The end of 2009

A year ago at this time we wrote a blog post entitled "Taking stock of 2008." It is worth revisiting because the issues we discussed then are still swirling around as pundits from all directions take stock of 2009.

We believe that the events of 2009 have borne out the interpretation we offered back in 2008. Back then we said that the "spectacular implosion of Wall Street" could well have been avoided if the government had removed the mark-to-market rule, which we had discussed all the way back in March of 2008 before the collapse of Bear Stearns.

As we would later see, when Congress finally forced the revision of mark-to-market during the first half of March this year, the recovery was rapid and impressive. It has been so impressive, in fact, that many are now saying that the markets have come "too far, too fast" -- but we would challenge that view by asking "too far from what?" In other words, we would point out that the panic-induced lows of early March, 2009 were an extremely abnormal situation, and it is very much appropriate for prices to rebound rapidly from the ridiculously low levels that they had reached.

Another important point to note is that we stated way back in September of 2008 our concern that, as a result of the financial panic (which could have been avoided, but wasn't), "government will become even more emboldened to interfere with the free-market system, just as they did after 1907." This observation has certainly come to pass.

Throughout 2009, we have published our view that TARP and the other extraordinary measures enacted at the beginning of the crisis should now be dismantled. One of the earlier posts on this subject, still relevant today, was April's "Four-letter government words."

Finally, our post from a year ago ended with this exhortation: "At the end of 2008, our most important piece of advice to investors is exactly the same as it was at the beginning of 2008: entrust your long-term financial well-being to the ownership of well-run businesses that are positioned in front of substantial opportunities for future growth." Those words turned out to be good advice, as the innovative companies we owned for our clients performed very well throughout the year, handily outpacing the broader markets for the second year in a row.

We would offer the exact same advice to investors as 2009 draws to a close.

Happy New Year!

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Issues raised by the indictment of Raj Rajaratnam

Today the Wall Street Journal ran an article entitled "The Man Who Wired Silicon Valley" full of colorful details from the career of former tech analyst and hedge fund manager Raj Rajaratnam, who has been accused and indicted by the SEC for profiting in the markets from insider information.

The Journal article's accompanying interactive graphic calls Rajaratnam's alleged web of Silicon Valley contacts "a far-reaching and complex scheme," but the story itself for the most part does not detail any actual criminal activity -- mainly it gives glimpses of Rajaratnam's history of aggressively asking for information at companies, along with descriptions of parties where "wealthy investors and executives swirled" around luxurious pools, "smoked cigars and hobnobbed with beautiful women" -- as if these scenes somehow indicate that all the wealth came from illegal or underhanded activity.

The one activity actually detailed in the report that may have been unethical, or even illegal, involved an employee of Intel* faxing prices and orders to Rajaratnam.

Let's be clear: at Taylor Frigon we do not condone trading on "material, non-public information" (which is illegal), nor do we condone the use of deceit or trickery in gaining information. We also do not personally practice an investment strategy based on short-term events such as the quarterly earnings performance that have become such a circus on Wall Street. We have explained many times that our strategy is built around the long-term ownership of good businesses, through many market cycles and short-term events.

However, we also believe that there is a tendency among many -- including some at the federal government -- to think that trying to find out everything you can about a business in which you are going to invest large amounts of capital should somehow be illegal. It may turn out that Mr. Rajaratnam did indeed cross a line between digging for information and doing something that the SEC defines as illegal, but the existence of such a line and where it is drawn are important philosophical questions.

There is a strain of thought which seems to believe that all investors should somehow be "equal" and that those who do no research should have just as much opportunity to make money as those who burn the midnight oil digging into the business details of a company and analyzing its future prospects. This misguided view seems to want to turn investing into nothing more than a roulette wheel, where everyone has an equal chance at winning and nobody has any more intelligence than anyone else.

We believe that this type of thinking is dangerous in that it undermines the important function of allocating capital to the best businesses. Investors should understand this misguided sentiment and be alert for it, and discuss these issues with their friends and families.
* The principals of Taylor Frigon Capital Management do not own securities issued by Intel (INTC).

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Some lessons from 2009

Over the weekend, the New York Times published an article which brings up a few important points we've made at length and which are worth revisiting as investors consider the lessons of 2009.

The Times article notes that many investors underperform available investment vehicles. We have discussed this phenomenon previously, linking it to the situation we call "The Intermediary Trap."

