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.
It has been a life-changing month for me and my family. For those of you who do not know, on May 15th I was hospitalized for treatment of a pulmonary embolism. I had multiple blood clots in both lungs, which the pulmonologist estimated were blocking 90% of the blood flow from my heart to my…
Today marks the first technical correction (commonly defined as a price decline of at least 10%) that we’ve seen since the beginning of the current bull market that began in March of 2009. We first referred to the possibility of a correction in our February 4th Insight and while we were a little early in…
Just after 2:30 p.m. today one of our analysts stormed into my meeting to tell me the market had just plunged 8% in a matter of minutes. At first I thought he must be wrong. I have been through some big market declines, but this was the biggest thing since 1987. Indeed, the Dow had…
On Friday Goldman Sachs Group Inc. was hit with charges of fraud by the SEC. That is a big headline, and it is worrisome; are major financial firms really committing fraud as a regular order of business? Goldman denies any wrong-doing and says it will fight the SEC allegations. Right now we are left with…
US stock markets have recently rallied to new 18-month highs as economic reports suggest improving conditions. The long-term outlook remains encouraging for the economy and the stock market, but prospects for another short-term pullback or correction like the one we saw in late January have increased. First, the factors suggesting economic improvement: The statement from…
It has been a life-changing month for me and my family. For those of you who do not know, on May 15th I was hospitalized for treatment of a pulmonary embolism. I had multiple blood clots in both lungs, which the pulmonologist estimated were blocking 90% of the blood flow from my heart to my lungs. Every time a doctor sees my CT scans for the first time, they give me a look that tells me they are amazed that I am still here.
I am fine now and on the road to recovery, so why do I share this news? I share it because I think everyone should be as lucky as I am. When one realizes – really realizes – how truly fragile life is and that they could just as easily be gone from this world, it adds perspective to everything. In my opinion there is nothing we need more today than perspective.
My first winter in Atlanta (1992-93), we suffered through “The Storm of the Century.” The snow storm blanketed the entire east coast from New England to Georgia. My parents in Boca Raton, FL, did not get snow but did get powerful thunderstorms. It was a huge storm.
Of course news ratings spiked during the storm as everyone wanted to know what was happening. However, only the real weather enthusiasts knew that Gloria – a 1985 hurricane – had already been crowned “The Storm of the Century.” There was another winter storm in 1996 that tried to vie for the title but was not as successful.
I suppose it is human nature makes us want to believe that everything that happens to us, or on our watch, has to be bigger and more important than things that happened in the past. In sports, the greats of our time must be “the greatest of all time.” This is seemingly true with recessions as well; we can’t have just a severe recession, we must have the “Great Recession.” We can’t have just a devastating oil leak in the Gulf of Mexico; we must have “the worst environmental catastrophe in the history of humankind.”
I am no expert on environmental catastrophes and I certainly recognize the environmental and economic severity of the situation, but I do know that this is not “the worst oil spill in the history of humankind.” In fact it is not the worst oil spill in the Gulf of Mexico in the last 31 years. In 1979 there was a similar leak that went on for nine months before it was stopped. In 1991, approximately six times more oil was spilled into the Persian Gulf. Keeping this disaster in context and realizing that the world has seen even bigger catastrophes and survived, even to thrive again, would bring hope to the people on the Gulf coast. The blame game and “woe is me” syndrome doesn’t fix anything. However, calling this “the third worst water-based oil leak in the last 31 years” just doesn’t have the same ring to it.
While I am poking a little fun at the media and its hype machine, don’t think such dramatization of the situation doesn’t have consequences. Last week Reuters reported that Florida beaches were feeling the hit from a lack of tourism because of the leak. The headline was “Most beaches are clean, but misperception continues.” On Monday, mayors of two cities on Florida’s west coast were talking about the deep local economic impact even though there is no oil in sight.
The oil spill is not killing the Gulf Coast’s tourism industry, but our national lack of perspective and the media hyping the spill is. The media is no longer concerned with educating people about the events of the day; instead it is about ratings, and ratings come from good stories, not cold hard facts. Good stories have villains, so BP in this case becomes not a group of people that made a horrible mistake that cost the lives of eleven co-workers, caused horrible environmental damage, and damaged the future reputation and potentially the survival of the company, but a faceless inanimate villain that is deliberately trying to destroy the environment.
This makes for a great movie plot, but unfortunately this is not a movie. It is real, and in the real world corporations are not faceless inanimate objects, but organizations made up of real human beings – human beings who are flesh and blood, who have spouses and children, who volunteer to coach little league. BP is nothing more or less than the thousands of people that go to work there every day. A large number of those people, if not a majority, live in the Gulf Coast region. Does anyone really believe that they wanted this to happen or don’t care about the damage being done?
Yet, this is the story we get, and not just from irresponsible media outlets but from Facebook posts and other social media rants of college-educated friends. Worst of all, this is what we get from our elected officials. The Obama administration has promised to “keep a foot on the neck of BP” and have been looking for someone’s “ass to kick.” I think Jack Welch summed it up best in his CNBC interview Wednesday morning when he called the administration’s response “horrible” and added, “Here’s the difference between a businessman and a politician: Businessmen focus on solutions. Politicians focus on ‘who can we blame.’”
