The Markets
In "Candide," Voltaire defined optimism as a "mania
“What is to be Done?”
Before drafting this letter, we Googled the title, to see
who else used it lately. Paul Krugman headed a post
on his NYT blog in early March, so while boasting
good company, we can’t claim originality. Nor can
Paul, of course. Lenin’s 1901 tract so titled set in
motion events which define our lives today.
What brings to mind Bolshevik theory from the advent
of the century past is not the prospect of Revolution,
rather the work of Nikolai Kondratieff, Lenin’s chief
economic architect, who in 1926 published "Long
Waves in Economic Life".
Kondratieff's central premise was that capitalist
economies displayed long wave cycles of boom and
bust ranging between 50-60 years in duration. His
study covered the period 1789 to 1926 and was
centered on prices and interest rates. Kondratieff's
theories documented in the 1920's were validated
with the depression less than 10 years later.
As the length of these waves roughly coincides with
our adult lives, it is instructive to establish where we
are, and to position ourselves and our capital
accordingly.
Watching our world careen forward, we consider
some fundamental truths, and how they guide our
actions. Above all, the party is over. After living
beyond our means, frugality and thrift are the
watchwords of the day. This is no elective exercise.
In order to spend more than we earn, a lender must
be found. As Dave Rosenberg of Merrill Lynch
notes:
All in, it now looks as though the banks have written off
$480 bln and have managed to raise $45 billion in
capital, according to the WSJ. That leaves them
undercapitalized by roughly $135 bln. Apply average
liquidity ratios to that capital shortfall and it implies a
$1.9 trillion plunge in lending capacity (an amount
worth 20% of total bank credit).
Applying average liquidity ratios to the prospective
total $1 to $2 trillion of net capital losses estimated by
credible observers like Bill Gross of Pimco, we face a
whopper of a credit shortage.
While one may contend that a fifth of last year’s
borrowers didn’t deserve credit, strip out half our
country’s lending capacity, and moving forward
becomes a daunting task.
Copyright 2008, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific
investment strategy or the purchase of securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol
Securities Management, Inc. Investment advisory services and brokerage provided through Capitol Securities Management, Inc, Member FINRA/SIPC.
for maintaining that all is well when things are going
badly." As professional optimists, charged with
keeping our clients focused on a secure future, we
face this challenge with acuity.
Financial stocks have rallied, sold off, and rallied
again, as investors try to handicap the survivors.
Keep in mind they trade at a fraction of their bid of
12 months ago. Their capital base is in tatters. A
pianist losing a hand has limited prospects. The
banks have lost multiple limbs and digits.
Commodities have paused in their rallies, having
delivered windfalls to investors associated with them.
Expect Oil to trade in a broad range, but with the
price remaining five times that of a decade ago.
Much has been made of the speculative demand for
commodities driving up the price. This implies sharp
traders, ready to swing to the short side once the last
rube is brought in through retail. By all means, they
exist.
What is underappreciated is the role longer-term
financial buyers have played in bidding the prices.
Foundations, Endowments, Pension Plans and
Sovereign Funds have made allocations to markets
formerly the preserve of Growers, Producers, and
Industry Users, creating persistently higher demand.
Other Sectors have less clear prospects. Investing for
a consumer-led recovery is panglossian at best.
While sales of footwear, bicycles and scooters are up,
not many of us are buying a new Suburban.
Arguably the two sectors least impacted by present
conditions are Healthcare and Technology.
Healthcare is not discretionary, as time and the
genome roll on. Technology, while a Capital Good,
is essential for a firm’s survival. Rebuild a press,
consolidate office space, but keep the servers up to
date.
Interest, Inflation & Exchange Rates keep us up at
night. In the good old days, prudent behavior called
for hedging. A laddered bond portfolio, blue chips
for income, and all assets firmly denominated in
dollars. With the profligate state of the National
Debt, our banking system in disarray, and emerging
economies overtaking the US in size and dynamism,
the hazards of this approach are clear.
The Federal Reserve cannot drain liquidity out of a
financial system which has slit its wrists. Fed rates will
remain muted, as will demand for greenbacks.
