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 may come as a surprise to some of our clients, but Iron Capital does not have a monopoly on economic or market insight (wink, wink). There are a lot of very smart people in our industry, and Wednesday night we had the honor of hearing from two of them. So I thought we would…
Originally I cited another piece of my anatomy, but this is a family newsletter. The bizarre weather week we had in Atlanta has finally come to an end, and everything is back to normal. The streets are clear, mail is running, and even the Falcons resumed normalcy and will be watching the remainder of the…
Clients and friends, The Blizzard of 2011 has wreaked havoc on the city of Atlanta, particularly with ice-covered streets. Schools and business are closed again today with Georgia under a state of emergency, and most of the Iron Capital staff is unable to get into our office safely. Fortunately all personnel are fully capable of…
What a long, strange trip it’s been. We began 2010 by telling our clients that the market, as defined by the S&P 500, would end the year up 12%. We ended up being a little conservative, but half way through the year when we were sticking to our prediction, we probably sounded a little crazy….
All this talk of quantitative easing reminded me I need to get my pants to the tailor for some ‘quantitative easing’ of my own in preparation for this Thursday’s feast. For those of you who may not have been paying attention to economic news over the past few weeks, the Federal Reserve has announced its…
This may come as a surprise to some of our clients, but Iron Capital does not have a monopoly on economic or market insight (wink, wink). There are a lot of very smart people in our industry, and Wednesday night we had the honor of hearing from two of them. So I thought we would share what others think for a change.
The occasion Wednesday evening was the CFA Society of Atlanta’s Seventh Annual Forecasting Dinner, sponsored by Iron Capital, BlackRock, Morningstar, Bloomberg, Factset, and Liquidnet. Our speakers were Bob Doll and Brian Singer.
Doll is BlackRock’s chief equity strategist for fundamental equities. His group was formerly Merrill Lynch Investment Managers before Merrill sold their investment management arm to BlackRock in 2006. Doll is an optimist. He has entitled the theme for 2011, “Muddle Through and Grind Higher Plus.” ‘Muddle through’ refers to the economy, which he expects to grow but not without issues. ‘Grind higher’ refers to the market, which he believes will be up in the low double digit return range by year end. The ‘plus’ is his opinion that the risk to his forecast is that he is being too conservative.
One of his more interesting insights, and a major factor in his optimism, is that the average man on the street knows all about the problems facing our government and what bad shape the government is in. This is a cause of much concern and why most people remain negative. However, that same person has no knowledge of how strong corporate America’s balance sheet is and what good shape it is in. Markets are ultimately driven by what is happening to the companies whose shares are being bought and sold, and those companies look good.
In fact, Doll is not only optimistic, but also believes U.S. equities will lead the way. His view is that the U.S. economy will grow twice as fast as any other developed world economy, and while absolute growth still will be faster in the emerging world, the rate of growth will be declining. The U.S. will have positive trajectory while emerging-market countries will have negative trajectory.
He also likes stocks over bonds. His group likes to track the earnings yield on stocks vs. the yield on average-quality corporate bonds. These yields usually track together, but they separated dramatically last year as the yields on bonds dropped. He claims that historically this gap is always filled and the way that happens is most likely that the prices of stocks go up – reducing yield – and the prices of bonds go down – increasing yield.
Brian Singer now has his own firm, but he was previously the chief investment officer for UBS Global Asset Management. Singer is not quite as optimistic. He agrees with much of Doll’s fundamental analysis but thinks 2011 may be one of those years where fundamentals don’t really matter. He sees a clash between positive fundamentals and negative attitudes and thinks the attitude may win out. Interestingly, he said that economic activity was over-stated in the last half of 2010 because people were doing things in 2010 that they would have put off until 2011 but they were worried about changing tax rates and rules. Therefore he thinks 2011 earnings will be softer than most expect. (If you don’t completely follow that argument you are not alone; neither do we.)
Singer also made the point that China is shifting from the world’s cheap manufacturer to a more consumer-based economy. We had discussed that trend in one of our Capital Market Reviews last year, so it is not new to us. What was new is that he believes China is destined to fall apart because of social unrest. Not in 2011, he says, but he thinks in the next 30 years or so, the conflict between free market consumerism and communist rule will come to a head and the result may be China splitting into multiple smaller countries. We found this interesting as we had not heard this exact scenario before.
