US Economic & Financial Markets Outlook: Rationality vs. Hyperbole and Extremism
January started the year of 2011 with a period which gave the country the start of the corporate earnings parade, President Obama’s State of the Union address, a decent 2010 GDP report, and a crazy lunatic deciding to shoot Gabby Gifford’s, the Arizona congresswoman in the House of Representatives. The U.S. economy is analyzed by many different economists from a broad swath of market participants, and the general consensus is it has rebounded from the recession of 2008-2009 and is now poised for quicker growth.
If this is the case, corporate earnings reports should reflect the improving conditions. Indeed, according to the Bespoke Investment Group (The Trader, Egyptian Conniption, Barrons, Bob O’Brien and Lawrence Strauss, January 29, 2011) ‘70% of companies that have reported fourth quarter results have beaten their revenue number.’ Typically, companies with solid businesses report larger increases in profit growth relative to revenue growth, and the better than expected revenue numbers translate into greater growth in profit numbers (that is the theory anyway).
In my opinion, one of the issues for investors to overcome is the current market sentiment. From my perspective, there is way too much extremism in the market and hyperbole and outlandish ideas are well reflected in many asset prices. It is not just stocks, its bonds, commodities, currencies, ETF’s, options, and without even looking at them, probably swaps as well. In many cases, investors are paying a great deal for assets which have quite a bit of risk. It reminds me of my little daughter, call her Superstar, whose age is 3. Superstar rides the emotional roller coaster every day, waking up and crying, and then getting very happy when mommy comes in the room. Her day swings from extreme sadness and crying if she does not get what she wants, to extreme happiness when she does get her desired object.
The same can be said for the current market- bond yields are too low but bond investors think it is justified because of the risk in the world- especially regarding European sovereign debt. Commodities have soared, but because of demand in China and India, those bulls see never ending demand. Stocks have soared almost 100% from the lows of 2009, but with low interest rates and an improving U.S. economy, many investors are paying huge multiples for stocks which have had huge runs. In my estimation, these volatile and emotional swings from market participants, sometimes on a daily and even hourly basis, are the enemy of good investors.
When I have studied great investors, from Jim Rodgers, Charlie Munger, Warren Buffett, John Malone, and even a guy like David Einhorn, a common theme is rationality. In order to be rational, one has to evaluate investment opportunities based on facts. The reality is with investing, before one puts a cent of capital into any kind of asset, trying to obtain every piece of information possible about the opportunity becomes critical in determining how successful the investment will be. Three specific items which you might want to read as a beginning to your investment process include: 1) All the headlines about a company 2) The 10-Q quarterly SEC filing 3) The 10-K annual report filing (at least the Discussion of Operations and Management Analysis). Every single time I have not gathered as much information as I could have; my investments somehow don’t give me the results I want. In many cases, you can acquire the proper research and make a rational decision, and even then, things might not go your way.
However, making rational decisions through very thorough fact gathering keeps your decision making process based on plenty of information. As such, when you see these situations where someone is justifying huge prices based on predictions 5 and 10 years from now, uh, at the very least, go find more information about the situation. Buying stocks at 100 and 200x earnings is not what I would consider rational. It may work out for you in specific situations, maybe as a trade, or maybe as a speculation, but from my perspective it is not a rational way to approach investing. In that light, especially if you are investing your own money, it is always a good idea to ask for a second opinion about what you are doing. Having to explain why you are making an investment to a third party is also a good exercise because it requires clear thinking. As they say in education, the best way to learn something is to go teach it.
Global Economic & Financial Markets Outlook: In 2011- ‘Many Shall be Restored that are now Fallen, and Many Shall Fall that are now in Honor ‘(Graham and Dodd’s Security Analysis, 1934) (All country index data provided by the market data section of the Wall St Journal January 30, 2011)
If you look around the world, a very typical dynamic is taking place in global financial markets, although we are only one month into the year 2011. The country indexes which outperformed in 2010, except for Sri Lanka, have underperformed in 2011. Furthermore, the reciprocal has occurred, those which underperformed in 2010 have outperformed in 2011, at least so far. For example, Thailand, Indonesia, and the Philippines are all down 6%-8% in 2011, and all were up at least 35% in 2010.
In 2011, Spain, Italy, and Greece are up 11.4%, 10.8%, and 12.9% respectively, leading almost every index, whereas in 2010, those indexes were all down over 10% in 2010, with Greece down a whopping 47%. Even more interesting is the index of India (Bombay Index), which is down 10.3% for the year, and in 2010 it ended up ahead by 16.7%. Brazil is down by 3.8% year-to-date, and China also has lost 4.2%. Russia continues its positive returns as it is ahead by 6% for 2011.
It would be foolish not to mention the events which are currently taking place in Egypt. With Egypt possibly changing government leadership for the first time in 30 years, there are many possible implications for the global economy- possibly higher oil and commodity prices, restrictions on commerce through the Suez Canal, and a new government which could be lead by extremist leaders which have hostile attitudes toward democratic countries. Time will tell how events play out, and I am sure the majority of investors will keep attune to how the events in Egypt unfold over the coming weeks and months. What I find interesting is social media and technology played a crucial part in the events which are taking place in Egypt, and possibly all over the Middle East
Y H & C Investments: Contrarian Thinking- Things are Seldom As They Seem, So Don’t Judge a Book by Its Cover
Try and remember when you were growing up, so think back to when you were about 10 years old. Personally, I can recall my mom assigning me books to read for a month or sometimes a weekend. Anyway, on many occasions, being a, shall we say, particularly enthusiastic young lad, I would much rather go play a sport or watch television than read the assigned book. So, when it finally came time to read the story, I would wait until the last minute or day to accomplish my task. I know, I know, not the best studying policy.
On of my problems was I would look at the front cover of the book, or read the first few pages of the book and get bored quickly. Probably something other young kids had happen as well. However, what I naturally found out was as I read deeper and deeper in the books, I became more and more interested in the stories.
In that same regard, many investment opportunities require more research than just looking at a description of the company, a quick glance of the stock price, or the spot and futures price of a commodity. From my experience in investing, one must always look deeper into beaten down assets, especially stock prices, as events are seldom what they seem. Consider the following quote by Warren Buffet on being skeptical on acquisitions:
‘It may seem strange that we exult over a year in which we made three acquisitions- given that we have regularly used these pages to question the acquisition activities of most managers. Rest assured Charlie and I have not lost our skepticism: We believe most deals do damage to the shareholders of the acquiring company. Too often, the words from HMS Pinafore apply: Things are seldom what they seem, skim and milk masquerade as cream.’ (The Shareholder Letters of Warren Buffett, Lawrence Cunningham, Pp 163.)
It is important to note Mr. Buffett is referring to possible purchases of businesses and their affect on shareholders whereas I am looking at buying stocks or assets so we do have different contexts. However, the key point is to research these possibilities far beyond one or two variables or data points. There are different facts and facets to each business and understanding the entire situation is the key to finding the diamonds in the rough.
If you have your own way of researching companies, or would like to share your steps in researching investment possibilities, please post your ideas to share with the board!!! Thanks for reading this month and I look forward to hearing how others go about finding their diamonds. Any comments, questions or thoughts, please email info@y-hc.com
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
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