However, currency leadership will change, with non-
Euro instruments gaining popularity.

Your Portfolio
In a Bear Market, the “enterprising caution” we
professed in our last letter seems, in hindsight, rash.
Any market exposure has been volatile, and your
portfolios were no exception.
Energy related positions continued to rally into June,
then turned sharply as oil retreated from its highs.
Precious metals followed suit, along with other basic
materials. Oil Services and Equipment are purchased
by the industry on more conservative oil price
estimates, upwards of a third below recent market
highs, so we are comfortable with this exposure.
“Demand Destruction” became the catchphrase on
TV for a few days. With a mere four percent of
Chinese owning automobiles, a secular case for
petroleum and basic materials remains intact. We
keep our backs to the TV in our office, and suggest
you try it sometime.
Healthcare and Technology holdings, added to in the
second quarter, held their value relatively well (don’t
you hate that phrase?), but more importantly, are
beginning to attract more widespread currency as
prudent opportunities.
Mutual Fund Investors continue to see mixed returns.
The “sector neutral” focus of many funds, maintaining
weights approximate to their benchmarks,
compelled overweighting to losing industries (Banks),
as well as frenzied re-allocation to the growing
Energy complex. Just in time for the worm to turn.
Our focus on funds has been in four areas: Precious
Metals, Foreign Stock, US Growth Stocks, and Broad
Allocation funds, the last of which replicate our
global diversification theme.
Precious Metals remain an important part of our
portfolios, through ETFs and Sector Mutual Funds.
Over the past decade we have counseled clients
that we do not really want to see Gold rally, as it
implies something very wrong elsewhere in the
economy. With a 10 year return of 217.8%, this
indicator proved prescient.
Foreign Stocks are an imperative, in a world where
the US Economy’s relative size diminishes. The
hazard, as with all investments, is selection. We
adopted a bullish stance on Russia in the first quarter.
Apparently, we were alone. The decline in
commodity prices and investor demand for risky
assets compelled us to trim this exposure at a loss.
US Growth stocks have promise in relative terms. In a
decade where the total return on the S&P 500 has
lagged the Consumer Price Index (+33.2% vs.+34.24%),
as the August 98 to December 00 rally of the S&P
Copyright 2008, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific
investment strategy or the purchase of securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol
Securities Management, Inc. Investment advisory services and brokerage provided through Capitol Securities Management, Inc, Member FINRA/SIPC.
(+47%) moves through the snake, there must be a
rally somewhere, right? That or we see the 10 year
performance of the S&P in 2010 at truly discouraging
levels.
Broad Allocation Funds permit “one-stop”
diversification, a quality we find appropriate for
obtaining prudent exposure quickly, as well as
conservative solutions for smaller portfolios. We
continue to find these portfolios useful, recognizing
that while we are unable to influence these fund’s
allocations, we are held accountable by our clients
for their performance.
Your Pension
Income prospects for retirement have not been this
vague since Bismarck created the first pensions in
1880s Germany. With the possible exception of 40
years later, when the Saufgau Landesbank printed
the 100 Billion Mark note now framed on our desk.
Twenty years ago, twice as many American workers
had pensions as today. Going forward, this number
will be smaller. If you have a pension providing half
your expected income needs in retirement,
congratulations. Absent that, there is indeed
Something to be Done.
Let’s review your Pension, Insurance and Annuity
policies. The guaranteed portion of our retirement
income should command the same attention as our
savings and investments.
In addition to the fact that few of us fully understand
what we own, costs, features, and mortality tables
have improved greatly over the past decade. The
more certainty we can establish in these uncertain
times, the happier we will be.
So what became of Kondrateiff? By 1928, “Long
Waves” was perceived as a critique of Stalin’s
collectivization movement, and Kondrateiff was
dismissed from his position in the Soviet planning
hierarchy. By 1930 he was in the Gulag, and he was
executed in 1938. Please allow your Investment
Advisor greater forbearance.
Frank J. Ruffing CFP
McLean, Virginia, August 7, 2008
frank@farragut.us.com
7918 Jones Branch Drive, Suite 800 McLean, VA 22102
Telephone 703-283-5220 www.farragut.us.com