Ramblings of a Portfolio Manager 12-21-2009

Ross Perot Had the Hoover in Reverse

As another quarter of corporate earnings reports winds down with another poised to ramp up, we anecdotally observe that Corporate America is beginning to sound like a broken record. Companies, on average, met or exceeded Wall Street’s earnings expectations last quarter but, once again, their “success” was largely due to cost containment with tepid sales growth. This marks the 4th consecutive quarter of the trend and Management conference call commentary of “cautious optimism” does not portend any change over the near term, auguring poorly for job growth. Despite the Obama Administration’s collective self back-patting after the November Jobs Report, which showed that companies “only” eliminated another 11,000 jobs and that the employment rate actually fell to “only” 10% (largely due to discouraged workers who stopped looking for jobs), the reality is that Corporate America is just not yet ready to begin hiring. If the financial crisis is well in the rear view mirror, why are managers acting so cautiously? Typically, in past recessions the faster and harder the economy has fallen, the quicker and steeper has been the snap-back. That isn’t happening this time around.

Rep. Paul Ryan (R., WI.), ranking Republican member of the House Budget Committee, was on CNBC last week echoing what many business people feel but have been too cowed by fear of special interest groups and other zealots to admit publicly—that Capital Hill policies and rhetoric are creating uncertainty, which is holding back business growth. Now, as a member of the minority party, Ryan may have an agenda but analyzing the Gestalt of Management Discussion and Analyses over the last year, we also read that the triple uncertainties of pending Health Care Reform legislation, continuing government spending, and the tax hikes needed to pay for it all, along with an overt and omnipresent hostility toward Wall Street and Corporate “Fat Cats” (you know, the people who create businesses, jobs and, thus [gasp!] wealth), have fostered reluctance among companies to invest in productive capital, both physical and human. Like any good forecasters, US managers base their hiring and capital spending budgets on a set of assumptions and if we and Ryan are correct lack of business confidence, due to the dour noises coming out of Washington, is muting those assumptions. Lower confidence in the future leads to lower economic forecasts by managers, reducing spending on personnel and equipment, which, in turn, retards economic growth and so on.

How do we break the vicious cycle of pessimism rife in American business? The answer is fairly simple and it doesn’t even involve a shift in Administration policy: Washington needs to cut the rhetoric, get to work and end the uncertainty. As we write this the Senate is rushing to vote on Obama’s Health Care Reform bill before Christmas. The cynic in us says the hurry is to achieve passage while America is otherwise focused with little time to review the details—as it was with the Economic Recovery and Reinvestment Act—but the pragmatist tells us it’s to allow for reconciliation with the House version in time for the President’s State of the Union Address in January, allowing him to declare a “victory” to the Nation. OK, maybe that’s cynical as well but whatever the reason we just hope for a conclusion, no matter the outcome—and the same for Cap and Trade. Just as a condemned man finds inner peace right before the lever is pulled US managers will have confidence that their assumptions are no longer subject to radical change with the lifting of the political cloud. Furthermore, if the Obama Administration’s contention that Health Care Reform and Cap and Trade are job creators is correct, that fact will eventually find its way into higher corporate forecasts; if not, then the 2010 mid-term elections will doubtless give us “gridlock” in Washington, which will also lead to higher corporate forecasts. Either way, managers will have greater confidence in those forecasts and that’s a good thing for the economy.
Although we don’t share the Obama Administration’s enthusiasm over the November Jobs Report we did see one silver lining: More than 50,000 temporary workers were hired--the first surge in months--and employees worked more hours, raising the average weekly wage by nearly two-thirds of a percentage point in a single month, to $622. This signals to us that worker productivity has improved to the point where companies can no longer extract more work from their existing workforce and to grow further they must add employees—but right now they are taking the conservative approach and hiring temporary workers. This is a crucial inflection point in the economy and if Washington can get its act together, giving companies the confidence and outlook for stability they require, then we just may get a “giant sucking sound” in the labor market…but in this case it would be from the ranks of the American unemployed into the ranks of the American employed.
We’ve had a two-week run of losers in our weekly stock focus. We remind readers that ideas highlighted are stocks in the portfolio that we think may have reason to outperform in the upcoming week. Some times that reason fails to materialize and we exit those positions before the week is over. So it was with Zale Corp, which we sold after speaking with Management following its terrible same store sales report, fortunately before it fell further over the next two weeks. Anyone interested in our weekly picks should recognize that we offer an active management strategy and that such portfolio changes can occur at anytime without warning and should call for further information before investing. Oh Christ, we sound like a Cramer Disclaimer now!