Jerry Jordan Commentary | Third Quarter 2010 Investment Outlook
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The Jerry Jordan interview, conducted in early July 2010, continues our tradition of expanding on Jerry’s quarterly update and providing investors with a deeper understanding of the Jordan Opportunity Fund manager’s assessment on the economy and investment philosophy.
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"I am more and more convinced that 2008 was a bubble in commodities. We cracked it."
—Jerry Jordan
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European Union and the Euro
If the European Union loses some of its constituents for the euro, say Greece, Spain, or possibly Ireland, what would be the implication for investors?
Jerry Jordan: In the short term, it’s a negative. But, longer term, it would be a positive although I think it is unlikely to happen. If it did, you’d be getting rid of a lot of the weak areas. I just don’t think it is a highly likely event.
Are there any indicators you are looking for?
Jerry Jordan: No. A lot of this stuff is like it was a couple of years ago—like it was 10 years ago where all of it is incremental. We had too much debt out there, which needed to get refinanced. And, that debt’s not going away. I think the most likely scenario is that Europe ends up turning itself into an entity essentially like the United States, where each country is like a state. And, there needs to be a broad group that oversees everything, the way the federal government does here. Each country will remain sovereign, but it won’t have all its sovereignty, and there will still be someone to backstop them.
What is more likely is that a situation where the ECB [European Central Bank] comes in and they start buying up the debt from Spain and Portugal but they cannot allow Spain, Greece, and Portugal to roll over. And, that will be the way out, through quantitative easing, printing money, and buying debt.
Exchange Traded Funds (ETF)
Do you think that ETFs will become more populated by active managers?
Jerry Jordan: No, I don’t really think so. There’ll definitely be moments, but I think, in general, if people are buying too many ETFs, it obviates the whole purpose of having a manager. The only time I use ETFs is when I feel like there really isn’t any other way to do it. I own one grains-related ETF, because there is no other way for me to own corn and soybean and wheat from a stock security standpoint. So, I have to own an ETF for that.
Price Stability and Risk of Deflation
There has been much speculation about inflation and deflation. Does anyone believe that price stability is a possible outcome?
Jerry Jordan: I think it’s a function of the time period, right? So, you could argue that price stability exists if you have stability over a 10-year period. But, you might not have it over a three-year period. If the Dow is still at 10,000 five years now, you would say there is a lot of stability. But, if it trades between 13,000 and 7,000, you would say there wasn’t.
I am in the camp that says deflation is a risk. It was not a risk a year ago because we knew the Fed was throwing everything at it. But now it’s going to be very hard to throw anything else. Congress isn’t going to allow it. And, the Tea Party isn’t going to allow it. So, the only thing left is quantitative easing, and that is done by the Fed. And for the Fed to step in and do that, I think you’re going to have to see some material weakness in the economy, and they will have to bear the brunt of a public hanging.
Sure, that makes a lot of sense politically. And, again, it seems that it goes back to time frames. What kind of a time period do you look at that makes you worry about deflation?
Jerry Jordan: I think the dilemma for me is reflected in commodities. This is the first time in 12 years that I don’t own an energy stock or a mining stock with the exception of gold. I am more and more convinced that 2008 was a bubble in commodities. We cracked it. We had bubble retracement in 2009, and in the early part of this year, in oil, in steel, in steel-related equities, copper, and coal-related equities. But, that was it. The global economy has peaked. We are going into some sort of malaise. I think Europe is probably going back into a recession. I don’t think it will be a violent one, but, they are probably going back into a recession and the U.S. is headed to 1% or 2% GDP. So, it may feel like a recession even if it statistically isn’t. And, in that environment, I don’t want to own anything that is very economically sensitive. I certainly don’t want to own a commodity. At the same time, China built aggressively for the Olympics. Then they built aggressively for the World’s Fair. Both of those things are now behind them as of this summer. So, there is a real risk of another deceleration in demand for infrastructure and thus demand for raw materials. The stimulus package from the U.S is also peaking about now. So the only commodity-related securities I own are gold stocks and the small investment I have in grains. That’s it.
Are there any tipping points you are looking for?
Jerry Jordan: You know it’s really hard to have a tipping point, per se.
Is it?
