Ramblings of a Portfolio Manager 8-17-2009

You Can’t Cruise Main Street in 500,000 Shares of GE

The annual classic car auction at Monterey, CA was held last weekend. Few records were set but the sales numbers were impressive, as they have been for the last decade. One car enthusiast paid more than $7mm for a 1965 Shelby Cobra Daytona race car while another plunked down $2.75mm for a 1958 Ferrari California Spyder. Yet, as we write this the world equity markets are in full sell-off mode. The Chinese Shanghai Index closed down nearly 6% and is now down over 17% from its August 4^th high while Japan’s Nikkei index closed down 3% and the S&P 500 has fallen over 3% since Thursday. Fears over the health of the US consumer are driving the sell-off, according to market pundits. Huh?

Actually, this seeming paradox makes quite a bit of sense and says a great deal about market psychology and the current state of the capital markets. Since the 1980’s, classic cars have morphed from fun toys held by car nuts with too much money and/or time on their hands to a serious asset class for investors. We won’t comment on the advisability of investing in old motor vehicles as a retirement strategy, however, we will examine the reason for the car market’s transformation. There have been two significant periods during which classic cars were treated as assets rather than playthings. The first was immediately preceding and following the stock market crash of 1987. Back then, cheap money had fueled both the US real estate and Japanese stock markets and the beneficiaries of those booms plowed a portion of their new found wealth into high end “collectibles” such as art, and then cars. When the stock market crashed in 1987, the classic car market boomed further as money came out of stocks and sought a “more stable” return. Again, art and old cars were the targets since their values had already been rising and—presto!--cars became an asset class. That house of cards tumbled in 1989 along with real estate and the Japanese economy. The current boom in classic car prices traces back to the Barrett Jackson Car Auction of January, 2002. Immediately following the attacks of 9/11, many baby boomers, wealthy after years of a strong economy and a rising stock prices (sound familiar?), began to feel that life was too short and that it was time to buy “the cool car I always wanted in high school but couldn’t afford.” The market sell-off following 9/11 and the Enron and WorldCom scandals further solidified the asset class status as once again money sought a stable asset whose values were rising. The car market’s boom was then further fueled and perpetuated over the ensuing years by real estate wealth (again, sound familiar?) and although it has weakened in the last 12 months it has not crashed in the true sense

Can we draw any conclusions from this history lesson? The strongest message we take is that the classic car market needs to correct, if history is any guide, and the fact that it has yet to do so signals that, perhaps, money is still seeking returns uncorrelated to the stock market. That, we view, as a longer term positive for stocks as it means investors most likely still doubt the recent rally and that skepticism, which is healthy to any market longer-term, still abounds.

Ramblings of a Portfolio Manager 8-10-2009

Summer has finally arrived on the East Coast!

No joke—last week we had our first 5 day stretch without rain here since Memorial Day. The mushrooms growing under the Ark we constructed in the office parking lot are in danger of shriveling. Might this favorable stretch of weather have any implications for the direction of the capital markets the rest of the year? Before you think we have gone off the deep end and are beginning to employ astrological charts in our investment process (and you still might be right here), hear us out.

Earlier this year we commented on the “sell in May and go away” myth. That quaint notion, borne of a simpler time before cell phones, laptops, wifi and DSL in the Hamptons, had its place in the white-shoe days of Wall Street, when market participants mutually made an unspoken, passive pact to do no harm during the summer months, when everyone’s attentions were focused elsewhere and communications with the office were slow and infrequent. The strength and volume associated with this current summer rally attests to the fact that the old gentlemen’s agreement regarding summer break is long dead. Still, with many of the near-term potential market catalysts such as quarterly earnings reports and significant monthly economic data now behind us and, most importantly, with congress on vacation (meaning fewer dangerous trial balloons) we may yet get our summer doldrums—they just may occur all in the month of August.

