Iron Capital Insights

  • Iron Capital Insights
  • July 30, 2021
  • Chuck Osborne

That’s a Two-Point Deduction

I don’t know about you, but I’m a once-every-four-years (or in this case five years) fan of sports like gymnastics and swimming. My heart goes out to Simone Biles and the USA women’s gymnastics team. I will admit that my first reaction was, “She just quit?” Yet, when we heard from Simone it was clear that she truly believed in that moment that her team was better off with someone else taking her place, and that actually is a brave decision.

I do not believe we can even begin to understand the pressure she is under; in fact I don’t believe gymnasts of the past can understand the pressure she is under. It is one thing to be the best on your team and the team leader; it is another to be told constantly that you are the greatest of all time while still competing. If Simone had done the impossible and gotten perfect scores in every event it would have been, “Oh well, that’s why she is the greatest.” Anything less is treated as a disappointment. Unrealistic expectations are an enormous burden.

It isn’t just Simone Biles who feels that pressure: Second quarter GDP was reported on Thursday this week. The expectation was for 8.5 percent, and that had already come down from more than 9 percent. The economy actually grew at 6.5 percent according to the first reading of GDP; that is a full two-point deduction, which is a little more than simply “not sticking the landing” – this is a huge disappointment.

Or is it? The market has been telling us that people who live in the real world have been lowering their expectations much faster than economists. The interest rate on the 10-year Treasury bill is now yielding 1.25 percent, down from the 1.75 percent range. What is that telling us?

It tells me that bond investors are pessimistic about future growth. They believe that we have seen all the economic growth that we are going to see. This is a sea change from just a few months ago when rates were rising rapidly, and it is not just the bond market.

I have said it a thousand times if I have said it once, but the real indicator of how the market feels is not the headline index return, but what is happening under the surface. While the broad indices have held up, underneath the surface we have had a closet correction. Small company stocks, as measured by the Russell 2000, have had a full 10 percent selloff. Value stocks, which had been leading the way in the optimism of economic growth, have sold off. Just about every type of stock there is has been negative over the last several weeks except for big tech, which had been trailing earlier.

Investors now go toward these large technology firms, when they believe there is no growth to be had anywhere else. These high-fliers have somewhat ironically become today’s defensive stocks. The market has gone from telling us that we are going to grow exponentially to saying we are headed for a recession. The market exaggerates.

In reality we are seeing good economic growth; less than the hyperbolic expectations, but still good. We live in a time, however, when missing even unrealistic expectations is treated like the end of the world; it is not, and right as the market was teetering on heading down, corporate earnings have come out and said, “We are doing well.”

Markets overreact on both sides. What was overly optimistic just a few months ago has become overly pessimistic. Small companies are fine, value stocks are fine; we are growing at 6.5 percent. That is a good number. There are never any guarantees in the market, but I suspect that before too long we will get back to rates rising and value and small company stocks leading the way.

We live in a world of constant hyperbole and the market is not immune. It would be great if the exaggeration would stop, but that is a subject for a future Perspective. In the meantime, we have Olympic Games to watch. USA! USA! USA!

Warm regards,

Chuck Osborne, CFA
Managing Director