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Quarterly Commentary

April 2022

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April 11, 2022

To the friends and clients of the Harvey Investment Company:

Ouch!  There was no New Year’s celebration for the big stock market advance last year.  In fact, for most equity investors, the first quarter of 2022 was downright painful.  The S&P 500 Index fell 4.6% in the first quarter, and the second quarter is off to a rocky start as well.  Bond investors, depending on the maturities they hold, fared even worse.

Why?  For starters, trees don’t grow to the sky, and the market had rocketed higher over the past three years.  More importantly for the future, a number of important relationships that influence the market’s direction are out of whack. 

Prominently, for a number of years now, debt investors have earned near zero or negative real returns on investment.  That is, the rate of interest they have received is less than inflation.  The willingness of investors to accept this seeming punishment is rooted in human psychology (fear), poor investment outlets for savings, and the position taken by central banks. 

Global central banks of most developed economies, the U.S. Federal Reserve included, engineered short-term interest rates to hover near zero or below.  Correcting this unsustainable condition will be unsettling as many investors have taken actions assuming the low rates would forever be the norm.

There are other disturbing imbalances.  For example, corporate America, sometimes by choice and sometimes involuntarily, cut production at the outset of the Covid pandemic.  Meanwhile, Congress, fearing a dreadful recession, implemented programs to support consumer and business demand.  The resulting mismatch between demand and supply has engendered startling inflation rates.  Further, the current tendency of nations to seek more economic independence makes international trade fraught, and the supply picture even more dicey. 

The healthy list of distortions needing to unwind for a more balanced financial picture to emerge will no doubt be addressed and, in time, cured.  Meanwhile, we expect turbulence and, in an admittedly perverse way, we welcome it.  Stock market volatility often creates unexpected opportunities for us to purchase our favorite companies at bargain levels.  

For quite some time, we have viewed with interest the tidal wave of investors moving toward funds that invest in groups of securities rather than those that emphasize their prowess in picking individual stock market winners.  In particular, S&P 500 index funds and index related funds have seen massive inflows of money.  Our interest in this subject was rekindled by the recent passing of Edward (Ned) Johnson, the long-time leader of Fidelity Investments.

Johnson took over management of Fidelity from his father in 1972 on the eve of the great bear market of 1973-74.  Fidelity, a small mutual fund company at the time, struggled, as did the entire industry during this discouraging period.  Undaunted, over the decades Johnson transformed Fidelity into the behemoth it has become today.  This was accomplished by bringing to the “man in the street” investment products and services once available only to the financially advantaged class.  A notable example of innovation was offering the first money market fund that allowed investors to write checks on their holdings.

At heart, Johnson, despite his skill as a business builder, never lost his passion for analysis of individual stocks.  He was the first manager of the fabled Fidelity Magellan mutual fund.  He relished discovering talented new stock pickers.  He was followed at Magellan by the legendary Peter Lynch, who ran Magellan from 1977 to 1990 and achieved a 29% compound annual return for Magellan shareholders.  Lynch made Fidelity famous far and wide.  His simple views and charisma made anything seem possible with the application of a bit of elbow grease and common sense.

It is difficult to review Johnson’s Fidelity saga, without also mentioning another of the industry’s great innovators and business builders----John C. Bogle.  Bogle was the progenitor of the index fund.  After being bounced as the Wellington mutual fund group’s president, in 1974 he launched Vanguard and, in 1975, introduced the world’s the first index tracking fund.  He became the peoples’ champion, ever fighting for lower fees for customers’ index tracking choices.  The rest, as they say, is history.

Eventually, despite Ned Johnson’s predilections, Fidelity itself caved and began offering index tracking funds and other companies’ passive funds to its investors.  As the parallel tracks of these two great industry innovators fade to historical lore, today’s thoughtful investor is left to contemplate the two tracks each pursued.  Certainly, the index approach currently dominates.

Do the two approaches connect in some way?  We think not.  It is a “never the twain shall meet” situation.  Is one of the tracks superior to the other?  It depends.  That is our way of saying nothing occurs in a vacuum.  There are always other factors at work.  The talent of the stock picker or the emotional fortitude of the investor are examples.

Certainly, the contrast in approaches is revealed in the priorities to which an organization offering the products must hew.  Individual stock picking entails intuitive number crunching, where talent and experience combine to construct portfolios company by company.  On the other hand, a firm offering an index product is a fabricator, putting in place specific pieces of a preordained puzzle.  They assemble stocks from a given index into a fund. 

In either case, there is a key factor to achieving desired returns-----being on the right side of buying and selling at emotional extremes.  Warren Buffett is often quoted as saying, “Be greedy when others are fearful; be fearful when others are greedy.”  Easy to say, hard to do.

Your continued support and belief in our program energizes us each day.  Thank you.

  

 Sincerely,

 Samuel C. Harvey