A Conversation with Jerry Jordan
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"We continue to believe that unemployment in the United States is going to remain high. We continue to believe that the only growth you’re going to see is overseas and in emerging countries, but even then, basically, the only real opportunities on a bigger secular basis are raw materials in short supply…"
—Jerry Jordan
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Are there new themes in the portfolio since we’ve last checked? What’s been changed, what’s been eliminated?
Jerry Jordan: We’ve reduced our U.S. domestic technology holdings to just a modest exposure, virtually to zero. We based these changes on a belief that a lot of the good news is already priced in the stocks. It doesn’t preclude them from going higher; it just means the risks on any short-term disruption become greater. At the same time, we’ve begun to add to our Chinese holdings. Some of these are technology related companies. We believe the longer-term growth story is still powerful, the valuations are low, and the stocks have had, in some cases, material corrections from their highs.
A couple of other things we’ve done are to add back some of the financials that we eliminated last August. We continue to believe that the overriding thesis going forward is to continue to reduce exposure to your winners and add to your losers, and if those losers get better you reduce exposure to them—and you add to your new crop of "losers." Essentially we have to be rotating more often than we have over the past 10 years and certainly over the last 20 years. We expect there could be a lot of up and down movement in the market and that a lot of asset shifting will go on. That’s likely going to drive performance, and, in general there are going to be more and more people who are going to be forced to change, especially when there doesn’t appear to be a lot of new money coming into the stock market.
So with either less money coming in, or as we experienced this year where there was very little money that came into the market and there were huge equity offerings, we think that it’s going to be much harder to merely buy an index fund and make it work. In our view, the only way to really make money, over the next five years, is going to be moving from group to group—sometimes very often, sometimes once or twice a year. And in that vein we have added a position in the financials because we thought they corrected too much, both absolutely, but especially relatively.
Taking a Position in the Financials
Let’s take an example like J.P. Morgan. The stock corrected almost 20% from its highs, which means that it’s underperformed the overall market by almost 25% to 30%, which is a pretty meaningful correction both absolutely and relatively, given the nature of a company like J.P. Morgan. And, we believe the Fed is nowhere close to raising rates. So, while there is some risk of inflation if the economy accelerates, some of that inflation risk will also likely be transferred over to the financials as positive for their loan books, i.e., there will be better loans for them to make and there will be less risk on their existing loans. So we think J.P. Morgan has the potential to profit from that scenario.
At the same time we’ve also added package-food companies like Coca-Cola, General Mills, Heinz, and Kellogg’s. We did this for many of the same reasons that we did with the financials. This is a group that everybody rushed into in 2008 for defensive purposes. Their earnings have continued to grow, but the stocks have dramatically underperformed the market. So what’s happened is both their absolute and relative valuations have gotten cheaper. I think there is a real opportunity in this group because people have rotated out over the last nine months, and there’s now room for them to rotate back in. While I expect the next couple of quarters of GDP growth to be fairly healthy, as people start to look at the second half of 2010 they may realize that growth will be decelerating. And, there may be a real opportunity in these stocks while at the same time I don’t think there is a lot of risk in names. And this is a company that I think has the potential for low double-digit earnings growth. As we get deeper into 2010 it may be that much more attractive.
This is an interesting time to find these stocks, especially with the market overbought, because we think that they appear to have a much lower risk profile in general. And the stocks still look very cheap. On top of that, you’ve got a U.S. dollar that appears close to finishing the counter-trend rally that we’ve seen over the last month; the dollar will more likely be flat to lower over the next three to six months. That has tended to be positive for these stocks as well.
Whither the Dollar?
Why do you predict a counter trend in the dollar?
