Iron Capital Insights

  • Iron Capital Insights
  • July 1, 2010
  • Chuck Osborne

Market Conditions

Does it feel like déjà vu all over again? This market correction is going on longer than most – and we – expected. So what is the market telling us?

The economic recovery is stalled. It appears at this moment that the surge we got in Q4 2009 was a rebuilding of inventories and now that it is done, there is little to no carry-forward. That is what it looks like and that is what it feels like, but is that reality?

Geo-political news gets gloomier and gloomier. We are witnessing the collapse of the welfare state in Europe; China’s economy is over-heating and beginning to slow down; and of course there is all that oil in the Gulf. Unemployment has remained very high. Top this off with the sensationalistic nature of media coverage and it is no wonder we feel like we are headed to hell in a hand-basket.

I think it is time to stop, take a deep breath and ask ourselves: does any of this geo-political news actually impact the future profitability of the companies I own, and/or does it impact the credit worthiness of the fixed income investments I have made? We are not so sure that it does. It is hard to see a direct impact of Greece’s debt crisis on how many computers HP will sell, and I’m not sure that oil in the Gulf impacts Coca-Cola’s ability to pay its bond obligations.

Unemployment is a little tougher – it can and will impact corporate profits, as everything eventually traces back to the consumer. This is also a problem that is not going away, unless we get a complete reversal in policy direction. Americans have voted for a bigger more European-like government with more European-like social programs, and that comes at the price of more European-like growth and unemployment. Until this policy trend reverses we will not see American the unemployment numbers of 4% to which we had grown so accustomed. However, this seemed to be priced into the stock market already. Before this correction really got going stocks were at almost twenty-year lows in terms of price relative to expected future earnings.

The only way we will know for sure if all this bad news actually impacts the companies we own is to pay close attention to this earning season. If earnings are good, which is what we expect, we think we will see this correction end and the markets pop back up to positive territory. However, if the gloom is real, we could be in for another bear ride. At this point the market is still in typical correction territory, and we do not believe one can time in and out of normal corrections. However if the Bear raises its head, we will take steps to protect your portfolio. Watch earnings: that is the key.

Chuck Osborne, CFA
Managing Director