"Beware of Greeks Bearing Gifts"

"It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker euro zone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate."
     Niall Ferguson
     February 10, 2010
     "A Greek crisis is coming to America", Financial Times

A few weeks ago my first grader took his favorite Myachi (think Hacky Sack, but for your hands) and one belonging to his younger sister to school. Unbeknownst to his parents and sister, he had decided to trade both of them in a noble effort to procure a pink Myachi for his sister. From what we understand, there were multiple trades and some unique uses of leverage involved. In the end, he did not end up with the coveted pink Myachi, but instead two Rice Krispy treats—which he subsequently ate on the bus coming home from hockey practice. Pockets empty, he returned home nervous yet hopeful that the trades of the day could somehow be unwound before settlement or that he could be bailed out.

What a fitting story to mark the passing of February, a month in which macro and policy risks from various regions of the globe have dominated market headlines over the past several weeks. Contagion fears have occupied center stage as investors fret over the ability of Greece, Spain and Portugal to resolve their respective fiscal problems. Bailouts, or expected bailouts, once again became front page news.

At the same time, Federal Reserve Chairman Bernanke was outlining his exit plan, increasing the discount rate, and China was raising reserve requirements for banks for the second time this year. Investors are nervous (just as my son was with his Myachi trade). Expectations are high given the market's performance over the past year and now, with re-stoked uncertainty, underlying valuations are being called into question, as in 2 Myachis = 2 Rice Krispy Treats? As is usually the case, short-term fears are once again outweighing longer-term fundamentals.

The uncertainty of the last few weeks created what we saw as potentially profitable opportunities in several industries, especially as fears of economic contagion were rising across the globe. In the Industrial Products sector, for example, which led the market's recovery in 2009, solid fourth-quarter earnings were juxtaposed against extremely high expectations and global economic jitters.

Once again, the short-term mindset of other investors allowed us to find what we think are potentially profitable opportunities. In this case, it was several of what we regard as high-quality metal fabrication and distribution companies trdaing at significant discounts to our assessment of their current worth as stock prices declined in response to near-term earnings announcements.

Unlike my progeny's execution of the Myachi trade, our process consists of three distinct hallmarks-a focus on risk, an absolute return orientation and a long-term investment horizon. Key to these principles is a proper alignment of expectations to potential outcome and a keen understanding of enterprise value versus current stock price.

We have always believed in the critical importance of focusing on what we know and not worrying about what we cannot control. Clearly, a process that I still have to instill in my next generation. Fortunately, he has plenty of time to learn.

Stay tuned…
FDG