Letter - July 2007





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What are the Chances?

It has been an up and down couple of months. May delivered outstanding returns; June turned into a downer after troubles surfaced at two highly leveraged Bear Stearns hedge funds invested in securities backed by low quality (sub-prime) mortgages. Things have settled down for now; the market has moved higher once again, though many investors nervously scan the horizon for a “black swan,” a metaphor for a low probability, high impact event.

The bull market in U.S. stocks is more than four years old so we ask ourselves: What are the chances of an unexpected event that ends the party? Assigning correct probabilities to possible outcomes and then acting at the right time is notoriously difficult. Nonetheless, going through the process focuses the mind. Some of the issues we debate among ourselves include:

What are the chances that the housing market softens even more? What are the chances that the market for mortgage -backed securities collapses, with a ripple effect through the economy? What are the chances that a hedge fund blows up, similar to Long Term Capital Management in 1998? What are the chances that oil goes to $100/barrel? What are the chances that the Chinese economy, a major engine of world growth, falters? What are the chances that rising protectionism derails global trade and growth? What are the chances of another major terrorist attack?

These are important questions for investors. The growing list makes us cautious. But reflecting back over the last twenty years, we’re not confident in that we can anticipate specific events accurately. We did not foresee, for example, the crash of 1987, the Asian crisis in 1997, or 9/11. After the fact there is always someone who turns out to have correctly predicted a major event, but most, ourselves included, have little chance of doing this consistently or getting the timing right. Rather, a steady hand at the tiller and calm in the face of a storm has helped our clients weather the rough patches.

Looking to the months ahead, we would describe ourselves as “bought-up” bears. We are cautious but remain fully invested. However, many of our long-term holdings are approaching prices where we contemplate taking profits. Energy stocks in particular have risen to a level where prudence suggests that we consider lightening up, though we remain bullish on natural gas. We anticipate increasing cash reserves in client portfolios as there are no obviously undervalued sectors in the market.


Our investment in Intel (NYSE INTC: $25) reflects a “small ball” investment strategy. In baseball, “small ball” means winning by bunting, taking walks and hitting singles. Similarly, with stocks it is a lower risk way to get solid but unspectacular returns. Fifteen months ago, Intel was an unloved, lumbering, unexciting, large cap stock. Since then, cost cutting and robust investment in R&D has enabled Intel to beat off a challenge by rival Advanced Micro Devices and gain back market share. Earnings are now expected to improve. The stock is up 25% over the past 15 months and we expect further modest gains but don’t look for long ball returns here.

Seneca Foods (SENE-A $26, SENE-B $26) recently reported its fiscal 2007 year-end results. The company showed solid progress in cutting costs though it hasn’t been able to raise prices. Earnings were up for the year to $2.65 but down for the final quarter. At 10 times earnings the stock seems cheap. We continue to believe that management is moving the company in the right direction and there is more progress to be made. We expect that the company will eventually be sold as large shareholders look for an exit.


In late June, isolated thunderstorms cut off power and telephones in our office for a day. We apologize to any of you who may have tried to reach us then. Like all NASD member broker-dealers and SEC registered investment advisers, we have emergency procedures, known as a disaster recovery plan or, for those who like euphemisms, a business continuity plan. We posted this plan last year on our website, where you can view it at any time. Among other things the plan provides emergency numbers you can call to reach us and our clearing firm, Pershing LLC., the wholly owned subsidiary of The Bank of New York Mellon that holds your investments. Pershing holds over $700 billion in assets for over 5 million individual investors. Its elaborate off-site data storage safeguards protect your securities and cash.


Tom Herzig


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