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Investment Process
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  by Dennis M.
 •Brae Head Total
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Past Commentaries

Current Commentary, Review and Outlook
May 15, 2006

To My Clients, Friends & Observers:

“ The successor to politics,” said Marshall McLuhan, “will be propaganda; propaganda, not in the sense of a message or ideology, but as the impact of the whole technology of the times.” (Quoted in Forbes magazine, January 30,2006, page 136)
Media technologies’ ability to facilitate propaganda has advanced so much in the last ten years that its impact on culture is almost dictatorial. Good politics is the art and science of governance based on some party’s particular ethos. Propaganda ignores ethos. It has nothing to do with truth. Its sole function is to advance an agenda. So now more than ever before, who controls the media controls the agenda. The propaganda spewed everywhere, on almost every subject, has become so oblique, so devoid of fact, so barren of truth that it begs one to step back - shut off the set, put down the paper, stop listening to the radio – and take a cold, hard look around.
The most sympathetic thing that can be said of contemporary American moral conventions is that they have become unconventional. The propaganda of diversity has made tolerance synonymous with acceptance, morality with bigotry. What is labeled “traditional” morality is not tolerated. In the broad media the designated poster children for morality are evangelicals, who actually do very little evangelizing, or, more accurately, fundamentalists, whose fear and ignorance is alien even to most Christians.
Look instead at the affairs of the political economy, which are more properly in context here. Everywhere you look you can find monumental, appalling failures of governments: in the cities of New Orleans, Washington and our Springfield, in the corrupted states of Louisiana, California, Massachusetts, Illinois and others; in the U.N.; in the interminable atrocities of the Middle East; in Europe, Russia, China, all over Africa and South America. Bureaucracies by their nature are empowered to serve no one as well as their own. Projects of governments, once initiated, are almost impossible to curtail. Mikhail Gorbachev has to be one of the most extraordinary heroes of the 20th century for ending a pointless, cold war, peacefully. Consider how many lives were saved.
Remember Waco? Please never forget it. If one person of government authority had simply said “stop” how many men, women and children would be alive today? Why were tanks, flamethrowers, helicopter gunships and a small army necessary to arrest the Branch Davidians when a simple surround or barricade would have sufficed? The answer is in human nature. It was because a group of unconstrained, giddy bullies could use overwhelming power to annihilate an enemy, without any recourse or danger to themselves. The killing of innocent men, women and children was the abstract and unfortunate “collateral damage” necessary to the operation.
Hugo Chavez is the leftist, populist president of Venezuela, one of the founding nations of OPEC and the world’s fifth largest oil exporter. Chavez barely escaped an assassination attempt and a coup to overthrow him in 2002, attempts he says were initiated in the U.S. by the CIA. Whether you believe Chavez or the CIA, take your pick, the U.S. has a newly entrenched enemy of strategic significance in South America and the populist movement leftward is picking up steam elsewhere on the continent.
The U.S. is the world’s sole superpower. Our military budget in 2005 was 43% of the world’s total. Second was China at 6%. Russian President Putin criticized U.S. arms spending last week as “excessive.” How could the rest of the world not be intimidated by American power, envious of American wealth, offended or frightened by jaded American entertainments, and suspicious of American foreign interventions? In whose best interests are American successes around the world? The benefits of American alliance are not as distinct as they used to be.
What was accomplished by carpet-bombing Belgrade? What threat to the United States was averted?  What will we have accomplished in Iraq having spent over a trillion dollars there? Democratically elected mullahs? Why do we champion democracy? America was not founded as a democracy, it was organized as a republic, with rights endowed – not voted - by a creator, and guaranteed by a constitution. That’s what protects us from a tyranny of the majority.
The U.S. and Britain overthrew the democratically elected Prime Minister of Iran in 1953, Mossadegh, and replaced him with the Shah. We have good reason to fear a nuclear Iran. They remember what most of us have never known. China and Russia have sided with Iran at the U.N. and will not back a U.S. demand for sanctions in the Security Council. Why would they, in their own self-interest?
And what conclusions do our enemies draw as they witness America bogged down in Iraq while being invaded at home on its southern border by 12 million Mexicans who enter with little or no resistance to freely demonstrate in American cities waving Mexican flags? Can it really be this easy to invade America? The governing classes shrug their shoulders and plead that it is futile to round up and expel 12 million illegal aliens. OK, could we not then expel one million, or maybe a hundred thousand? Ours is the first civilization in history to import its own welfare class. The government welfare behemoth grows yet. It is apparent that American lawmakers have no respect for their own laws. Ponder the possibility of street warfare on our own homeland with angry, hungry people who have never seen such wealth as ours before and who have no fear of death.
