Death of a Mentor - China - Bits & Pieces (Printer Friendly Version)
Kendall J. Anderson, CFA August 5, 2008
John Marks Templeton passed away on July 8, 2008 at Doctors Hospital in Nassau, Bahamas at the age of 95.
Since the eighteenth century mentoring has been a method used by countless craftsman and professionals to teach, counsel and provide guidance to less experienced individuals. This mentoring is given freely and all of us that have been the recipients of these gifts should be extremely thankful to the giver. It is with thanks in mind that I owe a debt to Sir John.
I began my investment career in 1979 with Merrill Lynch, Pierce, Fenner, & Smith, Inc. At the time the stock market was in complete disarray, and needless to say, the process of building a business relied more on your ability to sell bonds than any expertise in the field of common stock investing. The firm also had no desire to teach me how to build and manage a portfolio. At the time, their primary function was to teach their brokers how to sell anything and everything they chose. Those of you who know me, would quickly recognize that this approach did not sit well. The straw that broke the camels back was the order to sell a fixed number of shares of a company's common stock that the firm was underwriting or buy them personally. Since money was tight, this created a very troubling proposition. Sell share of a company that could not be sold by their institutional brokers or quit.
Well.... after a short stint back home in Webster City, Iowa, I took a job as an investment representative with a little firm out of St. Louis, Edward D. Jones & Company (today known as Edward Jones - The reason for the change is not flattering - I'll tell you about it some day) that has grown to one of the largest in the country. At the time they were quite unique. They would let you set up a business anywhere you wanted, and promised to leave you alone to create a business, as you deemed appropriate. The next few years with Edward D. Jones & Company were good to the Anderson family. Interest rates were in double digits, the stock market in the 80's was a roaring bull and I felt as if I had a Midas touch. All this changed on October 19, 1987 which forever will be remembered as Black Monday, the day stock markets around the world crashed. This was my first experience with, as Ken Fisher call its, "the great humiliator". Being alone, and with limited guidance, I was struggling for help. As has become a habit of mine, when in need I visit a local bookshop to look for my "mentors," the written words of others. This trip I came across John Train's "The Money Masters," subtitled "Nine Great Investors: Their Winning Strategies and How you Can Apply Them". The nine great investors were Warren Buffett, Paul Cabot, Philip Fisher, Benjamin Graham, Stanley Kroll, T. Rowe Price, John Templeton, Larry Tisch and Robert Wilson. From these nine I chose three, Warren Buffett, Philip Fisher and John Templeton as individuals I would love to visit with. So I took out a pen and paper, wrote each a note and waited.
Within a short time I received a reply from Sir John Templeton (I never heard from Mr. Buffet or Mr. Fisher). It's funny how little things can change you forever. I was on the verge of failure; a simple note from Mr. Templeton, brief but to the point changed all of that. He encourage me to stay the course, stating that the crash had created opportunities around the world and the best approach would be to persuade as many people as possible to buy a diversified portfolio of common stocks.
This note, short and probably a standard reply by Mr. Templeton gave me the courage to stay the course. I had one more correspondence with Mr. Templeton later in the decade that impacted my future. Sir John was a CFA charter holder (Chartered Financial Analyst) from 1965 until he retired in 1995. When I considered entering this very difficult three-year program on top of the day-to-day workload I contacted Sir John for advice as to its merits. He once again encouraged me to enter the program and complete it. Mentors take many forms, but in my case, Sir John Marks Templeton will be remembered as one of the main reasons I am still in this business.
Sir John provided twenty-two guiding principles that he said had enabled him to become one of the world's greatest investors. Given the times I believe his advice is as beneficial today as it was 25 years ago. Of the twenty-two principles (a complete list is available in "The Templeton Touch" by William Proctor) I would like to share a few that have been so instrumental in our investment approach.
#2. Achieving a good record takes much study and work, and is a lot harder than most people think.
#3. It is impossible to produce a superior performance unless you do something different from the majority.
#4. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.
#7. Bear markets have always been temporary. Share prices turn upward from one to twelve months before the bottom of the business cycle.
#9. In the long run, the stock market indexes fluctuate around the long-term upward trend of earnings per share.
#22. If you begin with prayer, you can think more clearly and make fewer stupid mistakes.
God bless you John.