We have rewarded a sensationalistic media with our attention, and we have created a class of professional politicians rewarded by reelection – people who have no experience doing anything other than campaigning. They campaign to get elected, they campaign to pass their initiatives, and then they campaign to get re-elected. In a campaign it is you against your opponent, and you try to make yourself look good largely by tearing down your opponent. This is the only experience Obama has. From that perspective, what other response could we reasonably expect from him?
Unfortunately, in the real world, BP is not an opponent to be beaten. Yes, BP is responsible for this accident, but more importantly they are an essential partner in its solution. Destroying BP does not save the Gulf; in fact it makes it less likely that the Gulf will be cleaned up.
Instead of looking for an “ass to kick,” true leaders might be encouraging fellow Americans not to cancel their plans to visit the Gulf Coast this summer. True leaders might try to bring the oil industry together to help with the cleanup and to find ways to ensure this doesn’t happen again.
We should be so lucky. In the interim we will continue to focus on what our job is, managing investment portfolios. The good news about the sensationalistic media and irresponsible politicians is that they do create investment opportunities for those of us who still value reason. Perspective can change your way of thinking and help you see things in a different light. And a little perspective can be a very profitable thing.
Chuck Osborne, CFA
Today marks the first technical correction (commonly defined as a price decline of at least 10%) that we’ve seen since the beginning of the current bull market that began in March of 2009. We first referred to the possibility of a correction in our February 4th Insight and while we were a little early in our prediction, we aren’t surprised at the outcome. Once again, fear rears its ugly head as worry over Europe and the uncertainty surrounding financial reform continue to weigh on the minds of investors.
~A Greek Tragedy
Just after 2:30 p.m. today one of our analysts stormed into my meeting to tell me the market had just plunged 8% in a matter of minutes. At first I thought he must be wrong. I have been through some big market declines, but this was the biggest thing since 1987. Indeed, the Dow had tumbled nearly 1,000 points in just a matter of minutes.
Immediately the 24-hour press had to have something to blame it on, so literally as it was happening, they pointed to Greece. This makes no sense. Don’t misunderstand, the situation in Greece is serious and certainly will not help the markets, but it is not going to cause the market to drop at superhuman speed.
As we were preparing to do what we could to protect your portfolios from any potential future damage, the market started coming back, almost as quickly as it had dropped in the first place. We were watching the chart of the S&P and it started to form a picture we have seen many times before…this was a trading error. Sure enough, as I am writing this, CNBC is reporting that it was an error made by a trader at Citigroup. Bloomberg is saying that according to NYSE Euronext, there were numerous erroneous trades.
Trading errors happen more frequently than most people realize. Usually it impacts only one stock, not the whole market. How it happens is simpler than it seems. Someone puts one too many (in this case it may have been two or three too many) zeros on a trade ticket, and lo and behold, prices move in dramatic fashion. The price movement also can trigger automatic trading, which can exacerbate the effect of the error.
The firm responsible has to pay to fix it, so once they notice it, they act as quickly as possible to correct it. The prices go back to where they were before the error as quickly as they moved away. If this was the fault of an error, it may be the most costly trading error in history. Some poor – soon to be unemployed – trader will be able to tell his grandchildren that his carelessness caused the most volatile 30 minutes in stock market history.
In the meantime, the real downward pressure in the market, which is much less severe, looks more like a technical correction in the midst of a bull market than anything to lose sleep over right now. Of course we will stay vigilant.
Chuck Osborne, CFA
~What Does This Button Do?
On Friday Goldman Sachs Group Inc. was hit with charges of fraud by the SEC. That is a big headline, and it is worrisome; are major financial firms really committing fraud as a regular order of business? Goldman denies any wrong-doing and says it will fight the SEC allegations. Right now we are left with more questions than answers, including the seemingly political timing of the announcement, so for the moment I will withhold judgment on Goldman’s actions. However, I think this case is all too illustrative of how Wall Street works to allow it pass without comment.
Let’s quickly review the facts of the case as they have been reported thus far. The hedge fund firm of Paulson & Co. asked Goldman Sachs to create a Collateralized Debt Obligation (CDO) security, which included particular mortgage securities that Paulson was interested in shorting. To put this in layman’s terms, Paulson wanted Goldman Sachs’ help in betting on the value of mortgages going down. Goldman Sachs created the security and sold it to clients while Paulson bet on it losing value.
Pay close attention here. If you do not remember anything else about this scandal, remember this: these facts are not in dispute, and the SEC did not say there is anything wrong with what Goldman did. Their argument – the entire case – is simply that Goldman did not disclose material facts. Paulson has not been charged with any wrong-doing. There would be no charges at all if the SEC felt that Goldman had the appropriate disclosures in the contracts their clients purchased. The big picture facts in this case do not represent fraud; they represent the Wall Street business model.
Wall Street firms are brokers, not advisors, regardless of what they call themselves. Their job is to bring buyers and sellers together. As the legendary money manager Michael Price once said, “Wall Street is in the business of creating fees for Wall Street. Period. It is not in the business of getting good investment results. You have to be separate from Wall Street to do that.”
