Steady Gains in Core’s Portfolios, Despite Sub-Prime Turmoil
Financial markets have become so volatile, news reports about the economy and markets so gloomy, it is perhaps the occasion to look at the bigger picture. Although we monitor Core’s investments closely, particularly during times of such turbulence, our view is a longer one. We seek to understand the large trends in the world to determine how we may invest your capital to take advantage of developments that will unfold over a period of years. This approach has served us very well in recent years: we have taken a relatively small amount of investment risk and have earned substantial gains. The utility of this approach has been especially well marked during the recent months of sharp stock market declines and sudden rallies. In the aggregate, Core’s client accounts have appreciated by 12% so far this year, while the S&P 500 has gained only 4%. (Returns in individual client accounts vary for individual reasons, including levels of risk tolerance and risk aversion. The SEC would have us remind you that we should not expect future returns to mirror those of the past.)
As the bear market of 2000 to 2002 came to an end, the wars in Afghanistan and Iraq began, and the global economic expansion gained strength, we foresaw a number of interrelated phenomena: We came to expect that developing economies in China, India, elsewhere in Asia, Latin America, and central Europe would grow at faster rates than the United States, and that there would be a shift in wealth and power from the United States to these countries. We concluded that the US current account and trade deficits with the rest of the world were unsustainably large and that the value of the US dollar would fall in relation to major foreign currencies. We expected that the demand for raw materials--especially oil--from rapidly growing Asian economies would grow faster than new supplies could be brought to market. We observed that the process of globalization and the free movement of investment capital around the world would invigorate foreign markets.
With these views in mind, we made a series of investments, beginning in 2002, in foreign bond and stock markets to take advantage of the appreciation of foreign currencies against the dollar and to participate in the dynamic growth in Asian economies. Beginning in 2004, we invested in physical commodities and in oil-related stocks in the expectation--borne out by events--that commodities, oil prices, and oil stocks would rise. Our major investments of the last several years have worked well. Now, with crude oil approaching $100 per barrel, with the dollar trading at 40-year lows in relation to major foreign currencies, with the rise in wealth and power of India and China apparent to all, what next? We now have large and highly appreciated investments in oil stocks, Asian equity markets, and foreign currency money funds. Will these appreciate further? Do the risks associated with higher prices for these investments outweigh potential future returns? For now, our view is that further appreciation lies ahead. We are holders of these investments.
In the last two years, we have taken the view that water will be an increasingly precious resource and that the global need for ready supplies of clean water creates favorable investment opportunities. Similarly, the terrible effects of climate change make it a near certainty that industries developing clean energy will grow in the coming decade. In 2006, we made initial investments in water-related industries and in alternative energy. In recent weeks, we have invested some of your cash reserves in a global water industries fund; we expect to make a further alternative energy investment soon. In the past year, these first investments in water and clean energy have performed well. Wonderful. We do not expect these to march upward in a straight line; let us not wait for a repeat of Microsoft and Intel in the ‘eighties and ‘nineties or Google more recently. But in five or ten years, we expect these two industries to reward us handsomely
Other long-term and low-risk investment opportunities lie before us. How can we recognize them and when should we act? Unsurprisingly, stocks of banks and investment banks have fallen as losses in ‘sub-prime’ mortgage instruments have mounted. Stan O’Neill and Chuck Prince, recent leaders of Merrill and Citi, are gone. Merrill has chosen a new chief executive, John Thain; Citi is still looking. The easy and cheap credit available to commercial real estate, which created a years-long boom in REITs, is grinding to a halt and REIT prices have fallen sharply. But the banking and commercial real estate industries will not go out of business. These are not buggy whip makers. If prices in these sectors fall further, we may find very compelling investments. It does not appear, despite another flamboyant stock rally on Tuesday, that we have reached the end of this long-running film about the housing bubble and easy credit. There are more losses to be recognized and more selling to endure. We hold large reserves of money market funds--US dollar and foreign currency--in your accounts. We will welcome the chance to buy financial stocks, REITs, or other investments at low prices. We intend to remain very cautious in our investing; the world is perilous and your capital is precious. We will guard it carefully.