A Conversation with Jerry Jordan
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"We believe that energy has the potential to be a bubble. … One thing that typifies most bubbles is the equities get expensive before it's over, and most of the equities involved in energy didn’t get particularly expensive."
—Jerry Jordan
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It’s been a year since the meltdown. Do you think we will ever learn to avoid these surprises?
Jerry Jordan: The answer is no, never, because I believe that what makes markets work is fear and greed. You can’t take away fear and you can’t take away greed. Therefore, I think we could always transition from one bubble to the next, from one overdone sector to the next overdone sector. That’s the beauty of capitalism, and the problem with capitalism.
Overcoming Fear and Greed
Because you’re able to pull money off the table when you’ve made a good deal, how do you balance your investment strategy against fear and greed?
Jerry Jordan: It’s hard to do, and I think that we do it better then most, but that doesn’t mean that we don’t succumb to the same foibles as others. That’s just being honest. Anyone who tells you otherwise is not telling the truth, unless they are totally a quantitative firm, where there isn’t any actual discretion that goes into the process.
We try to use quantitative measures to help us decide if a stock or industry is getting too expensive, getting too over-owned by the rest of Wall Street, getting too over-bought, getting too over-sold. There are lots of different ways of analyzing the landscape. What makes a bubble a “bubble,” is that it goes too far and then it goes even farther and then it doesn’t go down. What made housing a bubble, was by the third year of big returns people had become convinced that things had changed, and there weren’t going to be cycles any more on housing. And you kept hearing, “Land, they’re not making any more of it.” But, you know pricing will eventually obviate that.
The same thing is true with energy. We believe that energy has the potential to be a bubble. Last summer was not a bubble, we think last summer was the beginning potential of a bubble. One thing that typifies most bubbles is the equities get expensive before it’s over, and most of the equities involved in energy didn’t get particularly expensive. So we think you’ve still got another cycle in a lot of the stocks we own because they never got really expensive. And, we think the underlying fundamentals are still too powerful.
What is going on in the housing market? How will the economy be impacted by the outstanding loans that are still at risk?
Jerry Jordan: I still think it’s a material risk. I don’t think it’s as big of a risk as it was in February, because the Federal Reserve has indicated that they will not let all these loans all fail. What the improvements in capital markets has done is to open up the ability for the Fed to let more things fail. Because when everything is failing at once, you have to try to support things. When only some things are failing, you can let them go. Do I think that housing prices are going to go down a lot more? Probably not, but I think it’s very unlikely they are going to go up very much. We still have structural problems like way too much inventory, although that’s coming down. We have way too much in the foreclosed and past-due categories for mortgages.
At the same time, we have a lot of people who don’t have any equity left in their houses and are under water. That is something that was never true before. You have some random examples like Houston in the 80s and the Northeast in the early 90s, but you didn’t have the national structural problems of millions of people under water in their home, and that is still a big deal. That doesn’t necessarily mean they are going to walk away. They’ve either got to pay a mortgage or pay rent. Either way they’ve got to pay money. My guess is most people would rather stay in their house even if they are under water, with hopes that they eventually will get back to having some equity in their house. But it is an overhang and it is likely going to keep the housing business from being a good one. At the same time, we still have a demographic problem with too many baby boomers retiring over the next 20 years and they will likely be sellers of housing stock, and there probably won’t be the same list of buyers beneath them.
How do you evaluate the upward trend in the market and its sustainability?
Jerry Jordan: I am a believer that we are in an OK market. I was very bullish in March, I thought there were a lot of opportunities—tons and tons of opportunity. I’m less sanguine now. I am a believer with the rally we have gotten. At 1050 to 1100 with the S&P 500, a reasonable multiple for the market would be 14 times, maybe 15 times. That requires $70 in earnings. I think we could probably do $70 in earnings next year, but you know, that’s next year, so we’re 15 times the forward number, and normally it’s 15 times the trailing number. So I think overall, returns of the market are going to get slimmer. But I think opportunity in individual stocks has the potential to be extremely attractive, and if people own the right groups they could still make a lot of money. But, if you own the wrong group, you’ll probably start to see performance wane.
Whither Health Care?
One group in focus now is health care. Is it an investment opportunity?
Jerry Jordan: Yes. I think the opportunity potential should improve as we get into the fall. I have believed that no health care legislation would get passed. It now appears like we may get some, and that could act as headwind for the stocks as people buy more economically sensitive names as opposed to health care, but I think the overall opportunity is still there. Particularly in companies with a terrific product, a patent, a new diagnostic test.
Do I think the opportunities are great for Pfizer and Merck? Probably not. They may be cheap enough that they become moderate performers, but I don’t think there is a lot of opportunity per se. Yet, health care as a group has underperformed for a long time. It outperformed for one year, mostly because the market was so bad, but I think it’s got room in an environment where overall growth is going to be sluggish. I think you’re going to see higher multiples for companies, especially if they have a patent. I am intrigued and enamored with companies that have patents that protect them; or companies that have such dominant market share that they might as well have patents; or companies that sell funds that is a complete commodity, but the commodity is in short supply.
