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

Never let logic, reason or pesky things like facts get in the way of a compelling headline. That must be the mantra of the financial press these days.

It reminds me of a scene from “Pirates of the Caribbean; The Curse of the Black Pearl.” (As our long-term readers know, there is very little one cannot learn about investing by simply watching this movie.) The scene is when Captain Jack Sparrow is in jail and the Black Pearl attacks. One of the other prisoners says he has heard stories about the Black Pearl and how they never leave any survivors, to which Captain Jack responds, “No survivors? I wonder where all the stories come from then.” The humor comes in the scene’s reality. We hear something that is just too good to not pass along and the next thing you know we are repeating something that makes no sense whatsoever.

Without survivors there would be no stories. Likewise, a bubble cannot pop if it did not exist. The story for the last few days of this downturn has been that markets – both bond and stock markets – in the emerging countries have been pumped up by the Federal Reserve’s (Fed) policy of quantitative easing (QE). The story goes that investors, who would have preferred to purchase Treasuries but couldn’t do so because the Fed has been buying them all, needed some place to go and they piled into emerging markets. Now that the Fed will be buying fewer bonds – that is what tapering is all about – these investors are going to drop emerging-market securities like a hot potato and run into Treasuries.

This story is almost as good as the crew of the Black Pearl never leaving any survivors. Like that story it has a flaw. Emerging markets were actually the worst place to be last year; in fact they have been the worst place to be for about three years – which is why they now appear cheap. How could emerging markets underperform if all these investors are being forced to invest there? That question is about the same as asking how those dead people spread all the stories about the Black Pearl. If QE did not prop up emerging markets, which is pretty clear, then the mild tapering of QE is not likely to cause any real issues.

I had the pleasure about a week ago of meeting with Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta. He is always very professional and does not reveal anything unofficial, but reading between the lines of that meeting together with the official releases from Fed itself, it seems to me that the Fed is anxious to taper because they have finally realized that QE isn’t working. Some asset prices may have been pumped up, especially bank stocks and domestic small-company stocks, but the real economy has shown little benefit, if any, from QE. If it is not working then it is better to end it as soon as possible before any long-term unintended consequences occur.

So what is really happening in the markets? Markets do not go up in straight lines. After going up 32.39 percent last year and up 10.51 percent just in the last quarter, the S&P 500 is now down 3.06 percent year-to-date. The headlines are talking about markets “tumbling” and that is scary, but that is also the point; they are selling newspapers (or at least the electronic equivalent). Describing the current activity as “stocks in mild correction after a huge run-up” doesn’t compel attention like the word “tumbling.” However, no broad market indexes that we follow, including emerging markets, are even close to the ten percent drop that would constitute a normal correction during a bull market.

Of course, one cannot be complacent. We must always be prudent, and episodes like this are a good reminder of why prudent investing is done from the bottom-up. What is happening at the companies whose stock one owns is far more important than some sensationalistic headline. Prudent investing is absolute return-oriented, avoiding hot assets whose valuations cannot be justified. Prudent investing is also risk-averse, avoiding loss, or more specifically the permanent loss of capital. This does not mean avoiding three percent short-term price volatility; it means that when one is prudently invested, one is less likely to see any significant loss over time.

So what are we going to do in the face of outrageous headlines? We will stay prudent. What we own is sound and should do well in 2014. We have avoided or minimized areas like retail stocks, banks, and small company stocks in general that do appear overvalued and would likely lead the way downward if this proves to be more than a short-term blip. We will take action if this short-term volatility turns into anything more serious, but for now, rest assured: no bubbles have popped, nothing is tumbling, and dead people can’t spread stories.

Chuck Osborne, CFA
Managing Director

~News Flash: Emerging Market Bubble Burst by Fed Tapering!

The other night I had the pleasure of watching my two favorite college basketball teams win. There was a time when that was not unusual, but the last few years have been tough for my Wake Forest Demon Deacons. As a Wake alum, the Deacons are of course my favorite team. My second favorite team is whoever is playing Duke, and this week that was Notre Dame. Wake successfully vanquished the Carolina Tarheels while the Fighting Irish took care of those Blue Devils for us.

At the halftime break a reporter grabbed Wake’s coach, Jeff Bzdelik, to get a few words. Bzdelik said he was happy with Wake’s rebounding. The announcers, and everyone else watching, was left wondering what he was talking about. Carolina was killing Wake on the boards and had a huge lead in rebounds, even though it wasn’t helping them much on the scoreboard. It reminded me that things aren’t always what they seem when you are actually going through them. I’m sure when Bzdelik looked at the actual statistics his opinion changed, but watching it from his perspective in real time things looked different. It happens to all of us. This is one of the reasons keeping statistics can be so helpful.

Take 2013 for example: I think if you asked most people about 2013 they would say it was a wonderful year in the stock market, but a horrible year from a political or public policy stand point. But was it? At the beginning of 2013 we were facing a fiscal cliff, a sequester and the debt ceiling. The consensus among economists was that our debt situation required a combination of tax increases and spending cuts. There was also a consensus that it would never happen because one party refused to cut spending while the other refused to raise taxes. But it did happen. Yes it was ugly – very ugly – and far from perfect. No one is happy because no one got their way. However, we are in better shape fiscally today then we were 365 days ago, and that improvement is progress. Mild perhaps, but progress nonetheless. That progress is not acknowledged, but it is part of why the economy is improving slowly but surely.

That improvement has in part spurred the bull market. The year in stocks, however, is more complicated than it might seem on the surface. I say it all the time, but what is happening beneath the surface of the broad indices is much more meaningful than just the return of the index. What looked like a straight line bull market all year was really two very different halves. The first half of 2013 was all about junk; half way through the year the best place to have been within the S&P 500 was the 50 companies with the worst analyst ratings. That was unsustainable. We had a mini-correction in August and then began a rotation. The second half of the year quality once again mattered, and that is an encouraging sign in our opinion.

For two and a half years or so fundamentals and valuation seemed to not matter as the market was so focused on one political crisis after another – domestically and in Europe – instead of what was really happening at the company level. A recent article on Bloomberg.com noted that Warren Buffett has underperformed over this period. That isn’t surprising because almost everyone who pays attention and tries to act rationally has been in the same boat. But these periods never last. Eventually reality wins out and fundamentals are recognized. It appears that transition began in the second half of 2013.

That makes us optimistic about the beginning of 2014. Markets don’t go up in straight lines, and after a 10 percent quarter we wouldn’t be surprised by some consolidation. There is certainly some over-priced junk left from the bull run in 2013, but there are also some quality companies out there with decent valuations. 2014 could be a good year, particularly for the prudent investor.

Happy New Year, and Go Deacs!

Chuck Osborne, CFA
Managing Director

~It Really Wasn’t That Bad