Both men agreed it will be a bad time for bond investors, especially government bond investors. Both agreed that structural unemployment may be higher in the future than it was in the past, and both agreed that policy makers do not really know what to do about that. They said, as most people now know, 40% or more of the earnings for the S&P 500 companies now come from overseas. What many don’t know is that 70% of the incremental earnings now come from overseas, meaning more than two thirds of the growth in U.S. companies is now coming from outside the U.S. We are truly in a global economy.
We sent you our 2011 forecast last week, so you know by now we are more in line with Doll than Singer. Still, it is important and always interesting to gather the insights of other leading professionals. I hope you found it valuable as well.
Chuck Osborne, CFA
~An Evening of Insights from Bob Doll & Brian Singer
Originally I cited another piece of my anatomy, but this is a family newsletter. The bizarre weather week we had in Atlanta has finally come to an end, and everything is back to normal. The streets are clear, mail is running, and even the Falcons resumed normalcy and will be watching the remainder of the NFL playoffs from the comfort of home as usual.
Investing is often described as being part science and part art, but in reality it is part finance – which may or may not be science, and part psychology – which may or may not be art. The wonders of human psychology were all around us here in Atlanta last week, and I think much can be learned from what we witnessed that can benefit our never-ending search for investing wisdom.
First, for the majority of you who are not in Atlanta, let me attempt to set the stage for you. It does not snow often in Atlanta, but when it does, it is always much worse than when it snows in more northern places. I have spent the vast majority of my life in the South, but I did spend four years in northern Indiana, and what I remember about those winters is as follows: it would snow and be very cold until it warmed up and the snow went away. That does not occur in Atlanta. Here, it snows, warms up, then gets cold and freezes the half-melted snow, creating ice. Once that happens it really doesn’t matter what kind of tires you have or how many of your wheels are attached to the drive train, or for that matter the years of experience one has driving on snow before moving south. The entire city shuts down, paralyzed by ice, US Postal Service included.
Fortunately in Atlanta this happens only once every few years and usually lasts one, maybe two days, before our winter temperatures are back up in the 50’s. Except this year. People were stuck for an entire week, and they did not like it. This is where human nature comes into play. Every night the local news was interviewing local residents, many of whom have moved to Atlanta from Boston, New York, Chicago, and other frequently snowy regions, and every night the people were saying the same thing: Where are all the snow plows and ice trucks? Why is the City of Atlanta not prepared for this? They should have more snow removal equipment!
Herein lies the lesson for investing. One of my mentors used to pound into my head that you manage to the norm, not the exception. That sounds so simple, but it really goes against human nature. When we are stuck in our homes and our driveways and streets are solid ice, we want to know why the city doesn’t have enough snow plows. (Zambonies probably would have been more helpful, but the people cried for snow plows.)
I have lived in Atlanta for 19 years and nothing like what happened last week has ever happened. One of my neighbors, a retired minister who has lived here her entire life, recalls a similar storm in 1973. It would be foolish for the city of Atlanta to invest in a fleet of snow removal equipment to rival cities like Boston or Chicago when something like this happens only every few decades.
We should certainly be prepared for such rare but devastating events (and for the record there are reasonable things Atlanta could have done better in response to this storm), but we must remember that such events are the exception. This is surprisingly hard; humans seem wired to believe that what is happening now is what is going to happen for the rest of eternity.
In the investing world this mentality consistently leads to projections that are either overly pessimistic or overly optimistic. Today we see pundits talking about double-dip recessions and deflation one minute, and three positive data points later the same pundits are talking about rapid growth and the threat of inflation. Reality lies somewhere in between.
This leads us to our projection for 2011: We think the S&P 500 will be up 10% in 2011, a little worse than 2010 but still solid. We think it will continue to be a rough ride, three steps forward and two steps back, as much of the global economic uncertainty of 2010 remains. We believe large caps will outperform small caps and international will continue to lag.
We are very concerned about bonds, and expect negative returns in treasuries as interest rates rise. The big unknown for 2011 is how fast and how far interest rates will go up. The biggest risk to our equity market projection would be rates rising much faster than expected, which would spook the markets.
Many will think we are foolish to believe that large-cap US equities are the place to be after they have gone nowhere over the last ten years. But then again, there are a lot of people who think Atlanta needs a big fleet of snow plows. We’ll stick to managing to the norm, and the norm says it is usually warm in Atlanta and that putting money in equities after a ten-year secular bear market is usually a very profitable thing to do.