The market’s recent rally has many an “expert” calling for a pullback, retracement, profit-taking session or any number of other terms suggesting a reversal of the uptrend. We don’t disagree with the need for time to digest. Our anecdotal evidence is that a good deal of this rally can be attributed to short covering, in that many of the best performers are low quality, high short interest stocks trading under $5. We also note that retail investors are starting to belly up to the trough, judging from the volume and trade size in some of these higher flying issues, although the money market data and funds flow data have yet to bear this out. Both data points are classic causes for concern. Yet “digestion” doesn’t mean that stocks have to fall back to some technical preordained level to allow the rally to advance further. Treading water (now there’s a good old Wall Street technical term for you) sometimes works just as well to relieve the gas pains. True, the ownership profile of stocks may change in a sideways movement phase, but that isn’t necessarily bad. We disagree with the notion that retail investors being last to the party is a bad thing—especially if they help the “smart money” out of their positions during a flat spot in the market. All that would be happening there is that the cash horde changes hands from individuals to institutions—and we would strongly take the contrarian point of view as to which side is the “smart money”—and retail investors can be much stronger hands than institutional holders for any number of reasons. So, putting this thesis together with our August doldrum theory from above, we have good reason to believe in a small market sell-off at best and a boring (amen!) few weeks ahead of us.

Ramblings of a Portfolio Manager 8-3-2009

Ramblings of a Portfolio Manager or Farewell Earnings Central! We hardly knew Ye…

As some may discern from our weeklies, we often like to take shots at the financial media. With our aging eyes, such a large target is rather hard to miss…and in this business, where hitting the mark 5/8^th of the time constitutes a good record, we’ll take all the easy shots we can. So it was with a wry smile that we listened to CNBC declare “the most important earnings season ever” officially at an end with the closing of their Earnings Central news desk last Friday. Funny, we were unaware of any SEC regulation promulgating that all quarterly corporate earnings be reported by July 31^st. US companies are on many different fiscal years (particularly the retailers), with quarters ending in every month of the year, not just the convenient months of December, March, June and September. But if the pros at CNBC say that earnings season is over, then who are we, or any of the 100 or so publicly traded retailers out there, to argue? Not that anything such companies as Wal-Mart, Target or JC Penny have to say about the state of their business would shed any light on the health of our economy and, thus, the fate of the capital markets. It is folly to argue with someone with a larger pen or a taller pulpit so we humbly submit to the wisdom of the press…not!

Sorry, while not wishing to appear contrarian, or in any way in disagreement with the almighty media, we humbly submit that the “most important earnings season ever” has yet to begin. Investing in an economy that is 60% dependant upon the consumer as we regularly do, we would argue that the fate of the retailers will give us a better read on the future than how well Goldman Sachs did in high frequency trading last quarter. So far this year, the retailers have followed the playbook of the rest of corporate America—reporting lower-than-expected sales with better-than-expected EPS thanks to cost cutting. While that type of expectations management may have worked just fine with the likes of Goldman or Intel (which is more than slightly leveraged to the consumer by the way) this quarter, it will not get the companies serving you and us, or the stock market in general, very far. That is, if we get earnings reports from the retail sector similar to what we have been hearing thus far from the rest of the economy but without positive forward guidance, our little market rally may be in jeopardy. So stay tuned…but not to CNBC it would appear.

Ramblings of a Portfolio Manager 7-27-2009

Ramblings of a Portfolio Manager or Congratulations Mr. E.! You’re not going to die…but you may walk with a limp.

It seems like only yesterday that the market, along with the press, was throwing out all kinds of consonants to describe our inevitable descent into a deeper recession, all the while whining for a second stimulus package. Well, actually, it was about three weeks ago. Close enough. Today, we got extremely strong numbers from the housing sector and the press is officially declaring an end to the recession. So goes the schizophrenia of Wall Street in our just-in-time, immediate data driven, blogosphere-based economy. You recall we pointed out that there are many conflicting cross-currents at any economic inflection point—well, here you go.

