I know that everyone does not think like I do, but somehow I am always surprised by how so many people just do not get math.

For thirteen years I drove the same car. It was a great car and I loved it. Nothing lasts forever though, and I finally had to replace the vehicle. I had been thinking about what car I would buy so it did not take long. I called the dealer, they told me about the current deal option and it sounded good, so I went to test drive the car. The car drove beautifully and I told them I would take it. The salesperson came back with the numbers and just as I had feared they held little resemblance to what I had been told over the phone. In a strange way it was reassuring to know that nothing had changed in the car buying process over the last thirteen years. I informed him that this was not what I had been told and he explained that the difference was taxes and fees, which had not been included (in fairness to the auto industry the representative on the phone had indeed said, “plus tax and fees”). So I did the math. The extra amount they were going to charge me was twice the disclosed amount for taxes and fees. My poor salesperson was dumbfounded. It took me almost twenty minutes to explain the math to him. Of course he had to speak to his manager, as they always do. They corrected their “mistake” and I got the deal they had advertised, plus the actual taxes and fees.

My wife was with me, and she went from being embarrassed (it is no longer customary to negotiate with car dealers) to shocked once she understood that I wasn’t really even negotiating, just correcting their bad math. She then was mad. These people are crooks! Well, the nice gentleman who helped me get my first new car in thirteen years was not a crook; he was just bad at math and very trusting of his mysterious manager.

It is not all that surprising that a car salesperson might struggle with math, but when the chairwoman of the Federal Reserve does much the same, it is a little curious. In her testimony to Congress Janet Yellen said that the economic experts at the Fed have been surprised that the housing recovery has slowed. I am sure that part of the surprise may be that rising interest rates make homes more expensive and therefore reduces demand. I say surprise, because the Fed has to maintain institutional surprise about there being a relationship between interest rates and housing, otherwise they would have to take partial blame for the housing bubble and financial crisis, and that will never happen.

However, that is not even the biggest mathematical error. There are half as many people in Generation X as there are Baby Boomers; half the people, but just as many houses. Math. Housing is not coming back to 2005-2006 levels for a generation – not until the Baby Booms kids finally move out of their parents’ houses and have jobs that pay enough to support mortgages of their own. This brings us to another seemingly simple piece of math that eludes so many.

This week Wall Street seemed surprised that Walmart isn’t doing all that well. They are even more shocked that industrial production is not growing faster. After all, unemployment is down to 6.3 percent. Once again, it is math: the rate has dropped primarily because there are fewer people in the workforce today. More people are either retiring or giving up on work than are finding new jobs. If fewer people are working, Walmart will sell less, industrial production will be down and housing is going nowhere fast. It is just math.
We keep repeating the same pattern: the economy is slugging along at 2 to 2.5 percent growth while expectations keep going back and forth from boom to bust. Most recently expectations were for boom and now everyone is disappointed. Before you know it they will be calling for a recession. The reality is we are still stuck in the same old “new normal” – and there are too many factors keeping us there for that to change anytime soon.

That isn’t all bad for investors. Bond rates are fluctuating in a range between 2.5 and 3 percent; equity valuations are still reasonable; and the most attractive places to be, large dividend-paying companies, do not require huge economic growth to be profitable. One can choose whether to see the glass as half-empty or half-full. I have a car payment for the first time in many years, but my kids are no longer embarrassed to be seen in my car. That’s math I can live with.

Chuck Osborne, CFA
Managing Director

~It’s Just Math!

It has been a while since we sent out our last Insight, because there really has not been much of note in the investing world. That is not true of world events lately but we are not here to pontificate on everything, only those things that impact your investment portfolios.

Sometimes, however, something happens that may not impact your portfolio but does illustrate a learning moment. The end of the college basketball season can be such a time. For the winning programs this marks the spring ritual of the NCAA Tournament, also known as March Madness. Even people who never watch basketball through the year get excited about filling out their brackets. Our president filled his out on national television. It’s a big deal.

For the other basketball programs it can mark the time of another kind of madness: the search for a new coach, namely one who might get them into the aforementioned tournament. Unfortunately for my fellow Wake Forest Demon Deacons we are in the second type of madness. The search for a new coach has begun and the online commentary from the fan base has begun right along with it. It has struck me that hiring a new coach is much like making an investment. The processes share more than a few similarities: The success or failure of a new coach will be completely determined in the future, yet all one can possibly know about the individual is in the past. One must look at past data and project what the future may hold. The psychological mistakes can largely be the same as well.

