When at a loss for words, just add superlatives. That’s what CNBC is doing this month. Having already declared last earnings season the “most important ever” it has found itself needing to one-up its own pronouncements for the third quarter. So now we have the “most crucial earnings season in history” before us. To avoid embarrassment to the anchors, they aren’t even allowed to refer to it as such. Instead, “Jay in the booth” makes the announcement during commercial breaks. Lampooning all this is way too much of a lay-up so we’re not going there this week.
Instead, we thought we would take the opportunity to talk about what we are doing amid the media’s Halloween Hysteria. We’ve rambled about analyst expectations and media hype for several months now so a fair question to ask is how we are positioning ourselves. Our philosophy has always been to sell hype, buy pessimism. But before you dub us contrarians, realize that we’ve been in this business for over 25 years now and, perhaps, that means we’ve (hopefully) learned a few things. To use an allegory, we recognize that salmon swimming upstream strengthens the breed and ensures the perpetuation of the species--but we also recognize that only a very small percentage of the fish embarking on the journey actually live to achieve their goal. Remaining at sea, they would all survive the year but would eventually become extinct. John Maynard Keynes said it another way—the market can stay irrational a lot longer than you can stay solvent. No investment discipline (discipline being the operative word), rigorously applied, works in all market environments. So, using a mixed metaphor, even though following the herd too long often leads you off the cliff, there are times when you need to swim with the current. Flexibility is the key to survival in this business.
In the last 10 months the market has gone from extreme pessimism, to moderate doubt, to mild optimism. We responded, using the animal analogy, by starting off as salmon (not an easy thing to do, especially when at least one client called on March 6th to lambaste us for having ANY exposure to equities). This strategy unintentionally evolved us into herd animals as the market caught up to where we already were. Now, however, we are intentionally devolving ourselves back to the fish. In investment terms, early this year we recognized the extreme pessimism and bought the out of favor, low expectation cyclical stocks while everyone else favored the defensive and higher expectation growth names. As this strategy began to pay off we stuck with it, knowingly swimming with the current, as we believed that the levels of pessimism, although abating, were still quite high meaning our strategy had room to go. Now that we have returned to whisper numbers and analysts expecting companies to “beat expectations,” we are concentrating again on low expectation stocks. This doesn’t mean we have gone defensive—we believe that those stocks themselves have high expectations –but rather are lessening our exposure to technology and soft-cyclicals that have appreciated significantly over the past several months. We still think cyclical and commodity stocks, despite their recent run, still have very low expectations and will be given a “pass” on their earnings reports and so remain there. Technology, on the other hand, is fully within the whisper number realm and we are treating them with caution.
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