Dear Shareholder:
When I was much younger I owned a share of a Cessna 182 airplane which I flew out of the Harlan, Ky. airport. This allowed me to get to and from Louisville, Cincinnati and Lexington, all within one day, and it was a valuable asset to our expanding business.
So it happened that I flew to Cincinnati one day for an important business meeting, expecting to be home that evening. But there was going to be a problem.
The problem was created by a diligent waiter who kept filling my coffee cup without asking me. Because of the intense nature of the meeting, I kept emptying my cup without noticing that I was drinking too much of something that highly stimulates my heart. Nor did I notice anything on the way back to the downtown business airport, nor during the required pre-flight check. In fact I didn’t notice anything at all until I was about 7,500 feet in the air and twenty miles south of Cincinnati. It was only then that I noticed that my heart was racing, that my hands and feet were without feeling and there was a sense that I was suffocating.
I immediately called the Cincinnati air-control radio and told him what I was experiencing, adding that I was turning west and would try to land at the big commercial field in northern Kentucky if I was not feeling better by the time I got there. The operator acknowledged my message but sounded calm and reacted as if this were all routine procedure. But I noticed he kept asking me questions every fifteen or twenty seconds; things like, “repeat pilot’s name? Are you called Tom or Thomas by friends? Repeat airplane’s identification number?” Meanwhile, I was pushing the limits of consciousness.
What happened is I was hyperventilating. It seems that an over stimulated heart lowers your blood pressure, which makes you feel short of breath and this leads to over breathing. You literally begin to drown in oxygen. My sight blurred, my hands would no longer function to operate the radio and then I passed out. I would say I was in a state of semi-consciousness. I could talk to myself saying “you know this plane is going into a spiral if you don’t control it”. And, I was aware of the air controller shouting into my earphones, “Tom! Tom! Get your head up!” So I opened my eyes by the hardest and found myself spiraling straight down on Interstate 75. I was able to level the airplane and make a landing on the then nearly empty road. (This was over forty years ago.)
I am thankful for that air controller who followed me closely on radar and anticipated my passing out, getting my name in advance. I am thankful for that inner voice, whether mine or heaven’s I’ll leave to speculation, and I will never again forget what the over-stimulation of too much coffee can do to me.
Why would I tell this story in a shareholder letter? Because I am going to talk about economic over-stimulation and it’s troublesome after effects.
Have you noticed that television is full of advertisements encouraging you to borrow money on your home, using its residual equity as collateral? (Lost another loan to “you know who.”). The proceeds of these loans have been used to fuel consumer spending and real estate buying in the last couple of years. As more money was available for real estate purchases, the more real estate prices rose, giving impetus to further borrowing. This self-feeding cycle was particularly intense in 2005 and 2006. By early 2007 the trend had reversed in many parts of the country.
What happens when this over stimulation reverses? First, risky loans begin to default. When real estate loans default the collateral property has to be sold at auction. These forced sales put downward pressure on real estate prices. Then if the situation becomes extreme, real estate collateralizing good loans has to be reappraised downward, causing these loans to be called with further sales resulting. Meanwhile, new construction dries up. This is how the bubble bursts.
At the risk of being wrong, I am going to suggest that bond prices will stay in the present range for several months, fluctuating narrowly, and then, later this year, will begin a gradual rise. You can also expect bond prices to remain firm if the stock market gets weaker.
If you are holding cash you might consider committing some of it to bonds in the next few months. There has been an increasing flow of cash into bond funds lately. If you are just a long term investor with all your available cash committed, hold your position. But, whatever you do, do it in moderation, you can’t avoid risk entirely……which reminds me of a Joe Creason story about a Methodist minister who recalled that in his youth a favorite pastime of boys in the country church he attended was to gather around the stile block and watch the hoop skirted women and girls dismount from the horses that many rode. One day a girl caught a hoop on the saddle pommel and hung head down in a sea of petticoats. The church’s minister saw the boys gawking and came running saying “Look away boys, or you may be struck blind.” One boy slapped a hand over the left side of his face and giggled, “I think I’ll risk one eye!” That’s the spirit of diversification.
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