And are you going after these companies individually, or their funds that you’re looking at yourself, that aggregate those kinds of companies?
Jerry Jordan: Generally I am going to go for the company specifically. There may be times, like one of our largest holding is the Deutsche Bank Agricultural Power Shares, but it owns futures of commodities. It does not own common stocks. But in general, I am looking for individual companies.
Oil and Energy
Energy continues to have a large place in investor consciousness. Is this a continuation of a long secular trend or just another trade based on fluctuation in the commodity prices?
Jerry Jordan: In the short term it is based on commodity prices, but I think as we move through this economic cycle it will become a long-term thesis once again. I think it got derailed last year because we had a record decline in the global GDP (gross domestic product). If you asked somebody six months ago, “Where do you think oil will be, given where inventories are,” they may have said, “Well, oil will probably be $40 a barrel.” I don’t think they would have said $70 to $75 a barrel and I think what’s changed is the realization that inventories may be high, but production and new discoveries have still been fairly anemic as the global economy rights itself. We are getting auto sales out of Brazil and China that are booming. China is now the largest auto-consuming country in the world. And they’ve got a lot of people who still don’t own a car. So, if you assume that they continue to buy cars at a nominal rate, and even if you assume that we will continue to improve our energy efficiency, it may still not balance itself out. There may not be enough oil.
The Impact of Hedge Funds
Do you think the contraction in the number and size of hedge funds will dampen market volatility?
Jerry Jordan: Yes, and I think it should. Hedge funds, particularly the quant-oriented funds, are the bane of our existence. At the end of the day, as I always say to clients: The capital marks exist and the equity marks exist for the benefits of society. And having people, having investors, and having funds that benefit by making a stock go down, does not benefit society. You know that stocks go up too much and stocks go down too much, it has always been true, and it will always be true. But, it wasn’t until five years ago that the percentage of investable assets in a day’s trading morphed into a massive amount. We always had the ability to short stock. The hedge funds in the 60s and 70s were an infinitesimal portion of the overall global-equity markets, so they really couldn’t have an effect on how markets traded. That is no longer true with hedge funds and quant funds that may rack up 20, 40, 60 percent of trading volume in a day, while representing only five percent of overall assets, at best. That’s a relationship that I believe just doesn’t work.
Reviving Tried-and-True Investment Strategy
What would you tell someone trying to decide when to comfortably ease back into the equity markets? Or how?
Jerry Jordan: My opinion is that they should have done it a while ago. Now what you may have to do is what you were honestly always supposed to do—according to accepted investing wisdom: dollar-cost average.
Well, and if you had always been doing it as you are suggesting, you would be compensated.
Jerry Jordan: You might be very happy right now. And, there are times when that can be optimized: you know the whole point of dollar-cost averaging is putting less money in when it’s up, and more money in when it’s down. And when it’s down, maybe on occasion, you put a little bit more money in. If you say, “I am going to put $500 in every month, or $500 in every quarter,” if all of a sudden the market gets really trashed, down 20, 30, 40 percent, maybe you say, “I am going to put a $1,000 in now instead of waiting and doing $500 now and $500 three months from now.” But that may be the best way to do it, because that’s the easiest way to not buy the top and not sell the bottom. I think right now that’s by far the best strategy.
On the U.S. Economy
Do you feel the United States is becoming a second-class economic power, as you may be hearing from both pundits and perhaps the currency markets?
Jerry Jordan: You know, I don’t think we are a second-class economic power. I believe that we are a first-class power that may inevitably see the growth rate go to newer, younger, faster growing countries. I think what differentiates us from Japan 20 years ago, and Europe 50 years ago, at least at the moment, is our ability to continue to innovate. Now the risk is that Washington tries to take more and more control over capital markets and private entities, and they take some of that innovation away. I don’t think that’s going to happen. I think that some of it’s an outgrowth of people that took way too much advantage of the situation they had, and it ended up badly for everybody, not just themselves.
I think the currency stuff is being overplayed. I think the U.S. dollar is fine. I think maybe it will go lower, but the dilemma we continue to have is, why should the U.S. dollar go down? You could say, “We are printing all this money.” Well, they’re doing that in Europe and Japan. You could say, “Our deficit’s too high.” Well, our deficit is smaller, as a percentage of the GDP, than Japan. You could say, “We’re not going to grow as fast.” Well, you know what—I think we’re going to grow faster than Europe. Europe has huge problems and far bigger demographic problems then we have. So, I think the U.S. dollar is most likely going to trade within a range for the next five or 10 years, and that range may be the opposite of the euro and the yen. That’s the most logical scenario for me. Where maybe we trade between last year’s low, and this year’s high, for the next 10 years. And that’s a 15- or 20-percent band and it is material, but not crazy-material and people just work through that.
