Letters
January 30, 2008
Dear Investor:
The 4th Quarter again proved to be a challenge for Saddle Peak. However, it appears now that many of the concerns we voiced in our last newsletter have materialized. In our last newsletter, with the Standard & Poor’s 500 index valued over 1500, we commented:
"If you believe the stock market predicts the future, one could infer that investment prospects appear very positive. The old adage ‘bull markets climb walls of worry’ has been true since the market bottomed in 2002. However, as value investors, we are concerned that there may be some clouds on the horizon. What are some of the possible issues confronting the market? First, the enormous debt bubble that has spawned over the last several years could conclude with much more difficulty than the stock market indicates. Sub-prime may be the beginning of a long, painful economic correction. Second, sharp housing corrections usually do not end in soft economic landings. Earnings estimates in no way reflect a recession and in fact, profit margins are at historically peak levels. Finally, the Federal Reserve is attempting to perform a delicate operation, lowering interest rates without stoking inflation and dollar fears. Our worry is it may not have as much flexibility to lower rates as the economy needs or investors desire."
"The market could continue to move upward as it has since 2002, but history shows that stock markets do not progress forward indefinitely without difficult and sustained corrections. The fact is we have not had a sustained correction in a very long time. Because of these concerns we have remained highly disciplined in our investment decisions, including the decision to maintain cash positions generally higher in comparison to other periods of time."
Today, with the Standard & Poor’s 500 index hovering around 1,350 there is considerable uncertainty in the market. The “Four Horsemen” of Cramer are struggling (Apple, Research in Motion, Amazon and Google) and growth managers are questioning whether the terrific run in growth stocks is over. There is no disputing that we have had a correction in the market. However, the question is whether the correction is behind us or if it will be of a sustained, difficult nature.
Our premise is that there is no magical antidote to propel the market to a quick recovery. We believe that the debt crisis could be a long drawn out affair and the stock market could mirror this process for an extended period of time. Nature must run its course and the credit markets and the housing industry will endure an even more painful period of time.
Similar to the 3rd Quarter, Saddle Peak’s 4th Quarter cash position was higher than normal given our concerns about the general economy. Despite this cushion, we unfortunately did not execute as well as we hoped. As such, we joined several other managers in the value sector that underperformed the market.
What affected our performance? In short, like the 3rd Quarter we were not very successful in our short term stock picking. In addition, we initiated positions in certain stocks that proved to be premature. The breadth of the market in the second half of 2008 deteriorated rapidly, particularly for value-style managers. Cheap companies just got cheaper. Many of the companies that we believe were 70 – 80 cents on the dollar continued to drop.
As an example, after purchasing Manpower (MAN) in the low $60’s, the stock continued to fall to the high $40’s. Our calculation of Manpower’s intrinsic value was originally $85, or about a thirty percent discount at the time of initial purchase. Our opinion of the intrinsic value of the stock has not changed although the stock slid on impending fears of recession. Manpower is the largest international staffing company in the world and will survive quite well in a soft economy. As such, we have added to the position.
Another example is Amgen (AMGN), which dropped considerably on concerns regarding an upcoming FDA meeting to discuss safety issues related to anemia therapies. Despite the decline, we still believe that the long term future of Amgen is very favorable. The Company now currently trades below a typical pharmaceutical company multiple even though its biotechnology pipeline appears promising.
Our portfolio still consists of about 20 companies and our focus remains to invest in companies that are trading at a discount to what we believe are their true underlying values. Despite our performance in the second half of last year, we believe that structurally the intrinsic value of our total portfolio has not changed significantly. The portfolio has just become cheaper. This is in contrast to certain value managers that have large positions in the financial sector and have little chance of recouping their losses in the future.
During the quarter, we sold our holdings in Coca-Cola, McDonald’s, Altria,
Yahoo and Calamos as the positions reached what we believe are intrinsic values. At the same time, we purchased Hershey and Americredit. Most recently we have taken positions in American Express, Bear Stearns and Intel.
We realize that our clients are interested in absolute returns. Although we are disappointed by both our 3rd Quarter and 4th Quarter performance, we remain optimistic as the market appears to be shifting to a more balanced perspective between value and growth. An impending recession could place a high premium on the ability of investors to truly discern what is opportunity in the market and what is not. We believe that this potential “stock picker’s” market would be in our sweet spot and an environment in which our investors will be rewarded.
Thank you for your continued support of Saddle Peak.
Sincerely,
Saddle Peak Asset Management, LLC
Doug Grey
Partner
Our views and opinions regarding the investment prospects of our portfolio include “forward looking statements” which may or may not be accurate over the long term. While we believe we have a reasonable basis for our views and opinions, actual results may differ materially from those we anticipate. The information provided in this report should not be considered a recommendation to buy, sell, or hold any particular security.