Jerry Jordan: We’ve actually been looking for it for a while, which is one of the reasons we reduced our commodity holdings in October and November. Historically, the U.S. dollar has a tendency to reverse direction in November and December from whatever direction it’s been in for the prior 10-11 months. I think that has a lot to do with US-based multinational companies, rolling out their dollar hedges into the new year. As they finish, it relieves some of the pressure and that allows the dollar to reverse course, which it has done. At the same time, I think a lot of hedge funds were probably overly short the dollar, and have been squeezed a little bit into year end. I am not a huge bear on the dollar but I am a believer that the dollar will remain flattish because I don’t think the Feds are going to be raising rates and that would have the biggest effect. I think some other countries are more likely to raise rates before we do.
Please tell me your thoughts on the energy sector. Is it still interesting, or does the push for renewable resources, hybrids, wind, and air break the demand curve?
Jerry Jordan: The nature of the way most commodities have been used is that as the price gets high enough, people look for alternative sources, alternative methods, and alternative technologies. The minute that the price drops, all those blueprints fall off the drawing board. And that happened once again. Less so this time then back in 2000 when you had your first real energy scare, but nonetheless there isn’t as much excitement about the Toyota Prius today as there was in the spring of 2008 when oil was $120 and on its way to $140 dollars a barrel.
I think that much of this is inevitable; I think much of it is necessary because we also continue to believe that there just isn’t enough oil out there. And, that you’re going to have to have alternative renewable sources to take up some of the slack or else you’ll have $400 oil. There are far too many people who are going to want to drive some sort of a vehicle and at the moment the only transportation fuel readily available is gasoline from oil. The switch to renewables is still well out there, and I think we’re not going to have more than a couple million vehicles globally run on batteries for another five years.
Rare Earth
Last time we spoke you mentioned looking at Coke and the steel industry. Are there any categories in the supply chain that are attracting your interest in regards to advanced technologies and advanced chemicals relative to renewables?
Jerry Jordan: Yes, there are. There are some names we have looked at, and we actually own a company called Sociedad Quimica y Minera (SQM). It’s a Latin American mining & minerals company. They are a big provider of lithium for lithium ion batteries in addition to their primary fertilizer business. So that’s one way. Unfortunately, there really aren’t that many ways to play this in the domestic stock market, especially for our fund. We’ve looked at rare earth elements, which are at the bottom of the periodic table. The rare earths are necessary in all of the alternative energy technologies, and yet they are in very short supply. Unfortunately, most of them trade in places like Australia or Canada. And therefore, there haven’t been any opportunities for us to do it in the United States.
The Fed
Each quarter I like to get your thoughts on the Fed. What would you like to see them do over the next six months to a year and how would that impact the thesis you’ve described?
Jerry Jordan: I continue to believe that the economy is adequate but it’s not great. And that for the most part, all we’re really seeing is a kind of bounce-back demand which we started talking about a year ago. We noted that people had taken inventories and production levels to depths that were just totally unreasonable. So it is not really growth, it’s just getting back to some sort of normalization, and I don’t expect it to be any better than that.
We continue to believe that unemployment in the United States is going to remain high, and that the only growth you’re likely going to see is overseas and in emerging countries, but even then, basically, the only real opportunities on a bigger secular basis are raw materials in short supply and interesting technologies or products that you can manage the pricing of because you either have a patent or a dominant process that reduces the commoditization of that product.
Thematic Choices: 2010
So basically we want to either own a commodity—a pure commodity that’s in short supply, like oil or metallurgical coal—or we want to own companies that have intellectual property, or just a massive dominant share.
One of the last themes we bought into are low-price retailers. Wal-Mart, Family Dollar, and Dollar Tree are much like the banks and the food stocks we talked about, in that they were all the rage in 2008 but they have been left for dead in 2009 because everyone said, "When the economy starts booming again we don’t want to own these stocks any more." Whereas our belief is that the economy is not going to be booming for real, or more importantly the unemployment rate isn’t going to drop fast enough. Therefore, there is likely going to continue to be demand at low-end retailers and more importantly a number of people that used to shop at Target may now shop at a Wal-Mart. There is going to continue to be demand, these are stocks whose earnings have continued to grow, and they’ve now gotten very cheap. We see significant upside potential over the next 12 months in these names which should materially outperform the market over that time period.
