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July 7, 2022
To the friends and clients of the Harvey Investment Company:
Wall Street is replete with clever one-liners. Here’s one, “Stocks go up on an escalator and down on an elevator.” There is usually a grain of truth in these quips as the first half of 2022 surely demonstrates. For the full year 2021, the S&P 500 was up 28.71%; for the first half of 2022 it dropped 19.96%.
The woes precipitating the decline are in no way hidden or complex. The Fed is purposefully raising interest rates to combat a crushing rise in inflation. Russia’s military belligerence in the Ukraine has ushered in an alarming new version of the Cold War. An aloof China looms ominously in the Far East. There’s more, of course. The US is riven by polarized political factions. A recession may be at hand. Extreme weather events occur with increasing frequency and at greater cost.
The epigram introducing Benjamin Graham’s classic book The Intelligent Investor quotes the Aeneid, reminding us, “…through chances various, through all vicissitudes, we make our way.” Graham’s career validates the quote. His first day of work on Wall Street was in 1914 at a salary of $12 a week. Some 43 years later, he packed it in after enduring investment periods including the two World Wars, the Depression, and several wild, speculative bull markets. Unsurprisingly, in the last chapter of Graham’s book, he recalls the legend of the wise men who boiled down the history of man’s mortal affairs into a single phrase, “this too shall pass.”
As we fight through our current problems, it is important to remember that most companies and their operating managers exert virtually no control over their company’s stock price. The disconcerting lurches in the market are driven by investors with all sorts of motives. There is the hedge fund manager executing his algorithmic strategy; the shaken individual who just wants out; the individual who thinks he’s called the bottom and is pouring money in; the index fund manager trying to balance the capital inflows and outflows of the fund. And there are the frantic margin calls; the forced liquidations; the liquidations to purchase assets outside the stock market. All these voices and more are out in the marketplace setting prices with the most emotional often having final say.
An important criterion in our stock selection is identifying managers who focus on building long term wealth for themselves and their shareholders and not on the waves of ebullience and worry that rock their company’s stock price. They operate with full faith that if they succeed in a business sense, they will inevitably be rewarded by their stock’s appreciation.
There is a wide dispersion of returns achieved by the S&P 500 over the years. Returns are heavily dependent on the start and stop dates of the measurement periods. A sample of relatively long time frames suggests that double-digit returns earned in high quality stocks is a laudable achievement. Our foremost goal for your assets is to avoid losses and still achieve a double digit plus annual compound return. These dual aims are ambitious, but we think doable.
Are we there yet? This proverbial child’s question posed to mom and dad on driving trips has versions that are currently circulating among investors. Have rates peaked? Has the market bottomed? How long will a recession last? Unlike parents, no definitive answers to such big picture questions can honestly be given. The variables that will shape the future are too many and too unpredictable to allow for confident prediction. But these are not questions we need to answer to achieve our goals for you. If we do our company-by-company analysis effectively, the compounding of any one company’s earnings will go on and on---there is no final destination.
Warren Buffett has been quoted as saying, “Predicting rain is one thing; building an ark is another.” Ark building has been particularly difficult in recent years for conservative investors as securities of the highest quality became increasingly overpriced. Addressing this risk entails broad based exit from winning positions, heavy tax incurrence in non-retirement portfolios, holding large amounts of cash yielding very little, taking short positions, and repositioning into unfamiliar, often untested corners of the investment world.
Our ark is the orientation of the management teams that run the companies in which we have invested. Our hope is that, as the valuation risk fades, the forward earnings progress these companies maintain will be a strong buttress against difficult market conditions. We think they will hold big profit potential for when the rain passes. We are optimists, if not about near-term market prospects, then certainly in the investment positions we maintain.Your loyalty and belief in our methods keeps us working diligently. Thank you for your trust.
Sincerely,Samuel C. Harvey