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Strategy Update – July 2011Submitted by Stonebrook Capital Management on June 25th, 2011
“The essence of investment management is the management of risks, not the management of returns. Well-managed portfolios start with this precept.”
- Benjamin Graham
Benjamin Graham was a very successful money manager who influenced many of the most successful investors including Warren Buffett. Buffett said Graham was the second most influential person in his life after his own father.
We thought about Graham’s ideas on risk management a lot in the second quarter as investor worries about the debt crisis in Europe, Washington’s continued inability to resolve the US debt ceiling and budget deficit impasse, economic policy tightening in China, and some weak economic numbers caused an 8.2% decline in the S&P 500 Composite Index from May 2nd to June 16th. During the decline many of the strongest groups of the last two years such as energy and emerging markets were down more than the broad market. The decline forced us to take some defensive measures, but we’ve retained most of our top performing core holdings and with the market’s recent renewed strength many of these holdings are already back near their highs with some making new highs.
The market weakness gave us the opportunity to buy some outstanding companies at attractive prices. For example, we were able to buy Arcos Dorados more than 20% below its April 2011 high, while the Latin American franchisee of 1,755 McDonald’s restaurants has continued to rack up impressive gains in sales and earnings. We expect the company’s earnings to rise 48% this year.
It now looks as if European leaders have averted a default by Greece. Progress is being made on raising the debt ceiling and dealing with the deficit. Chinese Premier Wen Jiabao indicated in a recent op-ed piece in the Financial Times that China’s money and credit growth had returned to a “normal range”. If so, there would seem to be no need for further policy tightening , increasing the probability of stable growth in China. We think the disaster at the Fukushima nuclear power plant had a large impact on the second quarter US economic numbers and expect this to diminish going forward. Second quarter earnings may even surprise on the upside. Overall, we remain upbeat on both the economy and the world stock markets, but remain vigilant monitoring the risks.