Online the avid fans are all demanding a coach who has seen recent success. Winning two games in the NCAA tournament can turn a coach from someone no one has ever heard of into a celebrity and a must-hire. There are currently two coaches being rumored to be front-runners for the job at Wake Forest. One has the kind of background a reasonable person might expect: He played college basketball under a Hall of Fame coach and even won an NCAA championship as a player. He had a successful career in the NBA as a player. He has been an assistant coach at a major college basketball program working under another Hall of Fame coach. He has won an NCAA championship as an assistant coach. He has worked as a head coach in a smaller program and had early success.

The other candidate has little pedigree but did get a job as a head coach at a smaller program. He inherited a very good team from the previous coach who left for a bigger job. That team went to the NCAA tournament and made it all the way to the Final Four. Since then he has not accomplished much; in fact his winning percentage is not as good as the coach from whom he inherited that Final Four team. But, his name is always mentioned when major programs are looking for a coach.

I have no idea which coach would do better, or if the rumors are even true that these are the two finalists for the job. However, the Internet crowd is almost unanimous in their desire for the second option, and I find that both interesting and educational. Making sound investment decisions is about understanding probabilities. No one knows what the future holds; all we can do is use our logic and reason to judge whether success is more probable than failure. However, the madness of crowds gets in our way. What is probable and what is popular are often at odds.

Take the Wake Forest coaching dilemma as an example. The future success of the first candidate – the one who has been there himself as a player, has tutored under two Hall of Fame coaches and has had early success building a program from nothing – is highly probable. I would go so far as to suggest reasonable success is practically guaranteed.

The second candidate – who happened to win four games in a row at the right time once – could possibly be better. Anything is possible. However, I believe most reasonable minds would agree that the likelihood is far less certain. Yet the online crowd says he would be a “home run” and the other guy would be a disappointment.

Benjamin Graham, the father of security analysis, once said, “The investor’s chief problem – and even his worst enemy – is likely to be himself.” Evidently that is true for basketball fans as well.

Warm Regards,

Chuck Osborne, CFA
Managing Director

~March Madness

We start this week with the realization that we now live in what George Friedman, PhD., founder and chairman of Strafor Global Intelligence, calls the “Post-Post-Cold War World.” He freely admits it is a poor name, but it is the only one he has at the moment.

The “Post-Cold War World” was a world dominated by America. We had won and the Soviet Union had lost. More than that, capitalism had triumphed over the command economy, freedom and democracy had triumphed over communism and its weaker cousin socialism, and the United States of America was the sole world power. Our way of life was looked upon as being the correct model.

For much of the next twenty years the rest of the world not only relied on us to keep the peace, they copied us. Economic freedom grew globally. Democracy, at least in name, grew globally. Prosperity grew with it, as it always does. Then two events happened in the summer of 2008 that, according to Friedman, marked the end of that era and the beginning of the new era with the really bad name: Lehman Brothers collapsed, creating a financial crisis that eventually spread throughout the Western world. Then, Russia invaded the small country of Georgia.

We have obviously given much thought and written a great deal on the financial crisis, but until I heard Friedman speak a month ago I had not given much thought to the invasion of Georgia since it ended almost as quickly as it began. Friedman, however, makes a solid argument for how the two events are linked. The first showed that even our mighty economy can be vulnerable, while the second showed that we no longer possess the strength to deter all the potential bullies in the world. In his view after the summer of 2008 the United States became just a world power, instead of being the world power.

Perhaps Friedman is correct. It certainly appears that this was the lesson Vladimir Putin learned. Russia threatens Ukraine, the Western world threatens consequences, and the Wall Street Journal reports Monday that Oleg Panteleyev, a member of Russia’s upper house of parliament, said Saturday, “They talk and talk, and then they’ll stop,” noting that the West made threats but did little in 2008.

The geo-political and humanitarian consequences of these events in Ukraine could be huge. While that concerns us, as it should everyone, we are at work today and our job at Iron Capital is not to pontificate on global events, but to understand how they may impact our clients’ investment portfolios. So that is where I will focus.

The immediate reaction is likely to be negative. Markets were down yesterday, as the knee-jerk reaction to any global unrest is always to sell. Soon, however, investors will realize that these events, as important and tragic as they are, do not really impact the amount of iPhones that Apple will sell, or the Xboxes that Microsoft sells, or even the number of trucks Ford may sell. Ukraine – and even Russia, for that matter,  – are not really important business partners to most companies, and ultimately investing is about what happens at the company in whose stock one is invested.

