Market Commentary

Ferocity, Fallibility

July 2013

"Good advice rarely changes, while markets change constantly." [i] – Jason Zweig

We write in a summer of discontent - with your portfolios' short-term performance. Like you, we have watched the U.S. stock market move up strongly this year, yet see that your portfolios are flat year to date. We don't like it at all. Gold-related holdings are down. Foreign bonds declined significantly in the second quarter and, while outperforming domestic bonds, are still only slightly up year to date. We and your stock managers are holding ready liquidity on the sidelines for you to buy at more opportunistic prices – in accordance with our value discipline. All of that has contributed to your lagging performance year to date.

While we look at performance every day, we also have a long view that it is not only this quarter's performance that counts, but how we grow and protect your capital over many years. And, we are earnest about downside protection in circumstances when downside risks appear to outweigh upside opportunity. We are as interested in your return of capital as we are in your return on capital, and in this long, not-yet-over bear market that started in 2000, we have seen two dramatic price declines of -49% (2000-2002) and -56% (2007-2009). We don't think that the price trough in 2009 was the end of this long bear – the conditions for that were simply not in place. So, we remain cautious, and retain ballast in your portfolios. While this quarter's performance and in fact the past two years lagging the key U.S. stock benchmark has been frustrating, we think continued caution in our overall approach to growing and protecting your capital makes sense.

The unprecedented financial and economic situation we find ourselves in has not changed. One thing that strikes us as remarkable is the way that recent market activity – the sum total of literally billions of investor decisions made in the market – has become myopically focused on a single data point. That data point is the Federal Reserve's ongoing monetary easing – will it continue? At what rate? Will it taper off? Starting when? The media conversation and investor reaction leaves the impression that there is really no other systemic information required to decide whether to participate in risk assets – that central bankers are infallible, and the consequences of their unprecedented monetary policy can be controlled. Based on this, U.S. stocks in particular have rallied strongly; now both bonds and stocks trade at historically high levels, with residential real estate now coming up sharply, too. All this, despite an economic recovery that has been notably tepid.

The small group of people who make interest rate and bond purchase decisions inside the U.S. Federal Reserve and other central banks declared themselves willing to float our investment markets with literally any amount of liquidity beginning in the summer of 2011 in order to maintain confidence and to spur economic growth and recovery. It was this set of extreme central bank actions that in part led us to add to your gold and gold-based weightings and to stick with a large foreign bond holding in the summer of 2011. With so few people driving so many decisions, and the high likelihood of unintended consequences cropping up along the way, why posit that central bankers are infallible? We've seen in the last month renewed volatility at the possibility that fallibility is possible in the central banking endeavor.

We certainly don't make perfect decisions, and we are looking pretty darn fallible ourselves over this shorter run. It seems simple retrospectively to have pursued more risk, and yet, as Jason Zweig points out, "the advice that sounds the best in the short run is always the most dangerous in the long run."[ii] Nearer-term, we don't know what is next. We have a long view that stocks will have to get cheaper and more unpopular in order to generate truly strong returns for you and other value-oriented investors. We also know that buying high and selling low is what many near-term oriented investors do; to accomplish our long term goals we need the discipline not to chase near-term performance. Instead, we exercise patience until we can get you more heavily invested at lower prices when opportunity is compelling based on value. We aren't there - but we expect to see it at some point in the future – likely when many others think doing exactly that is not a good idea.

Winston Churchill pointed out that "you make all kinds of mistakes, but as long as you are generous and true and fierce, you cannot hurt the world or even seriously distress her."[iii] We think the same applies to the way we manage portfolios: adhering to our discipline, being willing to admit mistakes. And when the short-term news is bad, being true and even a bit fierce, so as not to distress your capital, but to protect it until we can invest in growth at lower values with less stress.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

[i] "Saving Investors from Themselves," The Wall Street Journal, June 28, 2013, available and well worth a read by clicking through to

[ii] Ibid.

[iii] from Churchill's 1930 memoir A Roving Commission, Chapter 4.

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