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.
The market rally in July was stimulated by better-than-expected earnings reports. Now we are entering the quiet period when most companies have already reported, and we won’t get much company-specific news until October, when companies report their third quarter results. Now the market seems to be driven by what I would describe as a nervous…
We just completed one of the best Julys in history with the S&P 500 up 7.56%. The reason? Earnings. It’s all about earnings. By and large, companies have reported earnings that have been far better than expected. Many in the mass media have been fretting about the fact that while earnings are indeed better than…
I am pleased to introduce you to a new service from Iron Capital. During the financial crisis last year we sent several unscheduled communications to you, our clients, letting you know our thoughts on what was happening and how it could effect you. We received very positive feedback on those efforts, so we have decided…
The market rally in July was stimulated by better-than-expected earnings reports. Now we are entering the quiet period when most companies have already reported, and we won’t get much company-specific news until October, when companies report their third quarter results.
Now the market seems to be driven by what I would describe as a nervous sentiment. The market is up substantially from the March bottom while the economy, though improving, is not great. Unemployment continues to worsen and consumer sentiment was surprisingly negative last week.
We think a lot of the nervous sentiment is stemming from the health care debate, which is all our clients have wanted to talk about over the last few weeks. In politics it is impossible to please everyone, but it is possible to not please anyone, and Congress and the administration have seemed to do that. Part of the backlash on health care, in our opinion, is simply because people feel it’s too much, too fast. Public perception is that the government has taken over the auto industry and bailed out the banks, now on to health care. It is simply too much to digest.
The market also is beginning to look forward. We have averted a true disaster and stock prices have jumped off those worst-case-scenario lows. However, someone will eventually have to pay for all of this big government and that makes the future look not so great from a market perspective. We don’t see a significant downturn at this point, but our caution is increasing. Third quarter earnings reports can’t get here soon enough.
Chuck Osborne, CFA
~What’s Driving The Market Now?
We just completed one of the best Julys in history with the S&P 500 up 7.56%. The reason? Earnings. It’s all about earnings. By and large, companies have reported earnings that have been far better than expected.
Many in the mass media have been fretting about the fact that while earnings are indeed better than expected, they still are not really good on an absolute basis. Worse still, many companies reported improved earnings just because of cost reductions, not increased revenue. What these commentators don’t seem to understand is that there are two factors that lead to the overall level of the market: the first is earnings, and the second is price.
The value of a stock is the present value of future earnings, and the current market price reflects the consensus opinion of what those future earnings are going to be. The price changes when the opinion of the future changes. This is why the best companies are not usually the best investments – the best companies are already expected to be great, therefore their greatness is already priced into the stock and although they may continue to do extremely well, their stock price is unlikely to increase greatly.
The real question investors should be asking is not how good are earnings going to be, but are earnings going to be better or worse than expected. That is what moves the market.
While we are growing more cautious ourselves, this negative spin on the market movement among the mass media is actually a sign to us that this rally may continue a bit longer. After all, the lower the expectations, the easier they are to beat.
Chuck Osborne, CFA
~This Market Just Keeps Going Up
I am pleased to introduce you to a new service from Iron Capital. During the financial crisis last year we sent several unscheduled communications to you, our clients, letting you know our thoughts on what was happening and how it could effect you. We received very positive feedback on those efforts, so we have decided to formalize them and create Iron Capital Insights. These will be periodic electronic client communications regarding investing and economic happenings that could impact your portfolios. With this we are proud also to unveil our new and greatly improved website. In addition to more accurately representing the firm, the new www.ironcapitaladvisors.com will archive our Insights and The Quarterly Reportnewsletters. Also in the Research & Commentary section of the site, our private clients will have access to our full institutionalCapital Market Review if they wish to see our analysis and views in more detail than we provide in our other communications.
We hope you enjoy the increased communication. Of course, if you prefer not to get these communications you will have the ability to opt out.
So now for our inaugural Insight.
There Is A Reason for The Separation of Powers.
Over the last few weeks, those who follow the goings-on in Congress have been witness to a witch hunt. Our political leaders have been attacking Federal Reserve (Fed) Chairman Ben Bernanke and former Treasury Secretary Henry Paulson for the unprecedented actions taken during the financial crisis. As a matter of firm policy we do not weigh in on purely political matters, and much of this is purely political, but there is the potential here for a longer-term economic impact that could be devastating to the United States: many in Congress are now pushing for greater congressional oversight of the Fed.
Last week 250 leading economists, representing all political persuasions, signed a petition essentially begging Congress to leave the Fed alone. In our opinion, the independence of the Fed is crucially important. Let me explain why. In many respects, the Fed’s job is to be the party pooper. They control the money supply, or how much money actually is in circulation. When the economy slows, they pump in more money to try to get it going, and more importantly, when the economy is booming they reduce the money supply to try to keep things from overheating. This is never popular, but someone has to be the “adult” who says it is time to take the punch bowl away before things get out of hand.
Congress, on the other hand, has the job of spending money. They control government spending and therefore are most responsible for the government’s impact on the economy. So the Fed creates money, and Congress spends it. When put in these simple terms it’s easy to understand why the Fed must maintain its independence. The congressional appetite for spending knows no bounds, and as we have seen this is true no matter who is “in charge” To give them sway over the actual printing press would be disastrous. There is nothing in the history of Congress that would lead one to believe they would have the discipline to take the punch bowl away while the party is still going.
This is not a defense of the Fed’s actions over the last several years; they do deserve some of the blame for this mess. But there is plenty of blame to go around, and Congress deserves a great big helping themselves. The same congressional leaders who are attacking Bernanke and Paulson were, just a few short years ago, pushing for more home ownership and easier access to mortgages. Who is providing oversight on them? Hopefully it is us, the American voting public, and hopefully we are paying attention.
Chuck Osborne, CFA