A Conversation with Jerry Jordan
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The good side is that U.S. corporate balance sheets, in my opinion, have historically never been this good.
—Jerry Jordan
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June 2008
An Interview with Jerry Jordan
When we spoke last February you criticized the Federal Reserve for their relative inaction. Following our interview—a day or two later—they began to take the more aggressive action that you called for by cutting rates prior to their scheduled meeting. And of course they’ve taken further measures to ease concerns about liquidity and avert panic over the demise of Bear Stearns. But the market doesn’t look back, it looks ahead. How do you define attractive returns when evaluating your prospects in the current situation?
Jerry Jordan: Attractive returns are literally what they say they are. People will say, “How much [do] you think you are going to be up this year?” You never know those answers. I think we’ve assembled a portfolio of stocks that could be up significantly in the right environment. Now, I also know some will be down. But that’s the way it always is. We continue to believe that international growth is going to remain firm. Europe will slow down, but China, India, Russia, South America, Australia will most likely continue to grow—and grow firmly. In the United States, economic growth may bottom sometime in the second quarter, [and] we'll then be out of the recession—if we ever went into the recession—by the third quarter. And we anticipate reasonable growth in the fourth quarter. I think the risk is that we are heading toward a period, much like the early ’90s, and much like what Europe has seen in the last decade, where the market does not grow too slow, or too fast.
So we are not headed back to 4-6% GDP [gross domestic product] growth for awhile and maybe we are not headed back to it ever. The things that many were concerned about are still concerns. The average consumer has too much debt—and that can’t be fixed quickly. It may require lower interest rates for them to refinance their mortgages; lower interest rates so that they can take out low home-equity loans to pay off their credit cards; or stable economical growth so they can keep their jobs. This is similar to the economy (of the early ’90s) but this could be worse.
How might this be worse?
Jerry Jordan: It could be worse than the early 90s because there is less opportunity for price appreciation on homes, and balance sheets are much more leveraged by debt.
What’s the good side?
Jerry Jordan: The good side is that U.S. corporate balance sheets, in my opinion, have historically never been this good. Except for the financial industry, the financials are terrible, and may remain terrible for a very long time. I believe that the true financial secular cycle that began in 1982 is over. The negative growth from 1991 to 2000 in the raw materials sector—copper, steel, coal—is similar to what we are going to see in the financial sector. There are too many banks in the United States. Regional banks could be gobbled up, or put out of business. And we may slowly—like we did in the raw materials and the energy sector—whittle our way down to fewer financial institutions.
How do you turn this economic environment into a “Jordan Opportunity”?
Jerry Jordan: New areas come to the forefront. When I look at our portfolio, I look at energy services, offshore drilling, names that you and I have talked about for a year and a half. The portfolio ebbs and flows a little bit on specificity but the overall trend remains the same. Energy demand remains robust globally and energy supply continues to be a vicious, vicious treadmill that requires ever-more spending. Eventually we will hit a point where we potentially can’t grow supply anymore. I don’t know when that is, next year, 10 years from now? Who knows?
And the global energy situation?
Jerry Jordan: It’s going to continue to be harder. We’re not believers entirely in the peak oil story. We are believers in the idea that it’s going to cost you a heck of a lot to find the next barrel of oil, and that potentially benefits some of the stocks that we currently own. We continue to believe in raw materials because the overseas infrastructure demands seem unstoppable. We’ve got hundreds of millions of people becoming industrialized, who continue to expand into the urban landscape year after year in China and India—and need more power. China should take their current power infrastructure and increase it by at least 30% and they have got to do it soon.
In the U.S. we grow our power demand of 1.5-2% a year, max. They are growing at 5%, 8%, 10%, or 20%. At 20% growth you could double every 3.5 years. They need to be ahead of things, because they will see periods with surges of demand for power. So I think we will see massive infrastructure build-out continue, and it will require more coal, more copper, more steel. It’s going to require more electric generators, electric cables. It’s going to require all these things. Steel stocks were one of the groups that we bought at the end of last year and in the past quarter. We’ve bought a lot of companies exposed to the global power play.
Right now, in terms of new themes, our expectation is to buy companies that are focused on global power. Even in the United States, we are in front of an enormous electricity build-up because we are starting to run out of electricity again. It sounds kind of silly, but in 1996 we were at the same excess capacity level we are at now. But these things take two to four years to put on the drawing boards. You have got to have real lead time. By 1998 we were at a fairly low spare-capacity level and that’s when we had a huge explosion of independent power producers. The way things are currently positioned, by 2011 we could have the smallest excess capacity in 40 years. I believe we’ve got to spend as much as China has ever spent, just to get our spare capacity back. So, there’s potentially huge infrastructure spending that has to go on. Regardless of whether the people agree with it or not, regardless if someone says, “Well, steel prices are up a lot.” Well, when steel prices are up you either pay the higher steel prices or sit in the dark waiting … and sitting in the dark generally changes people’s minds pretty quickly.
So, that’s why our newest themes play again on essentially the same global-growth story. We believe that it is going to continue.
Is there a wild card here as you consider global expansion, the need for energy, and consumer strength in the United States?
Jerry Jordan: It's oil. You know I’ve been saying this for months. Every time I’m on TV, people say, “You are telling us you like the market.” And my response is always, “Yes, unless oil keeps going up, because oil is a true wild card.” There doesn’t seem to be anything slowing down demand yet. Supply continues to be a problem. At some point, oil will break our backs. I just read an analysis … that since the time that President Bush announced the stimulus package—the tax rebate— the increase in the price of oil may wipe out every penny of the rebate for many people. It says a lot, having the government print money to pay for everyone’s oil. That’s not good. At least Bernake [Benjamin Bernake, chairman, Board of Governors of the U.S. Federal Reserve] recognizes that some of our inflation problem is a function of global demand for oil and grain, and is not a systemic inflation problem.
As a fund manager, how do you temper impulses in investing and managing the Fund that tend to get others in trouble over time?
Jerry Jordan: That’s a very good question. If you can find someone who can answer that, let me know. Seriously, I think what differentiates a good manager from a great manager it is not about making the right moves all the time, it’s about recognizing when you've made the wrong moves.
You can’t completely divorce yourself from your emotions, but I think what you have to do is, be able to temper your beliefs, and strive to recognize when trends are starting to change, when things seem to get ahead of themselves. The trouble managers have is rarely when they buy a stock or a group at $20 per share and it hypothetically goes to $40 over three years. It happens more often if the stock price goes from $20 to $40 in six months, and then goes from $40 to $80 in the next six months. And then some say, “OK, you know, I think I totally understand what’s going on.” However they may not really understand. A good example is what happened with tech stocks in the fourth quarter of 2007. The majority of the stocks went up and then they went down—yet I would argue that nothing changed. The stocks seemingly had no reason to go up, and no reason to go down so much. It was a function of, I believe, the quant funds bidding them up. And what happened was that many people didn’t know why they were going up, and they didn’t recognize that there was possibly a greater volatility risk given the fact that they’d gone up.
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