Jun-97
Verizon 34 Dec-96
SBC Communications 24 Aug-95
AT&T 225 Jan-83
Proctor&Gamble 57 Dec-99
Colgate Palmolive 56 Aug-99
Motorola 22 Jun-95
Intl Paper 32 Sep-93
Kimberly Clark 64 Oct-99
Intl Business Machine 94 Dec-98
Baker Hughes Inc.* 49 Oct-97

Every one of these companies has been or still is a widely-held darling of institutional or private client money managers. What else do they have in common? With the exception of one, all have share prices lower today than on the dates listed. Some of them are the best representatives of entire industries. Indicated are holding periods of 6, 10 or even 15 years and more for some of the greatest corporate names in the world. Eight of these eighteen companies have raised their dividend every year for the last ten years, at least.

Has the economy shrunk during these periods? No. Are these companies producing less? No. Are these companies victims of secular downtrends? Undoubtedly yes, but look at the one exception, Baker Hughes, one the oldest, most reliable, fundamentally sound oil drillers in the world. In the midst of a tidal strength uptrend in the industry, it did not break above its 10/97 price until June this year.

How long can a 70-year-old retiree afford to hold? More to the point, nobody wants to have to hold. Many of these companies have traded above their prices between today and the dates listed. What was the benefit of holding? Another piece of investment wisdom is, "Risk is mitigated by diversification and time." That should be modified to read "systematic risk."

Buying and holding, even the stocks of good companies, can be a lure and a self-deception. When one's head is stuck in the sand consider which part of the anatomy is left most exposed. I make the case for actively-managed portfolios. We benefit from buyers and holders. They give us time to move. The last one out of the restaurant gets the check.

Trading laundry

I spent 10 years of my life working for a paper manufacturer. The experience was a terrific adjunct to my MBA. I was exposed to every conceivable business problem: suppliers, distributors, raw materials, shipping, inventory, energy, unions and labor, OSHA, EPA, DOL, small town politics, human resource issues. And these were before you even got to the problems involved in making the paper, a tricky process that engineers machinery, electronics, chemicals, hydraulics and fiber into a beautifully consistent commodity. It was a great education.

At some point in the late 1970's a government agency analyzed our payroll impact on the local economy. It was calculated that our payroll of approximately $5 million generated about $30 million in local economic activity, a multiple of six. The mill also had a significant regional impact economically because of the breadth of goods and services required to sustain manufacturing operations. And the payrolls of those vendors to the mill had a significantly greater multiplier effect than a laundry, for example. Manufacturing generates much more economic growth logarithmically than do service industries. Were we all to do nothing except each other's laundry, we would be clean, but we would be poor.

So it is worth remarking on the state and nature of employment in the U.S. according to the August 8th issue of Barron's (page 8) which suggests that the real rate of unemployment is 6%, not 5%, and if you count all who should be working full time but aren't, the rate approaches 9%. Barron's quotes Philippa Dunne and Doug Henwood of the Liscio Report that the greatest contributors to new employment were, in order of magnitude, retailing, health care, bars and restaurants, and housing. "It looks like the U.S. economy is now dominated by housing, shopping, eating and drinking...These don't look like core productive sectors."

It should be said that a significant contribution to the productivity of our apparently healthy economy is by the millions of invisible illegal immigrants who are indeed here to work, at low pay and off the books. This partly explains the present political posture, which seems to be, "What illegal immigrants?"

The U.S. is at competitive disadvantage to the cheap labor elsewhere around the globe so we are importing our own, the first nation in history to import welfare clients. I suppose the wealth couldn't last forever, that the U.S. could go on hogging the lion's share of the world's resources to feed its voracious consumption. Manufacturing is not dead in the U.S. and it never will be. China and India are not going to manufacture everything. They are at the exact opposite side of the globe. Transportation and natural resources are costly for them and they are still decades behind in know-how. I just wish American companies (GE, Motorola, etc.) weren't in such a hurry to teach them. Galloping growth is behind us while for the Chinese it is just beginning. We will meet in the middle at some point. Fortunately, our economies are so interdependent that we will all share the pain of any arbitrary moves. No nation can act unilaterally without consequence.

A significant problem has remained countenanced if unaddressed until the Chinese government oil company, Cnooc Ltd., made a move to buy Unocal, and buy it at a premium we must add. Somebody in Washington finally said, "Wait a minute. Do we really want to start selling our free-market capital assets to a Communist/Fascist dictatorship?" This is the 500 pound gorilla that's been sitting in the living room for the last 15 years or so. Hello. Having allowed China to join the WTO, and invested billions in American capital equipment there, are we now prepared to issue an ultimatum for free and democratic elections before they can begin to spend the billions of U.S. dollars they've earned? This will be interesting.

And what of life, liberty and the pursuit of happiness in the Middle Kingdom? I discussed this with a friend over lunch recently. She is an American citizen and Taiwanese by birth. She said, "We talk about freedom a lot in America. It is easy. For the average Chinese freedom is secondary to food. First people need to eat. Then they can argue about freedom." Sounds like Maslow's hierarchy of needs. As brilliant and shining as our American Revolution is in history, our Founding Fathers were relatively affluent men. They were well fed.

Currently

Having trashed the concept of buying and holding at the start of this commentary, let me now show you why you have to be in the market.

From the New York Times, Sunday, July 3 (Money section, page 5) comes an article making a case for market timing as opposed to buying and holding. If one was out of the S&P 500 on the best 10 trading days of the 10-year period through 2004 the annualized gain would have shrunk to 6.9% from 12.1%. If one was in the S&P 500 for only the 10 best trading days in that period the annualized gain would have been 17.8%. Having made a case for market timing the article goes on to discus how difficult timing is.

This is confirmed by Dalbar, of Boston which study dated April 2004 shows that market timers in stock mutual funds for 20 prior years lost 3.29% per year on average. "The fact is most timers lose money most often," according to Lou Harvey, Dalbar president.

When the market is clearly overbought and due for correction, as it was and as I said in 2000, you beat the indexes by allocating away from them. After the correction you must take the portion of a risk-adjusted portfolio that is allocated to equities and fill that allocation. The market can appear to be perversely nonsensical when it moves up. That is because it doesn't move on what Alan Greenspan says or does. It doesn't move because oil hits $66 a barrel. It doesn't move because 4 bombs go off in London. It moves only because there are more buy orders than sell orders or vice-versa.

In the face of $60+ oil, a Fed committed to continue raising rates, and the terror in London and Iraq, the S&P 500 Index jumped almost 3% from July 6th to the 15th, and 4.24% by August 3rd. Most individual investors would have been happy with 4% for all of last year. These are gap ups in the market, the "best trading days" mentioned above, and you have to capture them. How does one know? Well, that took me many years to figure out and I'm not telling.

Finally

We made Caterpillar a new position for suitable portfolios in late May at $92 a share. It has since split 2 for 1 and trades at $55. It is a great, global company with outstanding products, good marketing and financial strength.

Munis have been outstanding values, in some cases yielding more than treasuries of the same maturity without consideration of taxes.

Cartoon in Barron's 8/15/05: three balding accountants are poring over statements, one remarks, "Is there an accounting equivalent of a comb-over?"

Best regards,