Our last quarterly letter began with a discussion of the pending end of QEII and its likely impact on Treasury yields. The best-of-the-best fixed income investors disagreed: Bill Grossour pessimistic view of the economy and the fiscal and monetary overhang that exists worldwide, we are finding exciting individual company investment ideas with what we believe to be sufficient margin of safety despite all of the “macro” noise. But first, our typical performance tableMay 14, 2011 Wall Street Journal “The Weekend Interview.” A logical alternative, we think, to the proposition espoused by editors hungry to sell newspapers, Wall Street chieftains levered to a point where any instability could once again render their firms insolvent, and corporate chieftains addicted to the cheap debt the Fed has provided. Failing to raise the debt ceiling will lead to a default, which will lead to a surge in Treasury yields, which will destabilize the global economy, their argument goes. When pressed, everyone seems to know the current situation (25bps Fed Funds rate and $1.5 trillion dollar annual fiscal deficit) is untenable longer-term, but “mañana” they all seem to cry in unison.
While Drunkenmiller may not be a household name, he is as good as they get in the investment business: before closing up shop in 2010 near the top of his game, Mr. Drunkenmiller managed $12 billion in assets and averaged annual returns of 30% since 1986.In other words, he has put his money where his mouth is and he has been right more often than he has been wrong. He makes several important points: First, the real issue is not whether the government pays a coupon fifteen days late; it is whether we make budget reforms to deal with our structural deficit. Second, it is highly unlikely that a technical default will have the multi-decade implications some are claiming. Russia had a real default and three years later their interest rates were at all time lows. Third, Treasuries rallied into the 1995 and 1996 government shutdown. As Drunkenmiller further points out, “interest rates never went back up again until the Republicans caved and … supposedly the catastrophic problem was solved.”
As we wrote last quarter, “We don’t spend a lot of time worrying about single events like the end of QEII [today’s substitute: resolution of the debt ceiling issue] because our investment process is not based on forecasting and we very rarely make binary bets. Our objective is to build portfolios that can outperform in myriad possible scenarios. We seek out investments where the price embeds a margin of safety.” The issue is not the debt ceiling debate or the specific end of one of the Fed’s interventions. Rather, the issues are excessive debt in the US and the developed world in general, a US economy artificially propped up by unsustainable fiscal and monetary intervention, and overvalued assets across the board. Capitol Hill is arguing over $1-2 trillion in cuts over 10 years when the Federal government is already $14 trillion dollars in debt, has between $50 and $100 trillion in unfunded liabilities, and is running a current deficit of $1.5 trillion dollars. History shows that no matter the marginal tax rate, the U.S. federal government revenues hover around 20% of GDP, so it is highly unlikely we can tax our way out of this problem. “Public choice” theory says the required spending cuts are equally unlikely. The remaining option is to monetize the debt. When it comes to “macro” issues there are two points worth thinking about regardless of the current headlines. Excessive debt increases volatility and the path of least resistance for the government is to print money.
While we still believe caution is critical given the economic instability that abounds, this outlook is a function of valuations and long-term issues, not the crisis du jour. Thus, despite the headlines, we find ourselves investing in a manufacturer of business printers, an owner of Asian casinos, a real estate development company, and a containership charter company. Our expectations are not that economic growth is set to pick up and with it real estate values and business printing, or that China will avoid a hard landing in its attempt to quell inflation, or even that global trade is immune from a slow down. Rather, in each case we see a business with solid fundamentals and a share-price sufficiently cheap that even should things go wrong in the short-term, we are likely to make money in the long-run. I.e. we have a margin of safety.
While Drunkenmiller may not be a household name, he is as good as they get in the investment business: before closing up shop in 2010 near the top of his game, Mr. Drunkenmiller managed $12 billion in assets and averaged annual returns of 30% since 1986.In other words, he has put his money where his mouth is and he has been right more often than he has been wrong. He makes several important points: First, the real issue is not whether the government pays a coupon fifteen days late; it is whether we make budget reforms to deal with our structural deficit. Second, it is highly unlikely that a technical default will have the multi-decade implications some are claiming. Russia had a real default and three years later their interest rates were at all time lows. Third, Treasuries rallied into the 1995 and 1996 government shutdown. As Drunkenmiller further points out, “interest rates never went back up again until the Republicans caved and … supposedly the catastrophic problem was solved.”
As we wrote last quarter, “We don’t spend a lot of time worrying about single events like the end of QEII [today’s substitute: resolution of the debt ceiling issue] because our investment process is not based on forecasting and we very rarely make binary bets. Our objective is to build portfolios that can outperform in myriad possible scenarios. We seek out investments where the price embeds a margin of safety.” The issue is not the debt ceiling debate or the specific end of one of the Fed’s interventions. Rather, the issues are excessive debt in the US and the developed world in general, a US economy artificially propped up by unsustainable fiscal and monetary intervention, and overvalued assets across the board. Capitol Hill is arguing over $1-2 trillion in cuts over 10 years when the Federal government is already $14 trillion dollars in debt, has between $50 and $100 trillion in unfunded liabilities, and is running a current deficit of $1.5 trillion dollars. History shows that no matter the marginal tax rate, the U.S. federal government revenues hover around 20% of GDP, so it is highly unlikely we can tax our way out of this problem. “Public choice” theory says the required spending cuts are equally unlikely. The remaining option is to monetize the debt. When it comes to “macro” issues there are two points worth thinking about regardless of the current headlines. Excessive debt increases volatility and the path of least resistance for the government is to print money.
While we still believe caution is critical given the economic instability that abounds, this outlook is a function of valuations and long-term issues, not the crisis du jour. Thus, despite the headlines, we find ourselves investing in a manufacturer of business printers, an owner of Asian casinos, a real estate development company, and a containership charter company. Our expectations are not that economic growth is set to pick up and with it real estate values and business printing, or that China will avoid a hard landing in its attempt to quell inflation, or even that global trade is immune from a slow down. Rather, in each case we see a business with solid fundamentals and a share-price sufficiently cheap that even should things go wrong in the short-term, we are likely to make money in the long-run. I.e. we have a margin of safety.