So are we really emerging from the recession abyss? The short answer is yes. But what about those generationally high unemployment numbers--do they mean nothing? The short answer is yes. Does all this mean that the market should be going up? The short answer is yes. We don’t intend to be flippant about such important questions, especially when it comes to the human toll of high unemployment, but a full discussion of their nuances is well beyond the scope and purpose of our weekly missives. Unemployment aside, there has been substantial evidence that the economy is indeed turning to the better. From leading economic indicators to company reports and guidance, the arrows point to an upward bias to economic growth. The question now being bandied about is over what the pace of the recovery will be (remember that just three weeks ago there was to be no recovery)—will we get a “V” or an “L?” They we go with those consonants again…

The fashion term being overused in this economic cycle is “new normal.” The bears argue that the “deleveraging” of US corporations and households will dampen demand for years to come, resulting in a “new normal” (lower) level of GDP growth. Others, more politically inclined, posit that the Obama Administration’s spending plans, anti-business bias and rapid u-turns in policies are causing uncertainty that stifles new investment by business (we tend to be somewhat in this camp). The bulls, by contrast, argue that fiscal policy is irrelevant and that the accommodative monetary policy of the Federal Reserve will be all that is needed to engender significant GDP growth. As bottom-up, fundamentalists, we look at all this from a seldom mentioned point of view. Stitching together the earnings reports we have observed so far, we note that US corporations, having cut early and deeply, are more lean than they have been in years. There is a reason that technology is outperforming this year--investment in technology increases productivity, allowing companies to be more profitable with fewer workers. So when companies “beat the street” on the bottom line with lower than expected top line they are telling us something very important: that when demand does improve—and it will—the new earnings leverage in corporate America is going to produce some impressive growth. And it is earnings growth that drives the stock market. All that without debt. Go figure…

Ramblings of a Portfolio Manager 7-20-2009

Ramblings of a Portfolio Manager or Really Bad Dandruff…

As might be divined from our past Ramblings, we are not big proponents of technical analysis. Not that we don’t think there is a place for it. Like any philosophy, if enough people ascribe to its tenants then it becomes a self fulfilling prophecy of sort. And, believe us, there are many adherents to the chart method if investing so to ignore it would be folly. Still, we remain firmly grounded in fundamental analysis while keeping a half an eye on the charts. But sometimes we like to have a few yuks at the technicians expense…

Last week a very important technical event occurred. The “head and shoulders” of doom chart pattern, which every bearish technical analyst used as proof that we were heading back to Dow 6000 and at which every bullish technician sullenly nodded his head in gloom, took a hit. The body blow came mostly from Intel with some help from a few other tiny tech companies such as IBM and Novellus. The bottom line was that, the bottom lines of tech companies (and a few really small financial service companies like Goldman Sachs and JPMorgan) weren’t as bad as analysts expected. As you recall from our last Ramblings, we suspected just the case would unfold thanks in part to conservative (frightened) Wall Street analysts’ failure to raise earnings expectations after last quarter’s reporting season. No, we are not tooting our own horn here. There are lots of earnings reports to come still and many sectors have not even begun their confessions. And, of course, we have really only heard from the “bell weather” companies. Frankly, we expect a mixture of positive and negative surprises versus expectations, which should form a “normalizable” bell curve when graphed. Yes, we know that’s not a real word but it is the best way we know how to express the fact that earnings reports are typically skewed to the positive since companies long ago learned to play the expectations game. 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. So, having said that we fully expect the Dow to hit 9123.75 if it can break 8778.5 at which point we should all be buyers…unless, of course. it stalls at 8771.3, in which case it we expect it to go to 8345.295 and we would be sellers. Then again, it could just sit here and we recommend doing nothing. Wait, are we holding the chart the right side up…? Happy Investing!

