The difficulty lies not so much in developing new ideas as in escaping from old ones.
John Maynard Keynes
Our insights, reflections and musings on the most timely topics relevant to managing your investments.
This market rally just keeps on going…or does it? It really depends on how you define “the market.” Over the last 13 weeks the S&P 500 has risen more than 6%. However, over that same time period, the Russell 2000 is up less than 1%. It has been a long time since we have seen…
This morning we were hit with the news that the economy is not as robust as originally thought. Economic growth for the third quarter, as measured by GDP, was revised down to 2.8% versus the 3.5% originally reported. When breaking down the numbers there really isn’t much good news. Almost every category – including consumer…
GDP grew 3.5% in the third quarter of this year, exceeding expectations of 3.2% and sending the markets up nicely after a week-long downturn…then back down, and then…is the recession over? Well…maybe. In digging into the GDP numbers more deeply it becomes a more complicated story. Consumer spending was up 3.4%, but this was largely driven…
Everything was going so nicely, then it dropped off a cliff. Yesterday the market was heading for nice gain in response to a blowout quarter from Wells Fargo among other positive earnings reports. Thus far 76% of the S&P 500 companies that have reported have beaten expectations for Q3 earnings. Then out of nowhere, we…
The gloves are off now. Our President has called those who oppose the current health care bills liars, and of course there is the now-infamous South Carolina congressman who lobbed the accusation at President Obama himself. I thought one was supposed to refrain from such lack of civility, but since it seems to be all…
This market rally just keeps on going…or does it? It really depends on how you define “the market.” Over the last 13 weeks the S&P 500 has risen more than 6%. However, over that same time period, the Russell 2000 is up less than 1%. It has been a long time since we have seen this much divergence in the market.
The headlines are all positive because they focus on large corporate America as represented by the S&P 500 or the Dow Jones Industrials, but the stocks of smaller companies represented in the Russell 2000 have gone virtually nowhere. Why is this?
We believe there are two main causes. First, the upward movement of the large cap indices over the last few weeks seems to be all about the dollar. The value of the dollar drops and stocks go up, but only the headline-grabbing large cap stocks have benefitted. The reasoning goes that large caps are primarily global companies that do a great deal of business outside of the US. A weak dollar helps these companies export their goods and services as it lowers the cost for foreign buyers.
We do not believe this is a sustainable trend. First, this is really a currency trade, not an investment theme. Currency movements are inherently unstable, and trying to profit off of them is by nature a short-term proposition. Furthermore, strong companies that represent solid long-term investment opportunities have competitive advantages that allow them to compete globally regardless of currency trends. The companies that are really helped by currency movements, beyond a short-term accounting boost, are companies that compete solely on price, for example: commodity producers, who do not offer a differentiated product or service. As a result many top-quality companies, including many smaller organizations, have been left out of this trade.
In addition to the weak dollar trade, the second factor in this market divergence is the mixed signals we are getting from the economic data and from policy makers. Retail sales were better than expected but the jobs report was bad. While the weakness in the job market, and thereby the economy, may actually fuel the weak dollar trade, it hurts the long-term prospects of domestic companies. Unfortunately we also are getting mixed signals about priorities and the future of policy out of Washington. For example, the Friday before last, President Obama said he was committed to growing jobs. A few days later he committed that the US will lower carbon emissions by the year 2050 to a per-capita level that we last saw in 1875. (Let me just say that I agree with you completely regarding global warming, so there is no need to send me an email on the subject. That is not the point here.) The point is these are two contradictory goals. One cannot grow employment without growing economic output, the unwanted byproduct of which is carbon emissions.
Similarly, just yesterday the President met with the leaders of our biggest banks, instructing that they need to lend more to help get the economy moving. Then he told them they should not be opposed to financial reform that is designed to lead to more responsible lending practices – i.e. no more loans to people who can’t afford to pay them back. So which is it, lend more today or be more responsible about how you run your business by rebuilding your capital and being more careful with your loan policy?
There is nothing new about people in politics promising the proverbial ‘having the cake and eating it too,’ but in our current environment it just seems that much more dangerous. What is really scary is that there does not seem to be any understanding that these goals are in conflict with one another. Our political leaders, more than ever before in our history, are career politicians who lack the real-world experience that leads to understanding the ramifications of their decisions, and perhaps more importantly lack the maturity and gravity required to make tough unpopular decisions. So instead, we get mixed signals.
