Mr. Burke: Johnston Lemon Asset Management is an SEC registered investment adviser and a subsidiary of Johnston, Lemon & Company, a New York Stock Exchange firm. At Johnston Lemon Asset Management, we manage money for individuals, associations and retirement plans. We believe that thoughtful construction of a disciplined investment program, with decisions not made in isolation, but within a total portfolio framework, present the highest probability of long-term success. Our equity investment discipline identifies well-capitalized companies that are positioned to deliver both capital appreciation and dividend growth. Our fixed income strategy emphasizes government and high-grade corporate bonds within the context of global economic market cycles and trends. The equity investment strategy employs inputs from both macroeconomic and valuation analyses. The macroeconomic approach provides direction or guidance on when to buy or sell a security. The value or intrinsic strategy looks at the financial characteristics and consistency of growth in revenues and earnings of select securities. Finally, we monitor our asset allocation model to take into account the nuances of the economy, interest rate trends and stock sector weightings.
TWST: These past 12 months have been most eventful. How have they impacted your
investment strategy?
Mr. Burke: Johnston Lemon Asset Management is not unique. The global economic
slowdown impacted our equity strategy. Trade, industrial production and consumer
spending reports influence earnings trends. We believe that the financial
markets have seen the worst. The panic phase is over. Because of the
repercussions of the economic slowdown, the stock market cannot move
significantly above the current levels in the immediate future. Market
confidence will return when the unemployment rate decreases and mortgage
payments are made. The recent upturn in the market is a short-term forecast of
the direction of GDP growth. The ISM Manufacturing Index, which fell to historic
lows over the winter, has climbed out of its hole to signal that the overall
economy is now expanding. The corporate reaction to capital risk has resulted in
deleveraging, inventory liquidation, and capital spending disciplines, which are
long-term positives. The VIX has also traded back to August 2008 levels,
indicating a reduction in investor fear.
Meanwhile, commodity prices such as oil, lumber, copper and gold are well off
their crisis period lows. Housing construction and automobile manufacturing
reached such depressed levels that a bounce back is likely in late 2009 and
2010. A debate exists or continues to exist about whether an investment strategy
should focus on deflation or inflation risk. The underlying premise of the
debate is that once the economy recovers, the easy money that has been injected
into the economy will spawn inflation. However the inflation argument fails to
take into account that too little demand will be chasing whatever supply exists.
For inflation to unfold at least in the next two years there would need to be a
major shift upward in labor compensation, since it accounts for 70% of corporate
cost. That is unlikely. The Federal Reserve Board will gradually stop pumping
dollars into the banking system through the purchase of Treasury bonds and high-
quality mortgage-backed bonds.
At some point, according to Fed President Bernanke, the Fed will start to
extract some of the credit from the economy and remove the source of inflation.
We don't expect the Federal Reserve Board to revalue the Fed Funds rate until
maybe the second or third quarter of 2010. As a consequence, the 10-year
Treasury bond should yield somewhere between 3.75% to 4.25% based on an
inflation rate of 2%.
The interest rate spread between the 10-year Treasury and high quality corporate
bond is an indicator of investor confidence. When investors are confident, such
as the period between 2004 and 2007, the spread between government and high
yield bonds is minimal. Conversely, when concern about the economy exists the
spread expands. In effect, when the economy is producing above average returns,
potentially impaired corporations are able to borrow money through the bond
market at minimal spreads above higher quality bonds.
For the past 15 months the lower quality bond market was closed. The window is
now reopening. The so-called flight to safety took place in 2008 and the yield
on government issues decreased to a minimal level. The current yield on the 10-
year bond has increased approximately 30% in the past three months. The increase
in Treasury yields is complementary to a weakening dollar and a slightly
improving economy. The current rise in interest rates has primarily occurred in
Treasury bonds rather than corporate bonds and reflects a shift from risk
aversion to some level of risk taking. Treasury yields are also rising due to
supply concerns. The government is financing the economic reconstruction with
new debt. Concerns will persist about the amount of debt and the ability of the
market to absorb the debt.
Tickers included in this excerpt: BA, COP, CVX, DVN, GOOG, MMM, MSFT, STJ, WMT
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