Iran is currently developing a system to trade its oil in Euros instead of U.S. dollars. Saddam Hussein did the same thing in Iraq and that, as much as the possibility of WMD, hastened his demise, in my opinion. Iran could probably succeed at trading oil for Euros, with Europe. If the entire globe traded oil for Euros instead of dollars it would effectively be the beginning of the end of the dollar as the world reserve currency. That would radically alter our investment strategy. It would at the very least complicate America’s domination of the world economy.
America has been willing to go to war for oil (“protect its strategic oil interests”) rather than develop its own energy. For thirty years since the last oil crisis we’ve built no alternatives and we’ve drilled very little domestically. No matter what we initiate today we are at least 6 years away from any significant changes to that scenario.
Be aware of the propaganda. It is ceaseless and it is everywhere.
On Funds
I was interviewed by our local paper recently for an article about hedge funds. I share a few of those ruminations here.
Hedge funds are pooled assets like mutual funds but with some key differences. They are not necessarily marked to market and priced daily, depending on the underlying investments. They do not offer the liquidity of mutual funds and in fact money may be committed for months and years. Most significantly, hedge funds are not regulated like mutual funds. The investor must sign a form certifying that he/she is an “accredited investor” having a certain high annual income or a particularly high net worth, which means that he/she can afford to lose a lot of money.
At a party in Fairfield County, Connecticut (known as the “gold coast” here in New England) over the Christmas holidays, I responded to inquiries of my occupation by simply saying I was an investor. I was hit on, in short order, by several gents who managed or were starting hedge funds. The attraction of little regulation, high fees, and the trendy cachet that hedge funds enjoy among wealthy if unwary investors makes them very attractive to package and lucrative to manage.
One would think that the mutual fund scandals of the last several years would have been resolved by now, after all the huffing and puffing, with the enforcement of significant corrective measures. One would be wrong. True, there has been a barrage of new regulations regarding reporting and legal compliance procedures, all of which are very expensive and so redundant as to put great pressure on smaller shops to the advantage of the big firms. So it goes: more propaganda and no material change.
Probably the most outrageous mutual fund rip-off was the market timing scandal. This is the practice of buying or selling a fund after the market closes and getting the prior session’s price. This is no different than betting on yesterday’s horse races. I was shocked to learn a few years ago that this practice was legal in some circumstances. I assumed that the practice would subsequently be banned. Wrong again. You probably did not read about this in the newspapers or see it on TV but the 3rd U.S. Circuit Court of Appeals in Philadelphia ruled in March that “legal market-timing provisions are still valid.” (Reported in Investment News, April 24, 2006)
People ask me, “What’s wrong with Microsoft and GE? Why don’t they move?” They are two of the best companies in the world. They dominate their markets. They have increased profits and have improved valuations. And they’ve traded in a narrow range for over five years. That’s a fair holding period to expect some upside. These companies - two of the most broadly held in the world - are good proxies for the broader market, as I look at the S&P 500 Index trading at the same level today that it was seven years ago.
They, and the S&P 500, haven’t advanced notably because they are so broadly held. Everybody who wants to own them already does. Until there are incrementally more buyers than sellers they will trade sideways. Where are the catalysts to attract buyers?
They are not abroad. Foreign investors are already here, having increased direct purchases of U.S. publicly traded assets almost 18% in 2004. And in fact U.S. investors are making significant net new purchases of foreign stocks, sending cash flows in the wrong direction. Latest data suggest that foreign investors too are retreating from our markets, incrementally, in favor of Asian securities.
The dollar has fallen about 9% since last December and I won’t commit to either direction. Our taxable fixed income portfolios have an average duration of 5 1⁄2 years. Our aggregate composite is 50% equities, 43% fixed income and 7% cash.
Housing starts are slowing, dropping 7% in April from March. Growth of M1 money supply is only 1.9% year over year. M2 expanded 4.9% for the same period. The Fed stopped calculating M3 in March, disclosing that it was cumbersome and not worth tracking. Excuse me? When has a government bureaucracy ever found something worth discontinuing? Then again, the Fed is a private government bank, not a public government institution.
The principal motivation for raising interest rates is to get some water under the keel for the U.S. banking industry, regardless of the posturing about inflation. Should the dollar plunge and foreign capital flee, our interest rates will jump. Our fixed-income investment strategy is prepared for interest rate moves and I wouldn’t be surprised at ten-year Treasury rates of 6% in 2007. Meanwhile, the yield curve is slightly positive and the economy at large is sanguine. It feels sluggish to the consumer due to the high oil prices.
Best regards,  
Dennis M. O’Connor