Iron Capital Insights

  • Iron Capital Insights
  • August 26, 2011
  • Chuck Osborne

This Isn’t Over Yet

Volatility is back in a big way. Since the downgrade of U.S. debt by S&P, the equity markets have been swinging wildly. There is a sense over the last few days that we have finally gotten past all of this as positive momentum has taken over, but I’m not so sure.

We are investing in the midst of a split reality. On one side you have governments throughout the developed world that have spent beyond their means. It is easy to make promises when times are good and you are running for re-election. Who doesn’t want their retirement funded, or healthcare provided? Who doesn’t want their taxes reduced or homes subsidized? All of this is easy until the bills come due.

The bills have arrived for Greece, Italy, and the rest of southern Europe. This has highlighted the fact that our bill is on the way, and it is going to be a doozie. Our politicians seem more divided and partisan than ever, people are anxious, and S&P says the U.S. Treasury bill is more risky than the mortgage-backed securities that started this whole mess almost four years ago.

However, on the other side of this split reality we have corporate America. Here most things are actually good. Every quarter it seems that corporations report better earnings than expected. Revenue has been growing year-over-year. Balance sheets are strong and the prices are right for long-term investors.

So it’s really just a matter of on what one wishes to focus: If we focus on fundamentals of the companies in which we are investing, the market is up three to four percent that day. If we focus on our national debt and our political environment, the market is down three to four percent that day. This volatility is why we have taken steps to reduce the risk in our portfolios, while simultaneously looking for opportunities.

This environment is stressful, and unfortunately it is not over. It probably will not end until the debt crisis is actually addressed. Thus far in most of the developed world, politicians have played kick the can: they apply one Band-Aid after another, thinking that if they can just postpone the inevitable for a few more months things will get better. That is wishful thinking.

In Europe the EU needs to do one of two things: get weaker, by allowing the troubled countries to get out and fix their own mess; or get stronger, by issuing Euro bonds and taking over the debt of troubled economies. Today I believe the latter to be the highest probability. The longer they wait to end this crisis by taking one of those radical steps, the longer we will be on this rollercoaster.

Domestically, we need a coherent direction. We all have our own political feelings and opinions on what that direction should be, but in terms of investing, which direction isn’t as important as having a direction – any direction. We now seem rudderless.

The story goes that Mark Twain and novelist William Dean Howells stepped outside one morning, a downpour began, and Howells asked Twain, “Do you think it will stop?” Twain answered, “It always has.” It may take a while, but this malaise will pass. When it does, investors should once again focus on the actual investments. When that happens we should be ready for a long bull run.

Chuck Osborne, CFA
Managing Director