During the first quarter we repositioned the portfolio significantly; during the second we made only modest changes. Three months ago we reported an abundance of quality/growth options at attractive prices. Many of the more promising participated fully in the market's surge. By end-June, we had net gains of 36%, 99% and 164% on the three stocks which we added in 1Q. Several leading companies report that they see no signs of green shoots, but have anyway doubled in price. Valuations are now much less compelling. We are back to carefully weighing the relative resilience and prospects of businesses for the long haul, against a backdrop of economic turbulence which we expect to continue, and possibly to intensify.
Governments, disappointingly, have 'wasted a good crisis'. Not only have they thrown away unimaginable amounts of taxpayers' money, postponing necessary adjustments, and impoverishing future generations. Not only have they missed opportunities for intelligent reform and appeared to be victims of 'regulatory capture'. Not only have they flouted the established hierarchy of creditors, imposing unwarranted losses on the prudent, and distorted the allocation of capital. They have also failed to seize the opportunity to reexamine market fundamentalism, to lead intelligent debate on the appropriate goals of societies, and to forge a new consensus on effective moves towards a more sustainable future.
We mentioned that the economic crisis may intensify. Papering over cracks serves only to obscure the necessity of remedial action while the problem gets worse. The patchwork of quick fixes will have unintended consequences. Crises in pensions, insurance, government finances, housing foreclosures, etc, may be visible long after their worsening becomes inevitable, long after they become impossible to avert - but long before they reach bottom. The same will at some stage prove true of energy resources, and environmental damage. The timetable for these is less forecastable: they could be decades away, but the possibility that they may intensify suddenly should be borne in mind. Planetary and bureaucratic overload, like military blowback, lend themselves to the models of catastrophe theory, and may reach tipping points with little warning.
How to plan for energy and environmental contingencies, we are not at all sure. Fortunately, it seems likely that there will be better times to act. The stampede for inflation hedges may be premature (forced and voluntary deleveraging may outpace the printing presses for a while). Exchange-traded funds have made the establishment of long positions in commodities more convenient for many, and more investors now seem to be viewing commodities as appropriate for large asset allocations, changing historic price relationships. In John Hussman's phrase, it may be 'hard for investors to sustain a durable sense of doom about inflation risk', if we have a period of subdued prices or deflation meanwhile. Likewise for resource shortages: some 1970s analysis still reads well, but many market participants would regard three decades 'too early' (even if intended as a warning) as tantamount to being wrong. However, early warnings are valuable. Investor views on appropriate long-term strategies would be welcome.
Meanwhile, the attempt to recreate the market economy of 2007 seems both doomed and foolhardy. Many industries will not quickly return to 2007 levels: some will never be the same again. We are wary of future predictions for most 'luxury', several types of retail and consumer goods (spending patterns may change for decades), the auto industry, many types of capital machinery, and construction equipment... among others. We nevertheless hold some shares in these sectors, if the risk-reward proposition remains reasonable, but many of our holdings are in other sectors where business is relatively predictable - supermarkets, fast food, consumer finance, aircraft maintenance, basic telecommunications - and life, for the time being, goes on.