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Quarterly Commentary

November 2022

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November 29, 2022

To the friends and clients of the Harvey Investment Company:

Crestfallen might be too strong a word.  Perhaps, though, you have felt a vague sense of something missing lately. Maybe it was because we did not send out a third quarter letter.  In any case, we pen this year-end letter ahead of schedule. That is unless December holds some special surprises worthy of comment.

Unfortunately, it has been a nasty year all around.   Through November 26, the S&P 500 is down 14.3% for the year.  The NASDAQ, home to many widely owned technology favorites, has fared even worse, down 28.2%.  The big gains chalked up in the prior three years no doubt assuage much of the pain and helps keep the dismal 2022 stock market results in perspective.  Still, pity the poor fixed income investor searching for income.  The 2022 bond market offered little respite.  While newly issued bonds this year came with higher yields, outstanding securities in the longer maturities that were issued over past few years plunged in value.

Understanding the cause of the declines is straightforward.   For more than a decade central banks around the world, often following the lead of our own Federal Reserve Bank, suppressed interest rates, keeping the shortest rates near zero.  Such policy is a very good way to invite all manner of speculation in the market place, and that, indeed, happened. For example, “meme” stocks, SPACS, crypto and various other flavors of exotica were created for the naïve investor to feast upon.  And feast they did.

A more pernicious condition subtly developed in mainstream markets.   Propelled by the rock bottom rates, the entire valuation structure for longer term bonds and stocks became dangerously elevated.  The overvaluation was indiscriminate.  The highest quality stocks and bonds were included on the up ramp.  Their lack of business risk was trumped by price risk.  When inflation soared and the speculative bubble became apparent, the Fed gradually realized what its “free money” policies had wrought.  Attempting to rectify the folly it had engendered, the Fed began to raise interest rates rapidly, essentially leaving conservative long-term investors with no port in the ensuing storm.    

Twelve years ago, we wrote “…the fundamental investment question we must address is how to invest when hugely important investment variables are wholly unpredictable.”  This past year reminds us that this observation is as true today as it was then.   At no single point in the distant future will the quantitative factors that determine a stock price be known in any definitive way.  What will inflation and interest rates be, will the economy be healthy or sick, which industries will be in vogue, what innovations will be influencing conditions? 

Since the quantitative factors cannot be known, we are left with, if anything, qualitative factors to consider. On this score we are more optimistic.  It seems to us that what endures through the years is a company’s culture.   The problem is how to define this elusive term and how to recognize it when it is encountered.  We think culture is palpable when a team of employees share common values.

The values we have identified as common among winning companies primarily fall in two areas.  First, top mangers’ see their company for more than pride in the money they make and the success they achieve.  They identify with the products and services they provide and how those products and services make their customers’ lives better.  Their company is like a family member to them - to be developed, to be kept healthy, and to grow in importance to the world around them.  The financial rewards for success are simply a by-product of doing a job they love.

Second, the companies embrace old-time values often expressed in hackneyed aphorisms.  “A penny saved is a penny earned.” “The early bird catches the worm.” “A stitch in time, saves nine.” “Early to bed and early to rise makes a man healthy, wealthy, and wise.” “Actions speak louder than words.”  Sure, these are corny, but consider competing each day against somebody who truly lives by them?

We try to build portfolios with companies who do live by such values.   Our research places heavy emphasis spotting such management teams. People are everything to us.   Certainly, this focus doesn’t give us any secret insight into the unknowable, but it gives us tremendous confidence that, given an economic system that rewards such values, your portfolio holdings will be full of winners over time.

Thank you for your loyalty and belief in our program.  It is most energizing and gives special meaning to our efforts.

  

 Sincerely,

 Samuel C. Harvey