Mixed signals lead to uncertainty, which leads to inaction, which leads to economic stagnation. This is what the market is telling us today. Of course, it may be appropriate to end with a famous quote from Paul Samuelson, the first American to win the Nobel Prize in economics, who passed away this weekend at the age of 94. In commenting on the market’s ability to tell the economic future, Samuelson once said, “The market has successfully predicted nine of the last five recessions.” Let us hope this latest prediction is one of the four bad calls, but we will be prepared just in case.
Chuck Osborne, CFA
This morning we were hit with the news that the economy is not as robust as originally thought. Economic growth for the third quarter, as measured by GDP, was revised down to 2.8% versus the 3.5% originally reported.
When breaking down the numbers there really isn’t much good news. Almost every category – including consumer spending, corporate spending, autos, etc. – was revised downward. This does seem like less of a disconnect with the 10.2% unemployment rate that shows no sign of improvement, but it is not exactly the kind of news you want to receive two days before our official national day of thanks.
The thing about tough times is that they are tough. There seems to be a gloom over the country, the economy is going nowhere, and we face the most anti-growth policies we have seen in this country in 30 years. We are beginning to get speeches about jobs, but speeches will not put anyone to work. For the first time in my memory I am really questioning whether our leaders are mature enough and serious enough to lead us out of this mess. Every day there seem to be stories out of Washington that bring to mind the phrase, “if you aren’t mad, you aren’t paying attention.” That is nothing new, of course, but in this climate it is all the more wearisome.
In the midst of this news, we approach Thanksgiving. While our circumstances may seem bleak, we know nothing lasts forever, and we still have plenty for which to be thankful. Here are some of my reasons to give thanks this year:
Ford avoided bankruptcy and a government takeover, leaving America with one domestically owned, privately run auto manufacturer.
Congress must face the wrath of voters every two years.
The stock market has come back dramatically and is hovering close to its high for the year.
The Wake Forest men’s basketball team is still undefeated, giving it a better record than cross-state rival UNC Chapel Hill.
Family and friends.
My mom’s pumpkin cheesecake.
My loose-fitting pants are clean and ready for Thursday.
I am also thankful for you, our clients and friends. This fall we have received notes of gratitude from several of you. We have been paid the highest compliment by being referred to friends, associates, and family members. We are greatly appreciative.
As always, we will do all we can in this tough environment to continue to earn your trust. Thank you all for being with us.
Chuck Osborne, CFA
GDP grew 3.5% in the third quarter of this year, exceeding expectations of 3.2% and sending the markets up nicely after a week-long downturn…then back down, and then…is the recession over? Well…maybe.
In digging into the GDP numbers more deeply it becomes a more complicated story. Consumer spending was up 3.4%, but this was largely driven by the “cash for clunkers” program that boosted auto sales. Will the consumer continue to spend in the absence of government incentives?
Exports increased 14.7% and imports increased 16.4%. (Exports are additive to GDP, imports are subtracted from GDP.) Both of these should be seen as good signs, as global trade had fallen off dramatically and it will be difficult to have a sustained recovery without robust global trade.
Inventory buildup played a major role, but was not as dominant as some economists had projected. This is good news, as this means there is still more to be done to rebuild inventories and any increase in demand should boost production.
Government spending increased 7.9%, which adds to the GDP for this quarter. However, government money must come from somewhere. Personal taxes increased $4.8 billion while disposable personal income decreased $20.4 billion or 0.7%, and real disposable personal income (adjusted for inflation) dropped 3.4%.
This is truly a mixed bag. There is some genuinely good news and some genuinely bad news. Economists’ reactions have been as mixed as the data. Some fear this is simply a “sugar high” from government programs, while other feel this is the beginning of the real thing.
It isn’t just the economic data either. While the vast majority of companies have reported better-than-expected earnings in the quarter, there have been some notable exceptions. Exxon’s earnings were down 68%, just a few days after their British competitor BP delivered much better-than-expected results.
I find myself siding with the pessimists. This is surprising, because my outlook usually swings from bullish to extremely bullish, but it is hard to see how economic growth can be sustained when disposable income is decreasing through a combination of higher taxes and higher unemployment.
The most likely scenario from here is that we muddle along, with the economy and the market going nowhere. But, that isn’t all bad: to go nowhere, some companies must win while others lose. This is a stock-pickers market, and that should continue to bode well for us.
Chuck Osborne, CFA
~Trick or Treat?
Everything was going so nicely, then it dropped off a cliff. Yesterday the market was heading for nice gain in response to a blowout quarter from Wells Fargo among other positive earnings reports. Thus far 76% of the S&P 500 companies that have reported have beaten expectations for Q3 earnings.
