Ramblings of a Portfolio Manager

Running Scared, Running Right

R&D tax credits for small business. $50bn to build and improve our transportation infrastructure (none of which would be spent on signs touting such!). Extension of capital gains and income tax cuts. A $30bn fund to invest in banks to lend to small business. $17bn in tax breaks to business to hire unemployed workers. Tax credits? Tax cuts? Sounds like George Bush in year 5 of his administration. Oddly enough, in the Bizzarroland that is Washington D.C. these days, these are all proposals that have come out of the Obama administration in the last month alone! Odder still are the Republicans who are breaking rank with their party to jump on the President’s bandwagon for these plans at the same time a fair number of Democrats are jumping the ship of Obama like rats. Yup, the mid-term congressional elections are coming up and with the economy wallowing in the doldrums of no-growth, the politicians up for re-election are starting to fear for their cushy jobs. Now you understand why they call this the “silly season.” Desperate times call for desperate measures and, it seems, even the starry-eyed ideologue in the White House seems to be getting the message. We had postulated that that lone intractable zealot would wait for the election outcome to head in the right (double entendre intended) direction but it seems that he actually, albeit slowly, may be taking some cues from history. Specifically we refer to the Clinton years and it sure seems from our perspective that Obama is already taking baby steps toward the middle of the political spectrum. In the 90’s this move worked for Clinton, it worked for our economy and, ultimately, it worked spectacularly for our stock market. Now, Mr. O may not care about any of these three items but he certainly has a big concern for retaining sufficient power to push through his agendas and, well, if he has to bend a little to retain that power, maybe that’s a good idea. If any of this sounds like a 180 degree turn in the administration’s thinking, it is; and for the equity markets it has been recently, and will continue to be, a good thing.

Will it last? Since the President began his (begrudgingly) pro-business stumping, the S&P 500 has risen over 60 points and the Dow is up close to 500 points. Is the market discounting a kinder, friendlier Administration post-November? Or is it looking forward to all the congressional bums being thrown out? Or is it starting to read the tea leaves that have been showing the World economy (including the US) was and is not as bad as believed in May through August? Did interest rates get just too low? Or was the market just oversold on light summer volume? Yes. The answer, in our humble opinion, is probably a combination of all these factors. Taken with the extraordinary build up of negativity in the markets since April--which we have been discussing over the last month--all these factors conspired to take what was a very over-sold US equity market and give it a lift. But, we ask again, will it last? And if so how long? Sentiment has definitely improved, the extension of the Bush tax cuts is seen as all but a given (the only debate is how far up the income ladder to extend them), Vegas is long a Republican victory in November, Obama is obviously on some pro-business narcotic (where can we buy more?) and even Warren Buffett is out saying “no way will we have a double dip.” Is all the good news already in the market? Will the markets sell off post-election day? The trader in us says “probably.” The long-term investor in us, however, says “ we still have some way to go and if the market does sell off, buy, buy, buy.” Over the last two weeks, taking advantage of historically low rates, corporate America has been drastically improving its balance sheet. Equity issues, sub 1% debt issues, 100 year bond issues, you name it, if healthy corporations could exploit the dislocations we have in interest rates and stock prices, they did it. And that bodes well for the future—for earnings and growth.

We’re buyers into mid-October when we will get a better read on the political polls. Investors will probably take whatever those polls say as an opportunity to take profits. Late October and early November may be rocky but that’s when you buy—economic data and the political landscape will be better then than they are now, earnings estimates will be higher and the market will start focusing on 2011 earnings, which are sill around $90 for the S&P500, an all time high. Remember, stock prices are a function of the multiple (Price/Earnings, for example) and that which the multiple is measuring. Right now we have a good number to measure (S&P earnings) but sentiment is keeping the multiple down. We expect late November and December will bring us a lot to be optimistic about and with both multiples and earnings estimates high, we could see a very, very nice Santa Clause rally.