As We See It...                                                                Second Quarter 2004

The New York Times recently carried the notice of the death of Philip A. Fisher at the age of 96. Fisher started his own investment advisory firm on March 1, 1931. He believed in owning companies that were growing and were likely to continue to grow because of their research efforts to develop new and better products. He wrote a classic text on investing titled: “Common Stocks and Uncommon Profits” which we read years ago and reread after his death. He stressed the need for patience if one wished to make truly big gains. As a counterpoint he wrote, “…doing what everyone else is doing … is often the wrong thing to do…” Fisher’s philosophy is just as sound today as it was when he expressed it in 1957.

Fisher developed a checklist for himself in making investment selections. The points reflect common sense: Is there a market for the product? Are sales, production and research, the three cornerstones for success, in place? He stressed knowing the company and its management. He would agree with the English accountant’s sniff test: “Does it smell right?” In sum he said: “If the job has been correctly done when a common stock is purchased, the time to sell it is — almost never.” He also had the wisdom to sell if he had made a mistake, which was not often. We embrace Fisher’s philosophy, which is fundamental in approach, growth stock driven, and long term oriented. How refreshing to reread a work that is so elemental and alive.

Equity prices have moved sideways for the better part of this year. Last year, stock prices rose smartly in anticipation of an improving economy and higher earnings. Now that earnings are being realized, stocks are taking a breather to evaluate the economic variables and the November elections as well as the situation in Iraq. None of the answers is clear now, but may be resolved in the months ahead. We continue to emphasize high quality companies that have above average prospects for continued growth due to their research investment in new products.

China: Dragon Tamed?

Not long ago it seemed that everywhere, from corporate boardrooms to the cocktail party circuit, China was touted as the great global growth engine. China chatter seems much less prevalent these days. Foreign corporations are taking a more measured approach toward expansion in China. Share prices have pulled back: “H” shares of Chinese enterprises traded in Hong Kong have declined more than 20% year-to-date. While still a great secular growth story, China is also a vivid illustration of the time-honored truth that nothing, economies and stock markets most definitely included, goes up in a straight line forever. 

Toward the end of 2003, the Chinese government began a campaign to slow the red-hot economy by imposing restrictions on lending and foreign investment. Beijing is pursuing a delicate balancing act aimed at curbing excessive capacity expansion in specific overheated sectors, such as steel, autos and real estate, while supporting private consumption. However, Chinese growth remains far too skewed towards fixed asset investment; it will take more time to change the composition of GDP growth and bring the investment rate down to a more sustainable level. 

A positive side effect of the credit tightening, enhanced by energy shortages and spiraling raw material costs, is the wave of consolidation that has been triggered in many industries. Small-scale, polluting and unprofitable industrial capacity is being weeded out, allowing efficient, large producers to thrive. Although a painful process, the end result should be a healthier corporate sector and more attractive investment opportunities. 

There are signs that the Chinese government’s tactics are beginning to work: second quarter 2004 GDP growth came in lower-than-expected, and commodity prices, excluding oil, are easing. Thus far, consumer spending has remained strong. Existing controls are likely to stay in place until growth slows further, but signs of effectiveness mean that additional tightening measures are on hold for now.

We believe that long-term prospects for China remain very bright. While it is still early, Beijing is likely to accomplish what it has set out to achieve: a soft landing. The country’s demographics are phenomenal: China’s middle class is expected to double to 100 million people by 2010. The growth prospects are mesmerizing. Unfortunately though, valuations remain somewhat stretched, despite the recent share price correction. Patience is required. The dragon is subdued, but not yet tamed.