Then out of nowhere, we got hit by two bombshells. First Richard Bove of Rochdale Securities downgraded Wells because he didn’t like where their blowout earnings –$0.61 per share vs. estimates of $0.39 per share – were coming from. Wells’ stock went down a little more than 5%.
The second bombshell came from our pay czar. Earlier in the day, reports suggested that the grand czar of compensation would not really be cutting the amount of compensation as much as the structure, attempting to tie compensation more to long-term corporate success vs. annual bonus. Guess again – total compensation cut 50% and salaries cut 90%.
The first shock received most of the credit for tanking the market, but I believe it is the second headline that deserves more attention. The downgrading of Wells Fargo after a fantastic quarter is certainly bold, but we don’t put much credence in analyst predictions. As Bloomberg pointed out in August, if an investor with a $10,000 portfolio had taken all Wall Street analyst advice in March of this year – meaning they bought all the stocks rated buy, and sold short all the stocks rated sell – they would not only have lost everything but also would now owe $6,000. This during the steepest market rally in more than 70 years.
If your time horizon is a few weeks or months, now may be a good time to sell Wells Fargo. However, if your time horizon is three years, you may want to consider that the current Wells Fargo, after the Wachovia merger, is selling for less than the old Wells Fargo did for most of 2008. After running up from a low of $7.80 to the $30 range there may be some pull-back, but longer term Wells Fargo will be one of the two strongest banks in the country. Not a bad place to be.
The second story has staying power. No one is going to come to the defense of executives at Bank of America, Citi, or AIG. If they do, the angry mob will certainly tear them apart. However, there are two very important questions we should be asking. First, is this justice or is this revenge? The end result of the two can often be very similar, but the difference is huge. How something is done is often as important, if not more important, than what is done. One could argue that had the government not stepped in, these firms would have failed and these executives would have received a 100% pay cut. Then that person might be accused of suggesting that a truly free market is more just than, say, the rule of a czar.
The second question we should be asking is one that comes from David McCullough’s biography of John Adams. Adams stopped at a tavern while traveling and overheard the locals discussing British actions regarding taxation. One man said to the rest, “…if Parliament can take away Mr. Hancock’s wharf and Mr. Row’s wharf, then they can take away your barn and my house.” Where will the pay czar stop? If he stops here, then I don’t have a problem with it. These firms essentially have become wards of the state, so the state arguably should have some say in what pay structures look like. The concern in the market is that he won’t stop, in which case no one will care until it impacts them, and then it will be too late.
This uncertainty is starting to look like the end of the rally. At the very least this rally is becoming fragile, and we remain cautious.
Chuck Osborne, CFA
The gloves are off now. Our President has called those who oppose the current health care bills liars, and of course there is the now-infamous South Carolina congressman who lobbed the accusation at President Obama himself. I thought one was supposed to refrain from such lack of civility, but since it seems to be all the rage, let me give it a try.
In his The Wall Street Journal column this morning, progressive writer Thomas Frank said conservatives are “…ignoring the fact that our current troubles are the consequence of government’s withdrawal from the economy.” Well, Thomas – you lie! Man, that doesfeel good. While I am at it, there have been others who claim that the crisis of the last year was all the government’s fault – I could not find one in particular to pick on this morning – and to all of them I say, “You lie!” Wow, this is fun.
All of this lying reminds me of a quote from Lyndon B. Johnson: “There are plenty of recommendations on how to get out of trouble cheaply and fast. Most of them come down to this: Deny your responsibility.”
This week the G-20, the leaders of the 20 largest economies in the world, will meet in Pittsburgh. They have a solution for the global financial crisis: cap the pay of bankers. For a year they have been pushing the populist notion that this whole crisis was caused by banker greed, and that they (governments) had nothing to do with it. So the simple cure for greed is to cap pay. This fits all of LBJ’s aforementioned criteria: it is cheap, it can be done quickly, and it denies any government responsibility for the crisis.
Unfortunately it won’t actually fix anything, and in fact it will bring on a host of new issues. There is no doubt that pay packages in the financial world can be excessive, but the only people who are actually hurt by that are the owners of these companies who would otherwise be reaping those rewards. Shareholders, not the government, should be policing the pay packages at the firms they own.
The economic truth is more complicated than simple right vs. left, capitalist vs. socialist. The truth is there is plenty of blame to go around. The truth is unless governments around the world, starting with our own, admit their role in this mess, there will be no real solutions. They will add yet another layer of regulation, creating new distortions in the market that will create some future crisis for the next generation to clean up. Let’s just hope the next generation is more honest than our current collection of liars.
Chuck Osborne, CFA