April 2007

Portfolio Comments

Market View

Dorato Services

The Library: articles by Steve TeSelle

Portfolio Comments

Sometimes I’ll get a puzzled look about a particular stock I’ve purchased for a portfolio, with the underlying concern that the company is poorly run or in a declining industry. Why would I ever buy stock in a company like that?

But there’s a difference between a good company and a good stock investment. Sometimes, good companies are priced so high that they make poor investments. And decidedly average companies are priced so low that they can make for good investments. The company is important, yes, but perhaps the bar of expectations has been set so high that even a high-quality company won’t be able clear it.

My approach is to take what other people give you. Sometimes you can buy great companies at reasonable prices; sometimes you can’t. Sometimes you get decent companies in a business that everybody currently despises. The bar is set so low that even a plodder could clear it.

Quarterly reports. You may notice a difference in the reports. In the past, I created the reports in Microsoft Word and entered the data by hand, because there were no reports in my portfolio software that supplied the information I want to give you. Now, due to recent improvements, I can create those reports directly from the software. The format may look a little different, but the reports provide at least the same information I was giving you before. If you have any questions, please let me know.

[top]

 Market View

China? Sub-prime loans? A renewed appreciation for risk? What caused the US stock market to drop 3.5% in a day? Who really knows? Whatever the cause, stock markets around the world suddenly got a lot bumpier starting at the end of February. While I don’t take great pleasure in watching prices fall, it’s not a terrible thing. Stock prices don’t rise inexorably, and sometimes we need to be reminded of that. Also, any time there’s a broad sell-off, we can usually pick up some good companies at reasonable prices.

Sub-prime loans are a concern. Inevitably, during these times of one crisis or another, we find out that there was a bit of fraud (mortgages made to fictional people based on inflated appraisals), and that the risk models of various banks or investors hadn’t accounted for this particular perfect storm. I expect we’ll see some fallout in bank earnings within the next year - it takes some time for the poor modeling to come to light. And if some bankers were even nuttier than I think, we could see something as extreme as a bank bailout. But I don’t expect any financial meltdown.

In spite of the noise surrounding junky loans, other factors are generally positive. The US economy has slowed to about a 2% growth rate, not great, but not bad; interest rates are still low, though rising a bit for riskier debt; inflation is hovering around 2%; and unemployment is about 4.5%. Overseas, Europe and Japan are both growing, and many emerging economies are in better financial shape than they’ve ever been in.

The dollar has finally started losing ground to the Yen. I expect that to continue. If the decline is gradual, the US trade deficit will shrink, inflation won’t be a problem because individuals and business will be able to adjust their purchases, and all will be right with the world. Well, at least from an inflation perspective.

And that positive inflation view seems to be prevalent in the bond market. The high-quality bond market has shown little change from the end of the year: 5% short-term rates, 4.5% to 5% long-term rates. Those rates imply inflation of around 2% for many years into the future. For riskier bonds, rates have risen (prices have fallen), but probably due to fears of increasing defaults rather than to fears of inflation. I think those riskier bonds will weaken some more, as investors re-evaluate their still optimistic assumptions about defaults.

The number of get-rich-quick-on-commodities articles has dropped, which is good. Commodities can offer decent diversification, particularly when they’re being ignored. But commodity prices are volatile, and the companies involved in digging them out of the ground have little control over those prices. So a piece of a portfolio in commodities can make some sense; anything more is thrill-seeking.

As always, there are risks. I cite them, not to ruin your day, but as a reminder that bad things can happen. It’s been a while since we had a terrorist attack on US soil, but that’s always a threat. Some kind of crisis in a major oil-producing country could also cause problems. If you could predict such things, and especially the timing of such things, you could make a lot of money by getting in and out of the stock market at just the right time. If you can’t predict such things, then it’s best to buckle up and enjoy the ride.

As always, I recommend investors stick to their long-term asset allocation strategies and retain a diversified stock portfolio (and buckle up).

Sources: Economist, Wall Street Journal, Value Line

[top]

Dorato Mission Statement:

To provide separate account management that meets the needs of each investor, and to educate and inform both clients and the general public about investment and financial issues.

Dorato Services:

• Separately managed stock portfolios
• Allocations for retirement accounts
• Small business retirement accounts
• Retirement planning
• Advice on stock options
• Assistance with tax questions
  

[Top]
The Library: articles by Steve TeSelle:

• College Savings Options
• Retirement: What's the Target?
• Fun Facts About Taxes
• Understanding Your Finances
• Risk, Anyone?
• A Primer on Asset Allocation
• Debt, Friend or Foe?
• Life Insurance Basics
• Calculating a Return
• Estate Planning
• Index Investing
• Financial Checklist

To read them online, simply click on the title. To obtain a printed copy, please call us at 303-733-4999, or e-mail me at steselle@doratocapital.com.

[Top]

The Mediocre Company High Jump

"This time, try tying your shoes first."

[Top]

© Dorato Capital Management, LLC. All rights reserved.