Ramblings of a Portfolio Manager 7-13-2009

Ramblings of a Portfolio Manager or “The most important earnings season of all time”

So runs the constant tag line on CNBC…this week. It truly amazes us the superlatives that have been used since the market meltdown last September. “Most important jobs report,” “most significant GDP report,” “most impactful INSERT ECONOMIC REPORT HERE.” Somehow, the financial crisis has ascribed additional significance to every piece of company or economic data due out on the wires. Were these data not important pre-crises? Did no one care about jobs reports, GDP or company earnings in the “good old days?” Of course they did but the media loves to assign a primacy import to all recent public events—we note that many a talking head labeled Michael Jackson’s passing “the most significant celebrity death ever!” As Farah Fawcett fans we take issue. Of course the media fails to realize that by aggrandizing every story they simply marginalize the impact of each successive one. How much bigger could the New York Post have made the front page type when man finally walked on the moon?

OK, enough editorializing. How important is this reporting season? We don’t want to belittle the significance of what companies will be reporting and, more importantly, what they will be projecting over the coming quarter. What is immediately clear to us is that the Market is jumpy and ready to react to the slightest bit of “impactful” data. Recall last week that we hypothesized that this behavior signaled a bottom…or at least an inflection point in the economy. Case in point: Monday morning the futures were down significantly as were European and Asian markets until bank guru Meredith Whitney made positive comments about Goldman Sachs and several banks. Those commentaries alone produced a 100pt rise in the Dow futures. Conversely, on July 2^nd, one weak jobs report for June changed market sentiment from fear of growth-related inflation to fear of further economic decline and dropped the Dow 600 points in one week. So, much as we hate to go along with the consensus “wisdom” we do sit in the camp that believes in the importance of this earnings season. At a minimum, it will be a “tell” as to the potential direction of the economy going forward. They key for investors will be to know which company’s reports will be the ones of significance. Last week, Alcoa’s positive earnings were all but shrugged off whereas Chevron’s were seen as a negative harbinger of things to come. The market got it backwards, in our humble opinion and, thus, we caution investors not to react too swiftly to earnings as they roll in.

Ramblings of a Portfolio Manager 7-6-2009

Ramblings of a Portfolio Manager or The ABC’s of W’s,L’s, U’s and V’s Last Thursday, the final trading day of the holiday-shortened week, the market received some unpleasant economic data. The US jobless rate climbed to 9.5%, a 26 year high. June Job losses exceeded the 363,000 expected by economists, bringing the total number of jobs lost to 6.5million since December of 2007. There were very little encouraging facts in the data. Even the average workweek fell, to 33 hours, its lowest since 1964. The market’s reaction was swift and merciless with the Dow falling over 200 points, its worst decline on a July 4^th holiday in over 50 years. Economists and pundits were equally swift in their reactions, proclaiming the recovery either “stalled” or farther off than originally expected. These same pundits were just a week earlier calling the recession at an end and wringing their hands over inflation and when the Fed would have to start raising rates to rein things in. That talk, too, sent the market down at the time.

The metaphors and acronyms have been flying wildly since this recession began. “Green shoots,” “brown shoots,” “mustard seeds,” recoveries with charts shaped in almost every letter of the alphabet, etc.. Everyone is looking for a sound bite to describe what is going on and where they see things going. The fact of the matter is, with all deference to the PhDs, the world economy is much more complex and dynamic than might be described in a convenient one-liner for the media (they know this but it doesn’t make for good TV). This recession, unlike many of its predecessors, began swiftly, mostly unexecpectedly, and, yes, the chart was almost a straight a perfect inverted “V.” But recoveries are seldom so neat and clean. There are many cross-currents in any economic rebound. Data will often be conflicting and opinions will diverge widely. This is characteristic of any change in direction—a “bottom” in economic terms. That is likely where we are now. So what letter can we expect going forward? All of them, of course! Economies never recover in a straight line. There will be fits and starts, periods of acceleration and periods of weakness. The data will continue to be conflicting…until its not. But make no mistake, the economy will recover—just not neatly enough to be summed up in a one-liner. This is what creates markets and more importantly, opportunities. The key is to read the data in a holistic sense and not react to each piece of information that comes through as the definitive data point. The good news is that, in our immediate information age, there will be many, many more data points to which to react over the next few weeks.