Given the fireworks and volatility of 2009, it is with some relief we note that most major asset classes edged higher into the new year with little fan fare. What is clear to us is that the extreme bargains that were available in the first quarter of 2009 are not with us today, and we are acting accordingly and more defensively. During any time period, but particularly in the short run, we re-emphasize our long-term goal – be competitive in rising markets and outperform in challenging to down markets.

In portfolio moves, we completely sold out of two longer-term mistakes, Fisher Communications and Exterran Holdings, both of which we bought high, bought much lower, and sold out after impressive 2009 rallies. We also cut our losses on one newer stock, Technitrol, as the original investment thesis materially changed due to a shift in the manufacturing strategy of their largest customer. We continued to trim back some of our superb winners in the fourth quarter, such as Liberty Media Interactive, Nalco and Altra Holdings, as they approached fair value on an absolute basis or relative to their size within the portfolio. We used some of the proceeds to slowly sneak into a very select group of high-quality regional banking companies which now consists of small positions in Wilmington Trust, TCF Financial and banking wannabe Hilltop Holdings, a $12 pile of cash run by noted bank turnaround investor Gerald Ford.

It is our well-researched belief that the “Great Pendulum Swing” of the last two years has mostly run its course, and we are now entering into a more normalized world containing the usual litany of economic and political questions, very few of which we pretend to have the answer. As economic historian John Kenneth Galbraith noted, “There are two types of forecasters, those who don’t know and those who don’t know they don’t know.” If 2009 proved anything, it is that the ability of an investor to reliably pinpoint major market inflection points and act accordingly is extraordinarily limited.

The alternative to reading tea leaves is of course value investing, which we continue to practice and preach at Reed Conner & Birdwell. We have built an eclectic research team of highly motivated portfolio manager/analysts who operate in a entrepreneurially disciplined environment that seeks absolute outperformance through hard work and superior insight within focused portfolios.

Recognizing the folly of elaborate forecasting, we focus our attention on the analysis and valuation of specific securities. When you have done your own work on the intrinsic value of a company, that is the benchmark with which you can compare to the publicly traded price of the stock, and this benchmark helps to keep your wits about you in the swells of popular opinion. In 2009, the key to success was having faith in this rational process and not being afraid to lean into what was obviously a terrifying wind and purchase more of very good businesses at better and better prices.

“The Lost Decade for Equities” seems to occupy a fair amount of press time these days and, in our view, represents possibly the best argument for stock investing today. Besides the old issue of data mining (starting with the highest point in history and throwing in the 2nd worst stock market year in history at the tail end), the time to be worried was exactly ten years ago when stock markets and investor confidence were at all-time highs. We cannot recall a single period in our own investing history during which we have witnessed as much rank cynicism and disregard of a few hundred years of financial and economic history as we are seeing today. To quote our favorite Omaha investor, “Be fearful when others are greedy, and greedy when others are fearful.” It is crucial to understand just how unusual it is for bonds to outperform stocks over extended periods, and we suggest that given the current level of interest rates, and the simple mathematics of dropping the 1999 market peak from the beginning of new ten year cycles, stocks outperforming bonds is very close to a slam dunk over the next ten years.

As we noted in our previous commentaries there remains a number of interesting values that can be intelligently purchased today, but we are going to need reasonable economic activity to “move the needle” in the broader equity markets over the next few years. We continue to have a balanced portfolio of offensive and defensive stocks as it relates to the correlation between investment success and relative exposure to a resumption of economic growth. Without tiptoeing into forecasting, we note that there likely is some symmetry between the possibility of good versus bad economic news on the horizon, yet much of Washington D.C. and the financial press seem to only allow for the possibility of Black Swans vs. White Swans. In both ponds and in the economic history of the United States, white swans are actually the rule, not the exception. Cycles are a fact of life and need not be feared, but be priced accordingly.

 

 

As of December 31, 2009, the Fund held the following positions: Altra Holdings 2.1%, Hilltop Holdings 2.0%, Liberty Media Interactive 4.1%, Nalco Holding 2.4%, TCF Financial 2.1% and Wilmington Trust 2.2%.

The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation.  It is a market-value weighted index (stock price times the number of shares outstanding), with each stock's weight in the index proportionate to its market value. Russell 2000 measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.   The MSCI EAFE® Index is an unmanaged index consisting of a market-value-weighted average of the performance of international securities listed on exchanges in Europe, Australasia and the Far East .  It is not possible to invest directly in an index.

Note: Past performance is not a guarantee or indicator of future results.  The information provided herein represents the opinion of the manager at a specific point in time and is not intended to be a forecast of future events, a guarantee of future results nor investment advice. Further, there is no assurance that certain securities will remain in or out of the portfolio. Please consult an investment professional for advice concerning your particular circumstances. There are risks involved with investing, including possible loss of principal. In addition to the normal risks associated with investing, investments in smaller companies exhibit higher volatility.

MUTUAL FUND SHARES ARE: NOT FDIC INSURED, NOT BANK GUARANTEED AND MAY LOSE VALUE.