A Letter To Investors
The last twelve months were highly volatile for the markets with the overriding result being large worldwide wealth destruction. Years of wealth creation in the real estate and equities markets and their asset inflation was erased. One estimate was an approximate $ 30 trillion equity change with an even larger change in the real estate market. The result has been a large loss in confidence. However, for Saddle Peak and some economists the future remains. Wealth will come back because the price of money has come down. Interest rates (the price of money) have fallen dramatically around the world. The lag between wealth changes and interest rates changes is not zero so all investors must be patient short term. Likewise, put in different terms the awful worldwide economy is frustrating, but it will come back. As Dr. Jeffrey Lacker (a widely respected Fed governor) said yesterday, he is looking for positive GDP returning in 2009. There has been a large monetary and fiscal stimulus package put in place.
Saddle Peak’s response to the 4th quarter could have been better timed. We and many others did not foresee the worldwide wealth destruction on the magnitude that took place. We were early. In 2007, we said the market would get ugly, but we did not foresee the extent of ugly. Thus, over the course of the quarter we increased our effective leverage as we purchased In-the-money calls and eliminated our puts for the market was trading for less than intrinsic value. The result is that we underperformed the S&P 500 in the fourth quarter. For the year, the fund decreased 27.4% versus 37% for the S&P 500. Remember our loss also included a major loss in the first quarter when Bear Stearns had its liquidity run.
Thus, we have arrived at the portfolio today. A market which is at least 30% undervalued today. A portfolio which is substantially cheaper yet. A portfolio with large effective leverage. The question remains how long will it take for investor confidence to come back? Will the economy come back the way the Fed anticipates? Saddle Peak’s largest investments are Goldman Sachs, Cymer, American Express, Starbucks, Speedway Motorsports and Coke. The portfolio companies are leaders. They are investments in the future. As the largest investor in the fund I look forward to the future and firmly believe the next twelve months will produce a large capital gain. The questions are how big and when. Please note the corporate bond market has rallied significantly from the lows of October and capital is available for quality corporations.
