Wednesday, November 17, 2010

Ramblings of a Portfolio Manager

News Flash: Lincoln Shot. South May Rise Again. Hide in Your Root Cellar and Don’t Forget Your Musket

It has always amused us that, while we operate in a stock market deemed highly efficient by the economists and other smarter-than-us PhD types, the same news tends to discounted once, twice, even three times chronologically though the contents and substance of that news package never changes. Take for example a negative preannouncement by a company—Management typically lays out a narrow EPS and revenue range expected to be reported for the quarter gone by, gives full reason for the miss and often gives a narrow projection for the next quarter and the rest of the year. And Wall Street, ever the immediate discounting mechanism (some might say spoiled child not getting its way) will send the stock post-haste to the nether worlds of price and valuation. But that price reaction doesn’t provide a great bargain hunting opportunity for value investors—for, 9 times out of ten (our back of the envelope observation), when that same company reports the exact same news on the originally planned reporting date, the geniuses in portfolio management will engender the same reaction for the same reason. And, God forbid, the company tapes the call and offers it up to those missing the original, we can fully expect the markets to put the stock in the penalty box yet again until the tape is pulled from the web. So much for the Efficient Market Theory.

But that’s all anecdotal evidence (although we are doing some home work on this phenomenon) on individual company reports. What has really gotten our goat (literally) is the markets’ reaction to the “same old same old” vis-à-vis European debt crisis—i.e the PIGS. Personally, we thought we had slaughtered those pigs months ago. Remember when the dollar was to reach parity with the Euro back in May? It was all due to weakness in the PIGS. Remember when commodities and exporters were crushed because a stronger dollar would hurt their sales and earnings? That was the talk back in May. Remember when a weakened Europe would engender a double-dip here in the US? That was back in May as well. Let’s examine that happened and rate the economists’ dire predictions: First, the Euro, instead of hitting parity versus the dollar, climbed steadily to nearly 1,50/1,00 (we intentionally used commas to look cool and Euro). US multinationals, instead of reporting weaker international sales, consistently beat estimates solely bases on European strength and are on fire. Greece, whom Long Island can kick in a rumble, seem settled; Portugal and Spain, larger than Greece but still a speck on the screen, were tamed and sent away with strong assurances. All markets moved up as a result. Meanwhile, ever looking back into the rear view mirror, the Fed decided to launch QE2 in response as an insurance policy, a move which initially sent the US markets into a roil because it was interpreted at the Fed knowing something negative about domestic economic weakness that the rest of us mere mortals did not. In short, none of the dire consequence have occurred and, in fact, things have gotten much, much better on both sides of the shore since May. Yup, the economists got it wrong again. Surprised?

So, here we are again, markets in turmoil, dollar rising versus the Euro, commodities and multi-nationals in the shit can and a host of pundits thinking maybe a double dip might be back n the front burner. The amusingly hypocritical part of it all is that many of those pundits, who at first lauded QE2, then begged for it, are now on the lecture tour panning the whole idea because it could cause—heavens to Betsy—inflation! All based on a few stronger than expected reports from the US economy. What, exactly did those pundits think was the intent of the program? Funny case is that Greece is somehow back in the mix (they are fixing their problem but not as fast as the Austrians or Greenwhich PMs would like). All that’s missing is the goat negotiating the riots. Perhaps Greece would like to lend the goat to the French—they could use a little humor in their seemingly constant parade of protests (we lost count of the myriad reasons years ago--we did too). The goat may also make them feel better about their personal hygiene.

Oh, we forgot China. Things seem to be so strong there economically that they continue to put the brakes on their own economy, hoping to stave off inflation. One pundit we haven’t heard from is Jim Chanos of Kynikos. Smart guy but it was is contention at the beginning of the year that China was in a bubble but at the same time was intentionally over-forecasting its economic strength? Huh? For his sake we hope he covered his shorts before the recent meteoric rise in the Shanghai index.

The Dow, S&P, NASDAQ and Russell have all lost 5+% plus in the last week or so. Partially on the back of Europe, partially due to China and a fair amount based on post-election blues. Is this the correction/pullback/consolidation that the technicians have been calling for? Notice that, long absent from the Tube, they are now back on again, all with a universal call for a drop of anywhere from 3% (done) to 50% (uh huh). Our answer, or question rather, is “what has changed in the global macroeconomic environment since April.” In fact, things have gotten better economically in the world with many of the global imbalances beginning to self correct (no disrespects to the central banks).

Michael Steinhart was on CNBC yesterday calling this price action temporary and based on information already discounted by the market. We tend to agree. Though he is light years smarter than we, we both look at the market from a bottoms up perspective—that is, companies and markets first, then look at what’s going on the world and how it may affect those companies.

And for all those wringing their hands about pending inflation, if you really believe your own PR, sell you Treasuries before you become a casualty. And remember that inflation is good for commodities. The Fed has gone from savior to villain based on your naive concept of what causes inflation (its employment costs, not interest rates per se). So when we reach full employment and the S&P is 500 points higher as a result, look at your depleted bond fund and remember that you were warned.

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