So, are there any other actions you think the Fed should be considering?
Jerry Jordan: No, I think the Fed’s obviously in a box and they can’t afford to raise rates right now because of unemployment. I am not even confident unemployment has peaked, even though the most recent metric listed it as having peaked.
That seems like the right conservative approach to take.
Jerry Jordan: And, unemployment also has had a tendency, especially over the last 20 years, to bounce around at the highs as opposed to make it to the top and then go down. Its tendency is to take a number of months to make a peak, so I am not confident that we won’t see a jump to 10.4% or 10.5% unemployment between now and the summer. I think whatever inflation we do have is going to be commodity related, which is a negative, but unfortunately there is nothing the Fed can do about it. You know if the Fed raises its rate to stop commodity inflation, then they’re going to damage everything else even more so. There’s really not much they can do. I think they’re basically on hold at least through summer, and probably through all of 2010.
Anticipating the Unexpected
You never know what you’re going to read when you wake up in the morning, or what comes across the wires at night. So what happened with the news last month about the delay of payments against $59 billion of liabilities at Dubai World, are there any financial nightmares you worry about over the next year?
Jerry Jordan: You know there is obviously risk in currency, there’s risk in bonds. The bond market has been weakening over the last few weeks. I think a lot of that is a function of people raising their GDP forecasts in the United States, so I view higher rates as being a bit of a risk. But really, higher rates are usually more of a function of a better economy. I think a better economy is better than higher rates. I don’t think there are any real scary scenarios out there, other than a complete collapse of somebody’s currency—and I don’t see that really happening in the next 12 months.
I think what’s more likely is, we’re having a regression to the mean. You know we’ve had a regression to the mean in stocks, I think we are probably going to continue to have a regression to the mean in bonds. Prices need to come down more and yields need to go up more to get into a sort of normalized environment. I think the economy is going to be stronger but it’s not necessarily massively sustainable at that rate. I think everything is going to be just sort of muddling along, and so the key is trying to find those areas where there’s either something new or something interesting going on, or there’s shortages and you try to take advantage of those shortages.
Do you feel like the financials have adequately anticipated the unemployment rate as you have described it in regards to the impact on outstanding loans and mortgages?
Jerry Jordan: I think they have, I think the major financials have. These are the big, big banks—Bank of America, J.P. Morgan, Wells Fargo, Goldman Sachs, Morgan Stanley, Citi— I think that they all have. With the regional banks, it still remains to be seen. Commercial real estate is still a risk, although I think it’s getting better. But there are, obviously, loans on the books that are still suspect.
Finally, we seem to be emerging from a financial storm of historic proportion. What are your thoughts about the opposite, the convergence of positive elements that might make for a less stormy 2010 and beyond?
Jerry Jordan: I think the real risk for making things too exciting for 2010 remains that there’s this delicate balance between the economy getting better: signs of improvement makes people feel better which may then results in shortages in commodities or raw materials which creates higher costs and then that takes some of the edge off of people’s excitement.
Oil dropping $20 a barrel would help a lot. What would cause oil to drop, in my mind, would need to be a major slow-down in the economy. Which would be a bad vicious cycle and I think that’s what we are trapped in for a while here. For the next five or six years, I think we’re going to be continually trapped in that vicious cycle of pinballing back and forth between a stronger economy and higher raw material prices, and a weaker economy and lower material prices.
Periodic Investment Plans do not assure a profit and do not protect against a loss in declining markets.
The views in this newsletter were those of the Fund manager as December 31, 2009, and may not reflect his views on the date this report is first published or anytime thereafter. These views are intended to assist shareholders in understanding their investments in the Fund and do not constitute investment advice.
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The Fund’s investment parameters are diverse and as such may be subject to different forms of investment risk such as non- diversification risk, concentration risk, small- and medium- sized company risk, interest rate risk, high yield bond and foreign securities risk, and lastly, the Fund may use derivatives such as options to increase its exposure to certain securities. Please see the prospectus for a more detailed discussion of the risks that may be associated with the Fund.
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