Ramblings of a Portfolio Manager 6-29-2009

Ramblings of a Portfolio Manager or Here we go again…

It seems like only yesterday that we were opining on the upcoming earnings reporting season and what it would mean to the equity markets. Our pre-season musings then, as now, focused on whether the lack of up-front negative earnings preannouncements signaled anything—they did. As the previous season unfolded our attention turned to the constituents of the individual reports—that companies were making, even beating, their bottom line estimates but with less-than-expected top line growth, thereby supporting our view that companies cut early and cut deep. When it was all over, given the data, we asked the question “now what?” What would occur during the post-reporting corporate news void and what would the next season look like, in light of the makeup of the current reports?

So here we are again, staring at an approaching tidal wave of corporate data that has the potential to produce significant moves in individual stocks, industries, sectors and the market overall. So far, once again the pre-announcements have been positive. What do we expect going forward? Our pre-season analysis suggests pretty much a repeat of last quarter. Wall Street analysts, having been cowed by the rapid implosion of earnings last year, generally did not accept company guidance nor did they optimistically raise earnings and sales expectations after last quarter’s reports. Company management, in the meantime, continued to cut overhead but there is nothing to indicate that their revenue growth has resumed to any great extent. What this all means is another round of “earnings beats” paired with tepid top line growth. Last quarter, that trend was sufficient to produce a nice return on stocks as the so-called “second derivate” trade was confirmed. This quarter, however, companies may get a “free pass” only if their forward guidance is sufficiently optimistic.

Ramblings of a Portfolio Manager 6-22-2009

Ramblings of a Portfolio Manager or Another Manic Monday.

Well, looks like we’re back to the pattern of big Monday sell-offs. Admittedly, we were lulled into a false sense of complacency by the full two Mondays (not back-to-back God forbid!) during which the market actually went up. Not really, but we do admit pairing that tiny sample size of behavior with a sub-30 VIX to dare think that the market might actually have a very boring (read flat) summer. We was wrong! Today’s explanation: a strong dollar and a new World Bank forecast that cut growth rates for the global economy for this year and next. Incidentally, the Chinese, Hong Kong and Japanese markets were up today. Does anyone remember last week, when the World Bank upped its forecast for China’s economy for this year and next? That, too, resulted in a sell-off here. No good deed goes unpunished.

Ramblings of a Portfolio Manager 6-15-2009

Ramblings of a Portfolio Manager or The pause that refreshes.

The equity markets are pulling back significantly today on fairly light volume. Pundit explanations range from a stronger dollar, to the re-election of the US-hostile Iranian President, fears that China’s stimulus may be insufficient to drive a worldwide economic rebound, the Obama Administration’s plan to give greater powers to the Federal Reserve, stretched stock valuations, concerns that we have “come too far too fast,” the possibility that the Fed may “take away the punch bowl” in the form of raising interest rates, the possibility of higher oil prices choking off a recovery, deficit concerns, dogs and cats seen sleeping together and the failure to mow the grassy knoll. We note that the sell-off is across all sectors, with basic materials and energy hardest hit but also including defensive sectors such as healthcare and consumer staples.

Is this the long-awaited pullback? Probably. Should we care? Probably not. Last week we highlighted our thesis that the Market is climbing classic wall of worry. We would argue that the concerns cited above constitute a well constructed wall. Market pullbacks are a normal part of climbing that wall. The reality is that stocks move on the “second-derivative” rather than the absolute. That is, stocks rise or fall depending on whether things (i.e. the economy) at the margin are getting better or worse relative to where we have just been. The second derivative turned from negative to neutral sometime in late March and since then it has been positive. There is no data to imply that is has gone negative again and the fact that all sectors are under pressure suggests that this is a normal round of profit-taking in a longer term upward trend.

Ramblings of a Portfolio Manager 6-1-2009

Ramblings of a Portfolio Manager or Paradise by the Dashboard Light

Once the largest industrial concern on the face of the planet, General Motors filed for Chapter 11 bankruptcy protection today. It was a widely expected move. Charlie Wilson, the former head of GM during the 50’s, once told Congress “what’s good for General Motors is good for the Country.” With the Dow Jones Industrial Average soaring 2%+ in the face of news of the Company’s demise, it’s hard to fathom an era when the inherent truth of such a comment was a given, Truly, we are in a new world.

In December, 1965 the Pontiac GTO ushered in the muscle car era, and the following summer the Beatles released Revolver just before their last tour date in August. On the back of the LP cover was a photo of the Fab Four wearing sunglasses. The unintended (?) subliminal message was that, for the UK singing group, the future was so bright they had to wear shades. And so it appeared to be for GM as well. That was then.

What exactly killed GM will be a debate for the next 100+ years—be it Government regulation, unionized labor, bad management, competition, high gas prices or all or some of the above—but what is clear is that the combination of high debt levels and declining sales is a toxic cocktail that even the proudest of companies cannot consume forever. There should be a lesson here: The Market’s rally since early March has been predicated, in large part, on the assumption of a return to economic growth and the indices have benefited from a rise in the stocks of the lowest quality companies—those with high debt and volatile sales. If the Market is correct, in a rising sales environment, high debt service will turn into high earnings leverage and rapid EPS growth. If it is wrong a spate of new bankruptcies looms ahead and we are poised to revisit Dow 6000. We cautiously side with Mr. Market in this debate but are getting our exposure to earnings leverage by investing in small cap stocks: smaller companies have enough direct leverage to an improving economy due to their single-business focus and we can get plenty of EPS leverage in companies that don’t have to rely on huge debt for financing.