In the long term the post-post-Cold War world may be re-introducing us to something we had forgotten about over the last twenty to thirty years: the concept of political risk in international investing. The world is no longer marching in unison toward more economic freedom and opportunity. Whether it is Russia or Brazil or Argentina, we are surrounded with examples of government corruption, incompetence and bullying. This environment requires a prudent approach to investing, and that is what we strive for at Iron Capital every day.

Chuck Osborne, CFA
Managing Director

~The New World

We live in a celebrity-obsessed culture. In case you didn’t know it, Peyton Manning lost the Super Bowl. I thought that was a forgone conclusion because, based on the media hype beforehand, the game was Peyton Manning against the entire Seattle Seahawks defense. When I turned on the game I discovered that there were in fact ten other offensive guys on the field with Manning, and evidently there is an entire 52-player football team in Denver called the Broncos.

The NBA recently had a big game that matched up Lebron James vs. Kevin Durant, two of the league’s best players. After seeing the pre-game hype for that contest one could understand my shock when I turned to the game and there were ten – not two – grown men on the basketball court. It turned out it was the entire Miami Heat team playing against the entire Oklahoma City Thunder team, James’ and Durant’s teams respectively. But if you only listened to the report of the game afterward, you would have never known anyone else was there.

This obsession with only the few top players is nothing new to professional sports, but it has spread to the college level. If you were so inclined you could have spent your day Wednesday seeing what potential future celebrity football players are coming to your school next year. As silly as that may seem, the phenomenon has also seemingly hit the stock market, which has to be even sillier.

Apple Inc. reported earnings and beat expectations on both revenue and earnings. Their guidance was in line with market expectations, all in all a very good report, except for one thing: They sold fewer iPhones than expected. They still beat expectations on total revenue because they also sold more iPads than expected. Still, the stock dropped in price. Evidently there are investors out there wishing to invest only in iPhones and not in the whole Apple team.

Gilead Sciences, a pharmaceutical company, reported and beat expectations all around and gave future guidance that was better than expected. They were a little vague on the prospects for a new star drug, so their stock dropped in price.

I could go on and on with similar examples thus far in the quarter. This is a very common market fascination. In sports it is a little different. If LeBron James has a bad game and the Miami Heat still win, it is seen as proof that they are a good team. They are not just a one-man show. Shouldn’t it make sense that if a company beats expectations in a quarter when their star product didn’t have its “best game,” then that is proof of the overall strength of the company?

One would think, but right now Wall Street seems to be in a “glass is half-empty” mood. The fact is that earnings season has gone pretty well; revenues are up year-over-year for S&P 500 companies, as are earnings. This quarter has been at least as good if not better than the two previous quarters that were greeted with gleeful appreciation.

Wednesday night I had the pleasure of listening to George Friedman, PhD., the founder and chairman of Strafor Global Intelligence. They research the geopolitical world and give insight into trends that could benefit or threaten investors. He confirmed my view of this recent downturn – that none of the excuses being bantered about make any sense. The truth is that markets sometimes move in inexplicable ways and then we search for some explanation because that makes us feel better. He suspected that the real reason for the weakness in the market thus far this year is nothing more than profit-taking.

In other words, markets do not go up in straight lines. Football and basketball are team sports. Teams win games and teams win championships. Not even the great Michael Jordan could win a championship without teammates who could help him. Seattle won the Super Bowl because, at least on that night, they were the better team. Teams are always bigger than any one player. Apple beat expectations because it is a very good company with a diverse product line. It is bigger than just the iPhone. The same goes for Gilead, and many other companies that have had their reports nit-picked by people who are simply in the mood to sell. Prudent investors understand that in the long term it is the whole that matters, and like any good team, the whole is often greater than the sum of its parts.

Chuck Osborne, CFA
Managing Director

~Star Power

Good morning,

As a result of the winter storm and resulting city/business/school closures in Atlanta, most of the Iron Capital staff is working from home today. Rest assured that the firm is open and the team is able to conduct all essential businesss operations remotely. A skeleton staff will be able to make it into the office today and will do so until conditions improve, but we are otherwise fully operational. We will return calls to the office at our first chance.

Thank you!
Iron Capital Advisors

~Iron Capital Is Open Despite Atlanta Weather Conditions