Tuesday, February 8, 2011

FPA Crescent Fund Q4 2010 Letter to Shareholders

Bulls currently outnumber bears by about 2 to 1, according to the American Association of Individual Investors, leaving an anxious complacency ruling the markets. With 1/6th of Americans now receiving some sort of government assistance, we just do not believe that the world is as good as it appears. On the other hand, stock valuations are not unreasonable, particularly in the context of such low interest rates.

We do not have a strong top down view as to what will transpire over the intermediate-term with respect to either the economy or securities markets, nor do we have a great love for the opportunities the markets are currently offering us. As a generalization, we require more upside than the market currently permits, because the downside (for reasons discussed later) is not inconsequential.


We have, on a number of occasions, discussed the necessity for investment that will translate into a longer-term, productive real return, and thus provide a more enduring lift to our economic fortune as compared to the quick fixes of today. Ill-advised policy machinations delivered manufactured money directly to the consumer, much of which inevitably found its way into the economy. By choosing consumption over investment, the government has created an unsustainable economic environment when real, beneficial change could have been accomplished. We thus brand 2010 as the Year of the Miss. We have been further expanding our waist lines and clogging our arteries instead of building muscle mass and exercising our heart. Enough already with the quick fix! Why do so many Americans take a pill to reduce their blood pressure or control their cholesterol, when better health could be accomplished with discipline and diet?


We cannot expect lasting success to come from government handouts. "Nearly half of all Americans live in a household in which someone receives government benefits, more than at any time in history." We have debt issues because we have a spending problem, not the other way around. With apologies to Winston Churchill, we observe that never in the field of economics has so much been spent by so many to yield so little. Fiscal discipline dictates administering medicine today for a healthier tomorrow. Instead of letting a correction take a more natural course, our policy makers have chosen to attempt to control the economic cycle through unprecedented largesse.

In the years preceding the recession, economic growth was driven by consumers piling on debt in order to spend. Since the beginning of the recession, the government has taken the place of the consumer, borrowing to support the economy. As a result, total household spending has increased, despite enduring a deep recession. Impressive, until you realize that government transfer payments swung $847 billion – an unprecedented amount totaling almost 18% of GDP. Still, in inflation-adjusted terms, household spending really shrunk anyway. The government has become the de facto spender. We do not believe that it is any more sustainable to borrow excessively as a group than it is for individuals to borrow excessively. After all, isn’t our nation a collection of these same individuals?


Meanwhile, the government’s spending spigot remains open, but what appears as largesse will hurt us later. Government outlays as an engine of growth cannot be sustained, and it therefore merely subrogates the traditional economic cycle. If we don't allow interest rates to seek a more normal level and prices to find their natural floors, we cannot comfortably know what our downside is. But maybe that's the point − keep things going until it becomes someone else’s problem. How else does one explain the malpractice of treating the symptom but not the disease? Under the circumstances, we doubt the current recovery is self-sustaining, which leads us to the conclusion that our economy is merely between crises. We fear, though, that our children will pay for the sins of their fathers.