Within a few days the long awaited Summer Olympic games will begin. The opening ceremony will take place at the Beijing National Stadium in Beijing, China on Friday August 8th, 2008. This alone will turn the eyes of the world on China, but for most of us, China has been impacting our lives for at least a generation. Our standard of living requires the use of oil, minerals, food, labor and capital investments. China's rapid economic growth has produced a bidding war on these necessities. With over a $1 trillion dollar government sponsored war chest, and over one billion citizens they can and do have a major impact on our cost which has a direct input into how we live our daily lives. Simply, their presence has a major impact on supply and demand, the determinants of price.
Being a citizen of the United States with all its diversity, we still get along quite well with each other whether we are in New York City or West Texas. There is a bond between us, and that bond is directly related to a single economy that has become highly specialized and requires us to depend on each other for our survival. This is why it is difficult for the average citizen to understand China and the problems that are inherent in their country. George Friedman and his team at Stratfor are experts on geopolitics and we must thank him and his team for their work. The majority of my information we are sharing with you is due to their efforts. China is not all for one and one for all. It has to be divided into two parts. On the east side of a line named the 15-inch isohyet, rainfall averages 15 inches each year. On the west side of this line less than that. The area east and south of this line is known as Han China, where over 1 Billion people live in an area about one-half the size of the United States. This is the China most Americans and the rest of the world consider "China".
This heartland is further divided into two parts. In the north, Mandarin is spoken, and in the south Cantonese is the language. This heartland with its annual rainfall is also the breadbasket of China. You would think that a country the size of the United States would have ample land available for the growth of food, but yet, given the landscape China has only one-third of the arable land per person as the rest of the world. This is probably the single most important fact about China. This pressure to "feed the people" has defined the country.
It is this need to protect its farmland that has led both the political and military actions of the country. The heartland of china is surrounded by Tibet, Xinjiang province (home of the Muslim Uighurs), Inner Mongolia and Manchuri. Most of the world would not consider these lands, China. Just look at the protest concerning Tibet. Yet keeping this buffer zone intact is the only way to protect their heartland and its farmland, which creates unity between the Mandarin and Cantonese.
Herein lies the problem. Isolating himself or herself from the rest of the world would keep everyone so poor that any economic development would be impossible. A poor country is easily controlled by a central government, the route taken by Mao Tse-Tung and his communist brethren after WWII. An open and free China would threaten the control of the ruling party, increase tension between the Mandarin and Cantonese and cause an independence movement from the buffer lands. But it is still the only way to increase the standard of living of its citizens. It seems the current ruling party wants to increase the wealth of their citizens but also wants to maintain full authority. A problem that if not managed correctly will ultimately end badly.
There is no doubt that the current freedom being enjoyed by its citizens and with the encouragement of their central government the country has grown rapidly. If unity can be maintained then this growth could and should continue. However, the risk is great. Ruling parties, especially a party that believes in communism will not give up power easily.
The country is not unified and has only been able to create and maintain unity throughout its history with the use of force against its own citizens. This by itself would and should discourage any conservative investor from direct investing into China. However, participating is such a large growth opportunity is something most of us would like. So how can we accomplish this - a conservative investment that is dependent on a developing and risky geopolitical economy? In order to answer this we need to explore one more element that is unique to China - their dependence on the world's consumers.
China's economic growth is directly related to their ability to export. The advantages they have are fully dependent upon the desire of its trading partners to do business with them. Currently they have a unique cost advantage in that their citizens are willing to work for wages that no American would considered worthy of their time. These same citizens are willing to go to work in an environment that no American would consider safe- another cost advantage. They are dependent upon the ability to transport raw materials into their country and transport finished goods throughout the world. This makes them a hostage to world oil prices. Given these advantages, anything that would disrupt this, i.e., sustained increase in the cost of raw materials; sustained increase in the cost of oil; a revolt of their citizens for greater wages; a health epidemic directly related to the effects of pollution, would materially change their economic growth. In other words, the country must maintain the advantages they can.
As a conservative investor, we believe the single best approach to gaining from the current growth in China is to own global companies with unit sales that are not dependent upon long-term contracts. In simple terms, items sold and paid for at the time of purchase or in advance. This creates revenues and profits at the time of sale and minimizes the risk of partnering with a communist government and the loss of the cost advantage derived from items that the Chinese have no control over. Justin, my number one research assistant calculates the amount of revenue from our current holdings earned from sales outside the United States. This currently stands at 44%. Of this, we estimate that approximately 3.5% of the portfolio's revenues are from sales directly to China. We believe this is sufficient to reap the rewards, but the appropriate level to reduce risk.