Jerry Jordan: Yeah. If we’re going back into a recession, that’s going to make it worse. But, the one thing I think that is so great about the U.S., that I don’t think ever gets enough credit, is that the U.S. economy is sort of a hedge fund. It’s kind of a market/neutral fund because when things get bad, what happens? Rates go down. Oil goes down. That actually helps support the economy. When the economy gets strong, what happens? Rates and oil go up. What does that do? It slows the economy down.
Sometimes it goes a little too far on the upside. Sometimes too far on the downside. That is less true overseas where they are still beholden to the rest of the world to buy their goods. Everyone is worried about the U.S., and all our debt, and, how we’re beholden to China. And, whom does China sell all their goods to? They sell to us. At the end of the day, and I’m pulling this number out of thin air, I would argue the average person spends 10% to 15% of their disposable income on things they don’t need, things they could do without. And, if that changed, it would be far more detrimental to China than it would be for us.
Has that changed over time?
Jerry Jordan: Yes. The real difference is, if you go back and look at what people were spending in 1960, 1970, and 1980, in terms of energy and food and rent/mortgage as a percentage of disposable income, those numbers were much, much higher. Now, arguably, the decline in spending on food and energy as a percent of take-home pay has been filled by health care spending. When I was growing up, we had back-to-school shopping, and then we went out sometime around Christmas or after Christmas for the spring. That’s when you went shopping. As a kid, you got your clothes in the fall, and then again in the spring. Partly because you were growing, and partly because it was seasonal. Now, the Abercrombie and Fitch’s of the world redo their store inventory seven to 10 times a year. People are coming in once a month to see what they’ve got. We didn’t use to do that. And, I think we could easily go back to that . . . maybe you don’t go in twice a year. But, you might go five times a year instead of 10 times a year.
How is this change reflected in savings rates, which have been growing of late?
Jerry Jordan: That’s the thing. Part of how you get there is reduced spending on a going-forward basis. Food prices remained fairly flat over the past decade, and energy prices went up a lot, I think now we’re going to have a swap. Where now food prices can compound at 5% to 8% to 10% a year, and energy prices could be flat over the next decade, and again that is a cost to the consumer. This will require even less discretionary spending to get the savings rate to rise.
Financial Research and Social Media
As you’re doing your research, has the explosion of social media, blogging, non-journalistic kind of reporting, had any impact, one way or the other, on your ability to judge corporate performance, emerging trends, or other implications?
Jerry Jordan: No, not really. There is more noise out there. I don’t worry as much about that noise. For the most part, those people don’t have any interesting information. They probably don’t have any new data. You know, I just think what it does is give you opportunities to sell and to buy because it causes volatility.
Not helpful on a research side?
I don’t think so. I mean there will be articles and things that you’ll read where it will either bring up a question for you about something that’s sort of data you didn’t know. It may just be a way of thinking about something. One of my biggest themes continues to be media. And, I’m starting to see more and more people in the popular press, like Newsweek and Time, writing articles about the iPad, and talking about how it is driving more traffic to places like Hulu. So, it’s actually going to increase demand for content, which is one of the things I thought a lot about six to nine months ago when I was buying these stocks, that there’d be new appliances. I wasn’t thinking the iPad, but I was thinking the iPhone to drive the ability for people to see this stuff.
Forward Thinking
Jerry Jordan: Our outlook is that global economy has peaked. You’re going to see lower growth rates, globally, and therefore you need to be focused on more stable companies with visible cash flows, solid balance sheets, and the ability to continue to grow cash flow on a going-forward basis, even in a muddled environment. And, economically sensitive stocks are going to be harder to make money in, the 100 or 200 largest companies in the S&P are the best stocks to own, and the small stocks, which have been huge outperformers for the last 10 years, are the ones you want to sell.
The views in this newsletter were those of the Fund manager as July 30, 2010, 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.
Past performance is not a guarantee of future results.
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Mutual fund investing involves risk. Principal loss is possible. 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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Fund holdings and sector allocations are subject to change at any time and should not be considered recommendations to buy or sell any security.
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Cash flow measures the cash generating capability of a company by adding non-cash charges (e.g., depreciation) and interest expense to pretax income.
The Jordan Opportunity Fund is distributed by Quasar Distributors, LLC.
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