August 9, 2010

Joshua Cooper Ramo

Mr. Ramo is managing director at Kissinger Associates and New York Times Best-Selling author of The Age of the Unthinkable: Why the New World Disorder Constantly Surprises Us and What We Can Do About It. Prior to entering the strategic advisory business, Ramo was an award-winning journalist and the youngest-ever Foreign Editor of TIME magazine.

PART I: MPMG – A perspective on the markets

Where we’ve been

• In 2008 and 2009, we experienced our nation‘s first credit crunch since 1974, along with the collapse of major financial institutions and a real threat to the entire global system.
• 2009 demonstrated the resilience of our national spirit, as the U.S. economy recovered and equity prices enjoyed their strongest rally in decades.

The current environment

The U.S. economy is still facing obvious challenges, but fundamentals about the economy are generally improving:

• Massive deterioration in employment has been halted and we have begun to see a modest uptick in employment.
• Productivity increases in non-farm business sector.
• Some of the largest productivity increases by U.S. corporations since 1948.
• Near-record earnings for U.S. corporations in the S&P 500.
• U.S. corporations holding more cash than at any point in 30 years.

This is important, because while fear and greed move markets in the short term, in the long run, markets move based on the ability of companies to generate earnings.

Investment philosophy

• George Goodman (pen name Adam Smith), author of the classic investment book The Money Game, said “If you don‘t know who you are… the market is a very expensive place to find out.”
• Individuals need to determine who they are – emotional short-term traders or fundamental, long-term investors.
• The constant chatter heard in the media (CNBC, etc.) tries to convince us with minute-by-minute updates that today‘s news tells us about the long term direction of the markets.
• Investors have more information than ever before. Does it lead to better investment prowess?, or more emotional, knee-jerk reactions
• Legendary investor Warren Buffet said “If you buy a farm as an investment, do you sit there and watch the farm channel on television all day, as they tell you corn went up a penny or something like that? No, you buy the farm and figure it is a good investment over a period of time.”

The long-term story

• Over the past 20 years, the S&P 500 has averaged 8.2%, but according to a study by Dalbar, Inc., the average equity investor earned just 3.17%.
• This is due to the fact that investors tend to make emotionally-based decisions that result in underperforming the market.
• During the 20th century, the Dow Jones Industrial Average rose from 66 to 11,400. That was a good train to ride.
• A challenge now is to look past the ripples in the ocean (stubbornly high unemployment, ballooning deficits) and pay attention to the tides – the long-term trends.
• This requires a focus on what is happening around the globe – where significant growth is likely to continue.
• Although the volatility of the moment may not make it obvious, it has never been so important to own good businesses with solid balance sheets and products or services that are unique. This is how wealth is created.

PART II: Joshua Cooper Ramo – The New World Disorder

Overview

Observations from Joshua Cooper Ramo

We’ve entered an era of disruption and instability. There are numerous examples of events that have occurred over the past decade that would once have been considered “unthinkable:”

• The financial crisis and the resulting economic environment that is far different from what America and the world experienced when the tech bubble burst little more than a decade ago.
• Questions about whether the U.S. dollar will maintain its status as the world‘s reserve currency.
• Numerous examples of “experts” turning out to be wrong about the direction of events in the world. A notable example is former Federal Reserve chair- man Alan Greenspan‘s stated —shock“ that his view of the world held for 40 years was flawed, as proven by the financial crisis.

These are examples of how we face a fundamental reset in the way things work in the world. This requires a new way of thinking about how about how to prepare for an era of uncertainty that lies ahead.

MPMG Views on Potential Investment Implications

• Investment strategies can‘t simply be modeled on past history, as we may be in the midst of historical changes in the way the world works. Many “quantitative (quant)” investors experienced this first-hand during the financial crisis.
• Investors must be prepared to adjust to a changing environment. Success may hinge on the ability to see the big picture, and take advantage of new opportunities being created in the market.

Causes of the Disruption

Observations From Joshua Cooper Ramo

#1 – An explosion of actors

• There are more groupings of people (i.e., an explosion in the number of non-governmental organizations, terrorist cells, hedge funds)
• The changes we‘re experiencing today can be compared to the emergence of quantum mechanics in the 20th century. It greatly expanded the laws understood under Newtonian mechanics. Once science made the leap, it made more progress in a matter of decades than it had in centuries.
• Urbanization is a huge trend – for the first time in history, more people live in urban areas than in rural areas worldwide. The movement to the cities is continuing.

• To visualize the unpredictability of today‘s world, consider the concept of The Sandpile. As grains of sand are added to it, it grows larger. But at some point that is totally unpredictable, an avalanche occurs. It is impossible to forecast what grain or grains of sand added will make that happen. Our world is very similar today, with new players and new forces added regularly. It is difficult to know what the results will be when they come into the picture and when.
• The classical power of states is waning, creating new dangers and new financial risks. Risks can‘t always be named or easily defined.

#2 – More choices

• More people (i.e., China) have the opportunity to invent their lives for themselves.
• Changes are happening quickly. In the mid-20th century, life had an assembly-line quality, with a great deal of predictability – staying at the same job, living in the same town, for most of your life. But this has changed much. It is likely that many people will be doing something different ten years from now than they are doing today.
• Foreign policy exemplifies this. Unlike the Cold War era where we fought one major foe in the Soviet Union, today there are a number of threats and potential threats to deal with, smaller in size, but still having an impact.