The troubles continue for our friends the modern day alchemist, whose addresses are located somewhere on Wall Street. As long as I can remember, people on Wall Street have been trying to create something from nothing. We are currently, and will be for some time, paying the price for the last great creation, mortgage backed securities and its large group of off-spring, securitized loans with all sorts of names, normally initials that most of us will never know what they stand for. Auction Rate Securities known affectionately as ARS, are long term bonds whose rate was reset at auction on short-term intervals, normally 30 days. They were sold as being a risk free alternative to a money market fund, while yielding a higher rate of interest. Sounds good doesn't it. Yes and we can turn lead into gold, if everything works. Well in February, the market for these risk-free investments fell apart. The banks refused to stand behind the auction process. Without an auction, corporations, public entities and individuals holding the securities could not get their money without a fire sale. Hundreds of millions if not billions of dollars were or will be lost. The authorities are blaming the cooks: Citigroup, UBS, Merrill Lynch, Wachovia, Bank of America and a bunch of other little guys. Once again I will leave you with these words, If it sounds too good to be true.... it is.
Last month the Federal Deposit Insurance Corporation (FDIC) walked into the headquarters of IndyMac and took control. This was the second-largest bank failure in U. S. History, topped only by Continental Illinois Bank & Trust way back in 1984. The Chairman of the FDIC, Sheila C. Bair said, "Over the past weekend, I have seen news reports which have fairly and accurately reported on the conversion of Indy Mac Bank to a conservatorship operated by the FDIC. I have also seen inaccurate and inflammatory reporting, which could well cause needless, unnecessary worry and angst among bank depositors throughout the country. The fact is that for insured depositors, IndyMac's $18 Billion are fully protected. It's important to keep in mind that the small percentage of uninsured are still covered for their insured amounts and half of their uninsured money. As assets of IndyMac are sold, they may receive even more. They have continued access to their funds through ATMs, debit cards, and writing checks over the weekend, and on Monday morning, it will be business as usual."
Please look at this statement closely. Ms. Bair said only the insured depositors are fully protected. This means up to $100,000.00 and slightly more for certain accounts including IRA's. Please, if you have money deposited in the bank, keep the amount under the insured limits. Why take the chance of loosing "uninsured deposits" when you have so many banks available, each of which is insured separately from the other.
As a firm, we are constantly grading ourselves against the markets and our peers. We provide our "composite returns" to various independent research organizations for the purpose of comparing our average accounts returns to other professional managers. These results are compiled by these firms and then sold. The buyers are normally sales people and institutional consultants who just love to comment on other peoples work. I guess that is why there are so few of us in the business that actually manage portfolios. A financial consultant doesn't want the responsibility of making investment decisions. By selling other peoples expertise, he or she can't be held responsible for the performance of the manager. One of the firms we provide this data to is Money Manager Review. Since 1987, MMR has tracked, ranked and analyzed the performance of private money managers. Currently over 800 management organization provide information on greater than 1700+ investment products. Their mission "is to deliver clear, comprehensive, timely, and cost-effective information to the investment community". More information on MMR can be found at their web address www.managerreview.com.
All four of our composites were ranked in the top 50 for various time frames. I am especially proud of our long-term rankings. Two of our composites are in direct competition with many of the largest and best know managers in the country. These are our equity only composites and both ranked in the top 50 for the one, three, five and seven year periods ending June 30, 2008 based on a risk/reward calculation. We pledge to continue striving for consistent high quality returns into the future and hope that we can be just as effective.
Our good friends at WRHI invited me to be a guest on their half-hour talk program on July 30, 2008. The show titled "Our Roller Coaster Stock Market" is available for download at the Straight Talk archive at http://www.wrhi.com/view/straight-talk. We encourage you to log on and listen.
Until next time,
Kendall J. Anderson, CFA
Anderson Griggs Portfolio Management
August 5, 2008
Anderson Griggs & Company, Inc., doing business as Anderson Griggs Portfolio Management is a registered investment adviser with the US Securities & Exchange Commission. Pursuant to laws and regulations Anderson Griggs also maintains notice filing with several individuals state regulators including North and South Carolina. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirements for advisors. This commentary is for information purposes only and is not an offer of investment advice. We will only render advice after we deliver our Form ADV Part II to a client in an authorized jurisdiction and receive a properly executed investment Management Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs Investment Objective, individual account, or index. The authors of publication are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Portfolio Management's office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.