Farragut Newsletter June2009

June 8, 2009

Courage We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and now if I am wrong somebody else can have my job. I want to see this country prosper. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. I say after eight years of this administration, we have just as much unemployment as when we started. And enormous debt to boot. Treasury Secretary Henry Morganthau, Diary entry, May 1939

Very little is new, through the lens of our grandparent’s generation. What differs today is the shrill and superficial means through which we discuss it. Witness the Chairman of JP Morgan’s mocking announcement of his firm’s intent to repay the Federal funds which kept his bank from collapse: Dear Timmy, we are happy to pay back the $25 Billion you lent us. We hope you enjoyed the experience as much as we did. Jamie Dimon to the NYU Hospitality Investment Conference, June 2009

Can you imagine the real J.P. Morgan saying that to Andrew Mellon? Over six million Americans have lost their jobs during the past twelve months. Income tax revenue is down 44% year over year. And so far our collective response has been to take whatever measures necessary to capitalize the largest banks. With income down sharply (both government and wages earned) and our debt skyrocketing (government and the relative weight of our mortgages), how will we become better off? Our government’s apparent solution is to encourage the return of animal spirits, or speculation. As they used to say, feed a horse enough oats, the sparrows prosper. Courage can be defined as taking unpopular steps to ensure a righteous outcome. Exploding the Federal debt to pay off the speculative class is cowardice. Our Founding Fathers spoke to this: Loading up the nation with debt and leaving it for the following generations to pay is morally irresponsible. Thomas Jefferson

One conceivable outcome of monetizing Wall Street’s excess is inflation. Printing money to pay for public works and welfare can put pressure on prices, though a good bit is offset by an improvement in the productivity of the beneficiary. Printing dollars by the Trillions to pay off troubled speculators emboldens them, with little impact on the productivity of the nation. An eerily similar scenario played out during the Weimar Republic of 1923, when the German Mark collapsed to one-trillionth its value of nine years earlier. A highly politicized and unaccountable central bank can be a destabilizing force. Few know this better than the Germans. We must return to independent and sensible monetary policies, otherwise we will be back to where we are in 10 years time. Chancellor Angela Merkel, June 2009

Hyper-inflation is not a foregone conclusion. The Japanese had a similar credit, realty, and consumption bubble, the bursting of which has led to a generation of stagnant prices, employment and interest rates. So there’s also the Deep Blue Sea.

Investing Today It appears that we have seen the worst of this credit crisis in the sense that we went over a waterfall but the river is still flowing south. The bulk of the economy's credit problems are still to come, as charge-offs on trillions of dollars in loans remain to be recognized. Bob Rodriguez, First Pacific, May 2009

As investors, we cannot specify the weather, only our degree of preparation. The dollar may collapse, but it may well not. And while Timmy and Ben may look at times like Lucy and Ethyl in the candy factory, what if they pull it off? Will Rogers counseled investors to buy stocks that go up, and if they don’t go up, don’t buy ‘em. Absent his foresight, we revisit the arithmetic of investing: Stocks pay off through dividends, earnings growth, or sale to a greater fool. Bonds pay off by meeting their coupon, declining interest rates, or again, sale to a greater fool. Presume for a moment we’ve run out of fools. We need companies to grow earnings, pay their obligations, and enjoy a benign credit/interest rate environment. So far we’ve seen little of the above, excepting the fools.

Copyright 2009, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific investment strategy or the purchase of securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol Securities Management, Inc. Investment advisory services and brokerage provided through Capitol Securities Management, Inc, Member FINRA/SIPC.

Your Portfolios Our approach has been to select a handful of longterm theses, invest in a short list of securities that support them, and never to forget our fiduciary duty to our clients. We are investing along four themes: Resources, Blue Chips, Red Chips, and Something in Bonds. Positions are in the form of Index Shares, Individual Securities, and well-chosen Mutual Funds. Resource Stocks have been volatile, as speculators scramble to front-run an economic recovery in basic materials, or to seek shelter in precious metals. In addition to broad index holdings, we have select stakes in miners, oil services, and an agricultural processor. Taking this diversified approach allows us to participate in broad market moves, while enjoying the rewards of directly owning shares in companies. Blue Chips is a catch-all for a sleeve of high-quality iconic firms, which we’ve been able to buy at fair prices during the downturn. Our expectations for this portion of the portfolio are modest, but should we get the sort of “melt-up” in stock prices that crises can bring, we’ll have some dogs in the fight. Equally important, we’ve found investors seeing their stocks down ask should they buy more. Investors in funds just sell in disgust.

Readiness The past eighteen months have given most all of us pause as we consider funding a dignified retirement. Having worked with many families on this transition, we’ve found some immutable truths. First, one never has “enough.” For a fright, price a Single Premium Immediate Annuity for your current gross income. That’s your “number,” before allowing for inflation or a legacy. If you’ve not done this, it’s an eye opener. Next, consider that most folks won’t use an annuity. Instead, they’ll strive to live on interest and dividends, maintaining principal for their heirs and the tax authorities. Double the number. Retirement security is replacing your pre-retirement income with a reliable equivalent stream. Part-time work, pensions, and income-producing real estate will complement a balanced securities portfolio. As we are seeing with stocks and the value of our homes, there is no one sure thing.

Courage Last June we’d counseled readers that life was to short to spend in the counting house. We hope you took that advice; our work has kept us there.

Red Chips describes the Mainland Chinese firms listed on the Hong Kong Exchange. Our exposure to this market, as well as Asian Realty shares is exclusively through exchange-traded index shares. There’s little sense pretending that the financials of a Chinese firm are transparent. It’s the Inscrutable East, remember?

These are challenging times for all, and fiduciaries, those engaged and trusted as prudent stewards, have had quite a journey. We are most grateful for the support we’ve had from our clients, many of whom have been investing with us for a decade or more.

Something in Bonds is as specific as we can get at this writing. The past few weeks have rocked our world nigh as much as the past eight months. What was an inexorable return to normalcy in credit markets, with terrific returns in Bonds, is now in jeopardy.

One constant has been our unwavering conviction to do what we believe to be right. This has kept us from many of the permanent losses of capital which have characterized our industry.

The Federal Reserve’s “Quantitative Easing,” or “Zero Interest Rate Policy” has failed, with the two-year treasury yield spiking 60 pct in less than a week, and the benchmark ten-year yield up nearly 75 percent from its mid-January lows (2.14 to 3.83).

We are in the eye of a hurricane not seen in 75 years. While much of the storm has passed, there’s plenty more work to be done. Courage. Frank J. Ruffing CFP McLean, Virginia, June 8, 2009 [email protected]

The Gordian Knot of interest rates keeps armies of wags and economists feverish. Expect the unexpected. Recall, Alexander conquered Asia not by unraveling Midas’ knot. He used his sword. 7918 Jones Branch Drive, Suite 800 McLean, VA 22102 Telephone 703-283-5220 www.farragut.us.com Copyright 2009, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific investment strategy or the purchase of securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol Securities Management, Inc. Investment advisory services and brokerage provided through Capitol Securities Management, Inc, Member FINRA/SIPC.