December 6, 2004

Notes from December 2004 Insights.

1. Reading Gary Shilling’s December 2004 report. He wrote something interesting. He claims that inflation is the norm in wartime, when government spending is huge. He feels that the country had been in war for 60 years, which started in the 1930’s rearmament. Hence, we have only lived through inflationary times. Hence he thinks we are now in a deflationary period. Yet, my question would be, “what about the war in Iraq”, “the war on terrorism”, etc. Yet, I do respect a great deal what Gary says.

2. In the same issue, Gary discusses his view of a housing bubble. He feels the burst might even happen before “good deflation” begins. He sites leverage as one of the causes. He mentions that average home prices have not declined since the Great Depression.

3. Gary feels that stocks should do well in a deflationary environment. He mentions that there will be an initial shock first. Feels P/E’s could rise in a deflationary environment. He adds a 1% premium to the Treasury Yield. I think he hinted that the Treasury Yield would be same as GDP growth. He thinks profits will rise faster than GDP. He assigns a 1% risk premium for stocks. He takes the 4% return, and inverts it to a P/E of 25. He has an interesting grid which places annual stock returns from 1802 – 2000 to be 4.30%. This does not include dividends, and looks fairly constant throughout the years. He mentions that a P/E of 25 is only okay for a deflationary environment. He mentions that stocks could grow to a 4% real return environment. He feels that if we had inflation and higher treasury yields, that P/E would normalize at 14.

4. Gary’s views on long term interest rates are incredible. He is also bullish on the US dollar for the long term.

Our current investment strategy

We have been real busy working on portfolios and research. We have also been entrenched in portfolio tax planning. I have not been very active in informing our clients via this website what our current strategies are. If you are reading this and would like to discuss your portfolio, please just call. We have been diligent in working with our clients portfolios. Of course, our clients portfolios are our greatest concern. You will see some of our diligence in your current portfolio. If you ever have a concern, would like to talk about risks, your portfolio, a specific position, our insight , please just let us know.

Our typical portfolio is in the defensive mode. Our US common stock allocations are on the low side. Our fixed income portfolios are stressing higher quality and lower durations. We have seen major run ups in Utilities, short dollar positions, Precious Metals and energy. We have also been witnessing what we believe to be a temporary melt up of speculative positions. We try to invest accordingly.

Mixed weekend readings and thoughts

1. Lots of talk on foreign central banks reducing their US dollar exposure. We have been positioned for a US Dollar decline since before 9/11/00. According to a recent article in December 2, 2004 The Economist, the deficit issue is the greatest concern of the US Dollar. The article mentions that although USA is a debtor nation, we are bringing in net investment income. Hence, we are bringing in more than we are paying out in interest. There is concern that this phenomena could stop with rising interest rates, and that we could turn net investment income negative.

2. Business Week in December 13, 2004 issue mentions that Asian Central Banks (except Japan), have been weaning off of USD all year.

3. Martin Barnes wrote in December 2004 Bank Credit Analyst , “There are some disturbing similarities with the turbulent currency and stock market environment leading up the October 1987 crash.” During that period dollar weakened, gold strengthened and bond yields went sharply higher. Just something else to watch.

4. Martin Barnes also mentioned that the current account deficit is a “symptom of a low national saving rate.”