#3 – A more networked society

• The more efficient things are, the better they work and the faster they can spread. This can be good in relation to positive elements of our world, but on the other hand, bad for negative elements, such as the rapid spread of the subprime mortgage crisis.
• The New Math – the idea of combining things that look harmless in isolation, but together can have a lethal impact. In our world, examples of this new math that worked against us included:
  • Hedge funds + home mortgages = meltdown
  • Cell phone + Iraqi insurgent = trigger for improvised explosive device

MPMG Views on Potential Investment Implications

• Rapid growth of urban societies is likely to place increasing demand on goods and services to meet their needs – notably infrastructure and commodities like oil and natural gas.
• This will also lead to a growing demand for food, creating opportunities for agricultural-related industries.
• Investment opportunities can be discovered by identifying secular trends in a changing world and investing in companies positioned to benefit from those trends.
• While an environment of unpredictability may exist, this also represents an era of potential new opportunity around the globe. If managed correctly, investors can benefit greatly.

How Do We Survive?

Observations From Joshua Cooper Ramo Lesson

#1 – Resilience

• Those who are succeeding in today‘s disruptive environment are those who have demonstrated resilience – the flexibility to respond to events and make appropriate adjustments to how they function.
• The terrorist group Hizb’allah (based in Lebanon) is a prime example of a small force that has a big impact – it has repelled the most respected army in the Middle East (Israel‘s) and also been focused on winning hearts and minds by building school and homes for residents.
• The challenge of being resilient is not just a concern for large institutions. Every individual has the power to generate their own resiliency and make necessary changes to their lives.

Lesson #2 – Seeing the whole picture

• A study of American students and Chinese students showed that Americans focus on foreground objects in a picture (a tiger or horse) while Chinese students spend more scanning the periphery of the picture. It exemplifies how Americans tend to fixate on the obvious, while those from other cultures tend to be able to observe much more.
• Survival in today‘s changing world requires an ability to see the big picture.

Lesson #3 – Stabilizing Instability

• W e don‘t always recognize the risk of instability. It is often the unexpected result of actions taken, such as focusing on taking out Sadaam, which created a country in chaos as a result.
• China is a nation that has challenges well beyond what we face in the U.S., and they are trying to attain some stability.
• Instability can‘t be eliminated in today‘s environment, but can be managed.

MPMG Views on Potential Investment Implications

• A resilient investment strategy begins with a focus on price and value. Avoiding investments that are priced at excessive value (including bonds, which are very expensive on an historical basis today) is critical to managing risk in an unpredictable environment. Value investors are better positioned to weather a volatile market environment.
• There is a need to be cognizant of how changes in the world can affect the investment methodology and specific business opportunities.

What do We Expect from the New World Disorder?

Observations From Joshua Cooper Ramo

• The most exciting, new ideas generated in the U.S. and in other parts of the world will not come from the “core“ (New York, Washington D.C., London, Beijing) but from the periphery.
• The traditional ways of solving problems won‘t be effective in the current landscape.
• There is a need for America to accept a greater sense of urgency in recognizing how the world has changed and how to respond to it. Americans tend to change too slowly.
• Those who believed that the spread of democracy and free markets was inevitable are mistaken. There is a need for each generation to fight for the success of both ideologies. This is especially true given the fallout from the financial crisis and the resulting upheaval it created in American business.
• Individuals have more power than they ever had in history, but they need to be active participants in finding solutions to the world‘s challenges.
• The challenges are complex, and the solutions will have to be as well. We need leadership that will take us to places we didn’t expect to go, but we‘re not seeing that in America today.
• One challenge is to empower more people to have the life of their dreams. W e need to put in place structures that enhance their ability to do it – such as a focus on education and training.
• The U.S. economic and political system is well-structured to benefit in this environment. The core value of our age is to create life for yourself and help make the change that needs to happen.
• Green technology is one of the areas of change, but this is not a race between the U.S. and other nations such as China. If China can create solar panels in a cost effective way that makes it more practical for Americans to incorporate as an energy solution, we all win.
• The future drivers of economic growth in the U.S. are hard to identify. Can we make the necessary structural changes that will lead to future prosperity? Current caution and his uncertainty of where to invest has led him to put some money to work in gold and hold much of it in cash.

MPMG Views on Potential Investment Implications

• We agree that gold offers protection in an environment where the dollar continues to be devalued and inflation risks persist over the long-term. W e also agree that bonds are not attractive at the current time because of the dollar erosion, inflation and specter of rising interest rates. However, we also believe that holding cash has become a default position for too many investors, as evidenced by the fact that $13 trillion remains on the sidelines.
• Mr. Ramo is very well versed in developments taking place China, spending much of his time in this fast- growing economy. Although he is generally optimistic on the Chinese economy, it is notable that he does not apparently hold investments in Chinese companies in his own portfolio at this time.
• It is vital for those seeking to accumulate wealth to own good businesses with solid balance sheets and products or services that are unique. During uncertain and volatile times, great opportunities often present themselves in the stock market. Looking for good companies at good prices is an important aspect of managing risk. Individual firms that are well-managed can find ways to thrive and boost market share even in a struggling economy.
• W e continue to explore investment opportunities with companies that are positioned to benefit from major secular trends – such as the exploding middle class that is emerging across the world. Both U.S. and foreign companies will be beneficiaries of this growth trend.
• Since the stock market tends to demonstrate more nervousness during periods of uncertainty, we anticipate that short-term volatility will continue to be a factor. However, markets will reward well-managed companies that are positioned to benefit from the developing trends. The challenges are to find the right investment and be patient while wealth grows.

Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted. Market returns discussed in this letter are total returns (including reinvestment of dividends) unless otherwise noted.

The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG‘s future investments. As with any investment, there can be no assurance that MPMG‘s investment objective will be achieved or that an investor will not lose a portion or all of its investment.