Chuck Osborne, CFA
~Neither Rain, nor Snow, nor Sleet…My Foot!
Clients and friends,
The Blizzard of 2011 has wreaked havoc on the city of Atlanta, particularly with ice-covered streets. Schools and business are closed again today with Georgia under a state of emergency, and most of the Iron Capital staff is unable to get into our office safely. Fortunately all personnel are fully capable of working remotely. We are monitoring voice mail and email remotely and will respond promptly to all service requests. Some staff, including Chuck Osborne, our managing director, is able to get into the office due to proximity. Be assured we are monitoring your portfolios, as always, and are able to make trades as necessary.
The storm has disrupted all mail and delivery services and our building is closed to the public. Unfortunately there is nothing we can do about these inconveniences. Hopefully, the sun will come out and melt the snow and ice away, but we appreciate your patience until we can return to regular working conditions.
~Winter Storm Update and Firm Working Conditions
What a long, strange trip it’s been. We began 2010 by telling our clients that the market, as defined by the S&P 500, would end the year up 12%. We ended up being a little conservative, but half way through the year when we were sticking to our prediction, we probably sounded a little crazy.
The first quarter of 2010 was great and everyone was talking economic recovery. Then we rediscovered Greece, the historic birthplace of Western Civilization, now the birthplace of Western Welfare State Implosion. The second quarter was one of the most painful in recent memory, and after 2008, that is saying something. The difference this time is that the root cause of panic – the national debt levels of Western countries – doesn’t directly impact corporate bottom lines in the same way the credit squeeze of 2008 did, and ultimately equity valuations are about the health of the underlying companies, not what is happening to mostly European governments.
The summer was marked by the first real Wall Street vacation since 2006. Volume went away. The professionals weren’t working, the average individual investor was still in wait-and-see mode, and the only ones trading were those who have bought into the sky-is-falling camp. By August everything looked negative, the macro-economic news was worrisome, and I had people telling me I was crazy to be optimistic about the stock market and maintaining our 12% target on the S&P. Fortunately, the market stormed back starting in September and now I sound clairvoyant instead of crazy. (Truth be known I’m neither, but let’s not ruin a good story with too many facts.)
Those, however, are just the numbers. There were bigger stories under these numbers that may impact the market for a much longer time – starting with Goldman Sachs, accused of fraud in the creation of a derivative security for one of its hedge fund clients. This front page headline-grabbing investigation launched the day Congress began debate of the new financial regulatory legislation and was quietly dropped the day that legislation was signed into law. From a legal standpoint, Goldman was at worst a little sloppy in their disclosures of potential conflicts. However, from an ethical standpoint, this scandal highlighted the problems of Wall Street that we have been preaching about since Iron Capital’s founding in 2003.
Another underlying story was the so-called “flash crash” when the market seemingly dropped off a cliff and then bounced back up. It brought back memories of 1987, although thankfully this was not the beginning of a prolonged sell-off. The huge trading error increased the perception that investing in stocks is a rigged game.
Finally there are the allegations of insider trading, which started with a single hedge fund and now it look like an epidemic. Much of this latest bout of supposed wrong-doing involves the use of so-called expert networks. There are legitimate questions about whether the use of these networks is really insider trading or just analysts doing their proper homework. Hopefully we will see how many people really crossed the line when there are actual indictments and convictions. In the interim, the perception will be ‘guilty until proven innocent’ and yet another black eye on the face of Wall Street.
In the midst of all of this controversy, how can anyone trust the markets and have the confidence to invest in equities going forward? The first step is to open one’s eyes and not be naive. My father once taught me the difference between having a positive outlook on life and being in denial: someone with a positive attitude will look out the window during a thunderstorm and say, that’s okay we can have fun inside today. Someone in denial will look out the same window and tell you it isn’t raining.
We are not in denial. Wall Street firms are in the business to generate fees for Wall Street firms, not to give investment advice. The rate of return on their clients’ portfolios is not their concern, but fortunately there are firms like Iron Capital who obsess over their clients’ rate of return.
In a world increasingly driven by technology, errors and fraud are going to happen. It is good to know what you really own. Our clients have learned that getting two sets of statements is not a bad thing. People will try to cheat, but the old adage “cheaters never win and winners never cheat” exists for a reason. Insider trading is as old as stock markets themselves, but none of the legendary investors have ever been accused of it. In fact, distance from the Wall Street rumor mill has proven a positive thing more times than not. John Maynard Keynes and Warren Buffett both made their investing legends largely by making decisions in their pajamas, completely isolated from the clamor of the markets. Sir John Templeton claimed his investment results improved when he moved his office from New York to Nassau. Insider trading as a strategy turns out to be hugely overrated.
