Dear Shareholder:
Keep the Enclosed Statement: Put the enclosed year-end statement in a safe place. It gives you your entire 2004 record of transactions. The next statement will show 2005 transactions and will not repeat 2004.
Whither Bonds in 2005?: I should first state that the “bears” are out in force, led by no less a personage than Bill Gross, senior bond manager for PIMCO Advisors and probably the country’s best known bond guru. Mr. Gross thinks inflation is coming because the dollar is falling in comparison with other currencies, increasing prices on imports, and this currency-induced inflation will, in his opinion, lead to higher interest rates. In addition Gross and others think the drop in the dollar’s value is a disaster for foreign holders of U. S. Treasuries and this, they say, may lead to foreigners eventually dumping our Treasuries.
Those are compelling arguments and may be right. What is disconcerting, however, is these folks were thinking exactly the same thing a year ago and, indeed, two years ago as well. Furthermore, the dollar has declined over 30% in relation to the euro in those last two years, an enormous change, and interest rates have really not risen, except for a brief period in the late spring of 2004. Nor has inflation started to rear its head, in the opinion of the Federal Reserve Board. So, there does not seem to be as direct a connection between interest rates and the value of the dollar as many conventional economists believe. If there is something wrong with conventional reasoning, and there seems to be, what is it?
China is one of the major components of the U.S. trade deficit. China has a big problem refusing to take dollars and possibly dumping U.S. Treasuries. If they refuse dollars they refuse to sell goods to the U.S., creating unemployment in China in the process. If they continue to sell goods to overspending Americans they are going to have to buy U.S. goods in return or buy U.S. Treasuries. If they choose to sell U.S. Treasuries and buy euro denominated bonds, they take a 30% hit on the dollar/euro exchange rate. They lose on any of these choices.
And, what about inflation? I have a country boy’s theory about the cause of inflation. I think it is a self-fulfilling prophecy. If you believe inflation is coming you will pay higher prices today because you expect them to be higher still at a later date. If you don’t believe inflation is coming you will resist paying higher prices today, forcing a roll-back in those increases. The great preponderance of folks will tell you they think the Federal Reserve will not permit inflation to get a serious foothold. They point to the Paul Volcker tightening of 1979 as proof.
I had a professor of Money and Banking at Yale whose favorite mantra was, “Gentlemen, the economy is like a barrel of eels. You push one down and they all adjust, but no one can predict how.” He had been an advisor to Eisenhower, so his experience was not all just academic. And he was referring to the U.S. economy when he said that. The international economy is an even bigger barrel of eels.
What’s my guess? I expect interest rates to be a little higher this year. That may negatively affect the price of our shares by 20 to 30 cents a share for awhile. But if this happens the stock market, already at high multiples, should react negatively as well. By the end of 2005 I would expect the price of our shares to be somewhere near their present levels. If we suffer another significant terrorist attack on a U.S. target, all bets are off. But, if that happens, you’ll want to be in good quality bonds.
On Keeping on Keeping on: As I sit here at my word processor, I am aware of damage to my left hand. Over twenty seven years ago, when we were starting this fund, that hand got yanked through a wood shaper late one evening and was pretty well chewed to ribbons. Fortunately I had a good friend who was a trained hand surgeon. Chase got out of bed at 11:00 PM and came to the hospital to see what he could do to help. He had been up most of the night before, reconstructing the face of a young woman who had been in an automobile wreck. When he saw what I had done, he immediately took me to surgery and worked on my hand until about 5:00 AM the next morning, driving himself and the exhausted operating room nursing staff mercilessly.
Chase wouldn’t let me go to rehab when my hand came out of the bandage and cast. He took over that task himself. The result was, after vastly more pain than even the shock-producing initial accident, I recovered almost 90% use of my hand, in spite of losing half my thumb and forefinger. It is amazing how your brain can eventually adapt to jumbled signals and how nerves will finally grow back to provide feeling to previously “dead” fingers. Somebody asked me recently what I would do if I had my fingers restored, to which I replied “they would be in the way”.
I’m thankful on this New Year that all those years ago Chase Allen was tough enough (and compassionate enough) to restore an otherwise ruined hand for me. In the same spirit, we are adjusting to the loss of Bill Griggs, our portfolio manager and President. The fund is running smoothly. Everybody is pitching in. America has some tough kids in Iraq we can all admire. So, if we can keep on keeping on in this way we will all be fine in the year to come, no matter what.
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