Ramblings of a Portfolio Manager

When the Tail Wags the Dog

2% of US GDP. That’s what exports to the entire European Union comprise of our nation’s annual output. Hardly seems worth the volatility that the market put us through last week. Of course, the prevailing fear is the “domino” or “cascade” effect of a weaker EU on the rest of the world and thus, ultimately, the US. We’ve seen this movie several times before. The premier, “Tarp I,” of course, was in September of 2008. The first sequel, “Oh God Obama!,” came in January through February of 2009. The third iteration, entitled “Double Dip,” debuted in July last year. Like all bad movies, the first was better than the sequels—and, as with most movies, it was the “real deal.” The others were just tarted up imposters. Now we have “Contagion IV. The Euro Story.” Is it worth seeing? We think not.

In our little book of investing, E stands for Earnings, not Europe. An excerpt from Ramblings, July 20th 2009:

Anyhow, all we are saying here is that this earnings season should actually turn out to be a good old fashioned one—some beats, some misses, some “in lines.” And that is what makes markets, produces opportunities on both the long and short sides and makes fundamentally-based active money management worth pursuing.

We feel the same way today. Right now the US markets are trading in more or less in direct correlation with the Euro, with exporters getting hit harder than domestically focused companies. We understand the psychology—a strong dollar makes our exporters less competitive vis-à-vis their European competitors and a weak Europe means reduced exports to that trading bloc. But things don’t just work that simply. First of all, as we point out, only 2% of our GDP is based on exports to Europe. Secondly, many of our exporters have no real European competition—think technology and pharmaceuticals. Thirdly, along with a stronger dollar, we have weaker oil (down 20% so far this month), which is like a tax cut for all companies, world wide. Finally, while a weak Euro does mean that European exports to the rest of the world are more competitive, it also means that Europe stands a chance of exporting its way out of an economic slowdown—in fact, UBS upgraded the EU for just that reason today.

We suggest investors turn off the TV and just watch the earnings reports and guidance from the US coming across the tape. It’s a better and more uplifting movie