It may be raining, but history has taught us that we can still deliver competitive returns to our clients without any cheating. Don’t be discouraged by all the noise and headlines. The fundamentals look good. It certainly appears we are in the still-early stages of a prolonged bull market. We may continue to see three steps forward and two steps back progress, but the trend is upwards for equities. Our predictions for 2011 are forthcoming, but in the meantime you don’t need to worry about whether you can trust the markets or Wall Street because you know you can trust Iron Capital.
Happy New Year!
Chuck Osborne, CFA
~2010: The Year in Review
All this talk of quantitative easing reminded me I need to get my pants to the tailor for some ‘quantitative easing’ of my own in preparation for this Thursday’s feast.
For those of you who may not have been paying attention to economic news over the past few weeks, the Federal Reserve has announced its intention to buy $600 billion in longer-term Treasury securities over the next few months in what is being called QE2. The very original name comes from the term quantitative easing, which is what the Fed is doing, and the number two, because this is the second time they have done this since the financial crisis and the ‘Great Recession’ first began. The idea is that the Fed will purchase longer-term securities in an effort to lower longer-term interest rates.
What is, in our opinion, more interesting than what the Fed has done has been the reaction. I cannot recall a time when the Fed has been attacked more than they have been for this announcement. Many of these attacks are based more on politics than economic reality. My personal favorite is the labeling of QE2 as “unprecedented.” (This is why I felt the need to explain where they came up with the number two in the name…see, they have done this before, which means there is a precedent, so it is not, in fact, unprecedented.) The other complaints have come primarily from foreign countries accusing the Fed of trying to devalue the dollar. Of course these arguments have come mainly from Germany and China, two countries whose economies are largely based on exports, and a weaker dollar makes German and Chinese goods more expensive here in the US.
In fairness there are legitimate criticisms, the most accurate of which, we believe, is that it simply will not work. It is more than interesting that the yield on the 10-year Treasury went up after the announcement of the QE2 program; however, by and large I think people are being unfair to Mr. Bernanke. The man has an impossible job. First, he must keep prices stable, and second, he must promote full employment. This is like the party host telling the bartender, “I want you to make sure everyone lets go and has a good time, but don’t let anyone get served too much.” This is the nature of the Fed’s “dual mandate” – under the current system it is the Fed’s job to do what they can to promote job growth, and with the Fed funds rate already at zero, quantitative easing is what they can do to promote job growth.
We believe QE2 won’t work because the lack of job growth has nothing to do with the lack of money. If anything, corporate America is sitting on too much cash. Companies are not spending because of the unusual level of uncertainty in our future, not for a lack of resources. But there is hope and reason to be thankful as we approach our national day of thanks. The proposals coming forth to help alleviate our budget woes are very encouraging. Of course there is always something not to like and pundits will get much more air time for singling those out, but the overall direction of lower tax rates with fewer deductions is a good thing. Just adopting one of the suggestions – lowering the corporate tax rate – will do more for unemployment than all the QE in the world. Who knows what, if anything, actually will come out of our new Congress in terms of deficit reduction and tax policy, but at least they appear to be starting from a reasonable point, and that is a big change from the past few years.
This continues to be a difficult time, but when we sit back and reflect on what really matters, the vast majority of us have much for which to be thankful this season. As is our tradition, here are some things for which I am grateful this year:
• Not being the Chairman of the Federal Reserve.
• A new Congress we can vote out again in two years.
• Positive equity market fundamentals.
• Not being Wake Forest’s new basketball coach (he may not want to unpack his bags).
• Having graduated from a university with an excellent academic reputation to which we can point when our athletic teams let us down.
• My many friends and family members.
• Mama’s pumpkin cheesecake.
• The quantitative easing of my waistband just in time for Mama’s pumpkin cheesecake.
• Being alive for another Thanksgiving.
I am also thankful for you, our clients and friends. Legendary hedge fund manager Seth Klarman was recently quoted as saying that the secret to success for an investment firm is to have good clients. I could not agree more. Thank you for your continued trust in Iron Capital.
Chuck Osborne, CFA
~‘Quantitative Easing’ and Other Thanksgiving Blessings