In my opinion, the real issue is that we are all printing too much paper. That has ramifications, at least for inflation. It still remains to be seen how it gets manifested. I think it may be evident in higher raw-material prices because it will allow people to continue to chug away, using up assets without having any repercussions. I think it could push a lot of macro-oriented funds—not just hedge funds, but big global pension funds—to continue to accumulate hard assets, be they gold, silver, copper, or oil. And, that should soak up some of the excess capacity in those commodities, then we may hit a point where, all of a sudden, we don’t have enough of them for the global economy to function. There may be nothing the Feds can do, because if they start raising rates, the economy may go to heck-in-a-hand-basket. So what you could end up with is the supercharged potential bubble-move in commodities, which I think could happen sometime next year or the year after.
The Obama Administration that campaigned on the power of innovation as an economic driver. What would you like to see happen at a policy level to foster more opportunities for innovation in smaller or larger companies?
Jerry Jordan: I think they need to be focusing on a way to get people to take entrepreneurial risk, but to be able to take entrepreneurial risks where the downside is knowable. So, the dilemma that we have with financial services is there was a lot of innovation to last five or 10 years, but it had open-ended risk.
Right, the downside was—maybe still is—unknowable?
Jerry Jordan: Exactly. Now, that is different than an energy company that designs a new technology for extracting gas out of a particularly interesting geography. That is the company that is going to take that risk and reap that reward, but if it doesn’t work, they’re the ones that lose. That’s what this country has always been about. You know there will be winners and there will be losers, but you don’t have it where he wins but if he is wrong, then we all lose. And that’s the problem that financial services have brought upon us. And I think that we are going to get back to individuals inventing and creating and starting up interesting businesses. One of the things that I think was an outgrowth of the 90’s recession and the sluggish employment picture, was that a lot of people went off on their own and said, “Hey, I’ve got a great idea for a service.” I think there is going to be a lot more of that, especially with the aging demographic. There is going to be room for a lot of people to do a lot of things for people who are 70-75 years old or older.
Wouldn’t we also expect to see that as the global economies improve, governments in India, China, and other countries also invest in innovation?
Jerry Jordan: They do, but they don’t have a legacy of it like there is in the United States. I personally think that those countries are going to have a much harder time of it than most people believe. Right now they are faster growing because of where they are in this economic cycle. I am less convinced that they will be faster growing 25 years from now, because they don’t have a history of innovation. They don’t appear to be fostering an environment that is pushing entrepreneurial spirit. India is to some extent, but the overwhelming dilemma for them is the number of people. Their secular problem is in food and water, and the risk that the government has spent way too much of its focused effort and resources on basic resources. If there is one country I would be worried about, it would be India. They’re smarter then everybody else and they have focused on entrepreneurial education. The number of Indian technology people that grew up there, came here and then went back, far dwarfs any other county.
To finish up on inflation, last we talked you were discussing the dampening effects of production capacity on inflation. My question is: do you believe it’s inevitable and do you believe gold makes sense?
Jerry Jordan: We own some gold stock. We didn’t own them three or four months ago, we bought them through the month of August. We believe they make sense, and we are trying to debate whether they make more sense than the actual gold metal. I think they do. Gold stocks in relationship to gold appear undervalued. The gold story continues to be a good one. Not every day, not every month. So it wouldn’t surprise me to see gold meander for a couple of months. But I think the idea of gold being a currency as a store of value, continues to be a strong thesis. And we think that’s going to play out especially if the economy starts to re-accelerate because one of the things you should get ... we’re still getting inventory de-stocking. One of the things that happens with inventory de-stocking is you don’t borrow money to hold inventory. So it’s one of the reasons the velocity of money has remained anemic. But I think as people start to feel more comfortable with this turn in the economy, as they realize they need to build up inventories, what you should see is the velocity of money improve, and if that improves I think you may see a much greater bid to commodities in general, to gold in particular.
Are you looking at other commodities as well in that regard?
Jerry Jordan: Well, we put a lot of money to work in natural-gas-oriented E&P [exploration and production] companies. Because we think natural gas on a 12- to 18-month basis is just way too cheap, we don’t think it has the upside it may have had in past periods. But we are not necessarily confident that gas is going to go to $12 or $15 like it did last year and like it did in ’05, but we think it could go into the high single digits And in that, we think the stocks that we own should be outperformers, and outperform at the expense of a lot of other areas of the market. Which is our real opportunity here? And there are going to be a number of industries—which we seek to own—that could be the performers going forward.
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 September 30, 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.
Past performance is not a guarantee of future results.
Before investing you should carefully consider the Jordan Opportunity Fund's investment objectives, risks, charges and expenses. This and other information is in the prospectus. Please read the prospectus carefully before you invest.
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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