Recession Impression

July 9, 2001

Dear Investor:

While many analysts see brightness ahead, recall that the light at the end of the tunnel can be an onrushing train. Therefore, it’s important to shed companies with weak balance sheets as the recession continues.

Yes, recession.

Despite debate about the R word’s suitability, we have been in a manufacturing recession for two quarters. The weak NAPM Manufacturing Index, consistently languishing well below 50, points to a manufacturing sector that has gone fishing, or worse. The worst peak to trough market declines since the Great Depression have wrought damage in the real economy. And companies with poor balance sheets will continue to circle the drain.

We are monitoring our managers very carefully to confirm their attention to strong capitalization. This is accomplished by: (1) screening all holdings for requisite debt/cash ratios, (2) watching closely for any major impairments of capital, and (3) applying special vigilance to any companies in negative earnings cycles. Although screening by the balance sheet is always a cornerstone of our strategy, it acquires greater importance as GDP deteriorates. This is the single most important feature of successful recession investment. Vetoing its singular importance, many people remain in denial about the scope of this recession: they are living dangerously, clinging to their fallen tech idols.

One reason this recession doesn’t much feel like one is that unemployment remains at historically low levels (even with this week’s uptick to 4.5%). As long as unemployment resides below 6%, consumer spending could remain strong, supporting the retail and service economy. We are watching unemployment levels very closely.

Bear market rallies will continue, most of which won’t be worth the ticker tape they used to be printed on. But just as two years ago it seemed impossible to imagine a hole in our invincible economy, it now seems equally impossible to divine the inevitable recovery. All United States bear markets have ended eventually, even that well-publicized debacle in the thirties. To think anything else would be to bet on possibilities, not probabilities–never a good idea, despite its perpetual appeal to a gambling spirit.