The article also notes that many investors pulled out of the market and thus missed much of the powerful rebound that began in March. This reinforces the intermediary problem, as many of them pulled out based on the advice of an intermediary. It also raises another important lesson, which is the speed at which market moves take place. The Times article says, "History shows that market rebounds can be so quick that they are easy to miss."

This point cannot be repeated often enough. We ourselves made it in an article entitled "Don't get off the train" which we published on March 2, before the rally began.

Finally, the article ends with a good quotation about patience, tying it to patience with one's investment process. This kind of patience is easily confused with "buy and hold forever" type obstinacy, and this confusion leads investors to make serious mistakes. We discuss the distinction between the two in "Remaining calm without being blind or obstinate," "The importance of a proper sell discipline," and "Seeing beyond a huge false dichotomy," among other places.

The ending point about trusting one's investment process for long-term success is the most important one in that article. It ties all the lessons mentioned above together. The main problem with the intermediary trap is that it makes it almost impossible for investors to maintain a consistent investment process, and leads to a lifetime of jumping from one train to another, so to speak. We discussed this point in 2009 as well, in "The same thought process for 30+ years."

Investors would do well to consider these lessons as 2009 draws to a close.

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We get by in spite

Over a year ago, we published one of our quarterly commentaries on the investment climate (dated October, 2008) in which we began with one of Richard C. Taylor's favorite phrases: "We get by in spite."

In that commentary, we explained that to Dick Taylor, "We get by in spite" was a kind of short-hand expression which meant that "in spite of the lunacy of government and its intervention in the free enterprise system, great businesses and the entrepreneurs who lead them find ways to profit and ultimately make money for their owners."

He would often use that phrase when government lunacy seemed to reach a fever pitch, and legislators were enacting laws threatening unprecedented intrusion into the right of the individual to be able to do what he wanted with his own private property (and his money).

We believe he would find occasion to use that phrase quite often right now.

The wisdom of his observation, "We get by in spite," is in its recognition that such intrusion and restriction of freedom has taken place in the past, but that great businesses have still found ways to deliver value, economic growth, and better living standards in the past, and that they will do so in the future.

Even now, there are momentous business opportunities for innovative companies. We touched on some of them in our blog post yesterday. This perspective is very important for investors to understand, especially during times when many in the financial world and media are being distracted by the political news of the hour.

Richard C. Taylor managed portfolios alongside Thomas Rowe Price, and his investment philosophy directly influenced the consistent process that the principals of Taylor Frigon Capital Management have employed for many years.

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For later posts on this same subject, see also:

• "Index of Economic Freedom Released; US Slips" 01/27/2010.

• "Recovery-bashing will backfire" 04/06/2010.

• "Have you heard of this company? IIVI" 08/05/2010.

• "Glenn Beck is an economic butterbar" 11/04/2010.

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Unstoppable Wave: Revisited

Mary Meeker and the rest of her tech research team at Morgan Stanley* recently released a trio of research documents entitled the Mobile Internet Report.

They can be downloaded at the Morgan Stanley link above, and also read online in their entirety at ReadWriteWeb.

Meeker and her team are one of the first major Wall Street firms to delve into the enormous paradigm shift which we have written about in several places earlier, such as last January's post entitled "The Unstoppable Wave."

We would recommend that all investors understand the enormous wave that has already begun to radically transform the technology landscape and which will work its way through just about every other business during the next several years. It promises to be even more transformative than the tidal wave of technological change that hit the world in the 1990s, and may be even more rewarding to investors if they align their capital with the right businesses.

As we noted in the Unstoppable Wave, this is a paradigm shift that refuses to be stymied even by inept government meddling, of which there seems to be plenty these days.

Also, while they are now beginning to pay attention, this impending paradigm shift has been largely overlooked by the traditional investing voices, which have been distracted over the past two years (and, in fact, over the past decade -- see here).

Investors may wish to review some of our previous notes on this topic, such as:

• The Bandwidth Revolution 07/29/2009.

• Revisiting the "New Economy" 05/06/2009.

• Must Read: Unleashing the Exaflood by Bret Swanson and George Gilder 02/22/2008.

• "Have you heard of this company? HITT" 07/06/2010.

• "Have you heard of this company? IIVI" 08/05/2010.

• "What battles of the tech titans tell us about investment theory" 09/08/2010.

• "On the verge of something important" 09/29/2010.

* The principals of Taylor Frigon Capital Management do not own securities issued by Morgan Stanley (MS).

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