Goldman’s CEO summarized it best last month in a letter to shareholders when he said, “Our goal was, and is, to be in a position to make markets for our clients while managing our risk within prescribed limits.” Their goal is to “make markets” – to bring buyers and sellers together – not to provide advice and get a competitive rate of return for their clients.
I don’t know whether Goldman committed fraud. I am willing to allow our legal system to find that out. I do know that Goldman, and every other Wall Street firm, believes their role is to make markets, not to provide advice.
Regardless of the outcome, if one has a retail account at Goldman, JP Morgan, Merrill Lynch, Morgan Stanley, UBS, Wells Fargo Securities, or any other full-service broker dealer, that person should understand that they are on their own. Every time their broker, a.k.a. “adviser,” calls them with a suggested investment, they need to know that the opportunity has arisen because some other client of the firm is selling that very same investment, not because the investment is in the client’s best interest.
Fortunately, Iron Capital provides an alternative. Our goal is not to create markets but to provide counsel and to generate superior rates of return on our clients’ investments. If we buy an investment in your account, we are buying it for ourselves as well, and if we sell an investment out of your account, we are selling too. If you have ever wondered what the real difference is between Iron Capital and a firm like Goldman Sachs, you found out on Friday.
Iron Capital owns Goldman Sachs in several client accounts. We do business with Goldman and will most likely continue to do so. Regardless of what you may think of them, they do a very good job of their stated goal – creating markets – and as professional investors, we need markets. The problem in our system is that somewhere along the way people forgot what business the Wall Street firms are really in. Their role is to work with firms like Iron Capital and Paulson & Co. and to provide us with markets for the securities in which we wish to invest. It is our role to provide you, our clients, with independent investment counsel.
Chuck Osborne, CFA
~Wall Street Revealed
US stock markets have recently rallied to new 18-month highs as economic reports suggest improving conditions. The long-term outlook remains encouraging for the economy and the stock market, but prospects for another short-term pullback or correction like the one we saw in late January have increased.
First, the factors suggesting economic improvement: The statement from the Federal Reserve following the March 16, 2010, meeting noted that “economic activity has continued to strengthen and the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. While bank lending continues to contract, financial market conditions remain supportive of economic growth.” Inflation remains benign as indicated by the recent release of the Consumer Price Index (2.2%/year), industrial production rose for the 8th straight month, and factories are operating at the highest rate in a year (72.7%). Also positive, the Philadelphia Fed Survey revealed significant gains in the six-month business outlook that showed a rise in expectations for new orders, and suggested a majority of manufacturers expect to increase production in the second quarter.
Now let’s review the indicators for a short-term pullback: The S&P 500 had dropped 9.2% from 1,150.45 on January 19, 2010, to an intraday low of 1,044.50 on February 5th. This came very close to the target 10% drop to 1035.40 we suggested in our last Insight (“Correction or Bear Market,” February 4, 2010). With the added luck of the Irish, the index subsequently rallied 12% to 1,169.84 by St. Patrick’s Day (March 17), the highest since September 2008. This was up 75% from the March 2009 intraday low of 666.79. On the same day, the Russell 2000 index was up just over 100% (342.59 to 686.94) from its March 2009 low. Prior doubles in the Russell 2000 have triggered corrections in the past. John Schlitz from Instinet recently identified the following examples: “October 1987 to February 1992 (+101%, followed by a -14% correction), October 1990 to February 1993 (+96% / -8%), July 1992 to May 1996 (+97% / -17%), December 1994 to October 1997 (+99% / -13%), October 1998 to March 2000 (+102% / -28%), October 2002 to December 2004 (+102% / -14%) and March 2009 to March 2010 (+100% / ?). While those events suggest a choppy fire-fight isn’t too far off, keep in mind that only the 1998 to 2000 double resulted in lower prices six to twelve months later.”
Reviewing additional technical indicators reveals overbought conditions where prices are considered too high and susceptible to a decline. This should not be confused with being bearish; it merely suggests that perhaps we have risen too far too fast and might be due for a pullback.
When the stock market appears vulnerable, at Iron Capital we are vigilant in looking beyond technical indicators for potential catalysts that might confirm the view of a short-term move lower. Of particular concern are the uncertainties surrounding the sweeping overhaul of the nation’s health care system, financial regulatory reform, and huge government deficits both here and abroad. Winners and losers in health care may appear obvious (insurers have 32 million new customers), but a closer look reveals a more complicated picture (significant risk of an altered business model peaking in 2014). Costs and benefits for businesses from health care and regulatory reform remain difficult to quantify. Leaving little room for error, these historic changes are occurring while the U.S. is using about 7% of tax dollars to pay debt this year, and almost 11% by 2013.
The point of identifying these risks is so we can position ourselves defensively when needed, while preparing to pounce on undervalued stocks when given the opportunity. Economic momentum appears positive, which should translate to better earnings and higher stock prices, at least before elections this fall.
Director of Trading, Iron Capital Advisors
~The Outlook Remains Encouraging