April 2012

……….April Thoughts and Comments

Information flows so quickly these days.  When I first started in the financial business almost thirty years ago, it easily took a week to ten days to get information on a company just to start getting to know them.  My desk was always piled with copies of 10-Ks, 10-Qs, annual reports and proxy statements.  Now that information is obtained on the Internet; the piles on the desk replaced by gigabytes stored on a computer.  I can research industries, people and opinions in seconds.  The question is whether all of this data and information is productive or valuable?

At first blush, the answer would seem to be a straightforward, unequivocal “yes.”  If one wants to quickly find out about some one or industry, a quick Google search often answers the question.  In fact, the word “google” was added to the Oxford English Dictionary on June 15, 2006, just less than six years ago (yes, I Googled this information on Wikipedia).

With such easy access to so much information, logically, we all should be well informed and there should be little information with which to surprise us as investors.  Yet, the markets are more confusing and less logical than at almost any time in the past thirty years (1999 prices were not logical, but the driver and the consequences were easy to see).  It seems that with more and more “information” readily available, investors are having a harder time making “intelligent” investment decisions.  This month we explore this issue.

Research in the Information Age

The world has moved between two extremes.  Several hundred years ago, few could afford books and thus the ability to gain knowledge was limited.  Benjamin Franklin helped found one of the first libraries in the United States.  In his memoirs, he states, “(These) libraries have improved the general Conversation of Americans, made the common tradesmen and farmers as intelligent as most gentlemen from other countries.”

The Internet has created the opposite extreme.  Now access and information is practically unlimited.  However, just as any other gas will fill up a defined space, so do gasbags.  Not only has the Internet allowed for easy access to information, it has also provided an easy way for anyone to express their thoughts, regardless of the depth or breadth of such thoughts.  The extreme example of this is people now tweet their latest movements, bowel or otherwise. This over-abundance of useless or incorrect information is nothing more than noise.

Such noise can be one of the greatest debilitations to investors and individuals in general.  I would like to thank Dr. Marc Faber for allowing me to reprint the following article that was part of his March 2012 Boom, Doom & Gloom.  This monthly communiqué (a worthwhile subscription) often discusses topics that seem tangential to investing, but upon reflection have remarkable value to investors.

The article continues on, and is very worthwhile reading; however, the point I wish to make is that often the most creative and clear thinking we can do is not done by watching CNBC or Bloomberg news (or any of the other “talking heads”) endlessly, nor by listening to what everyone else is saying, but by turning everything off and thinking, long and quietly, for ourselves.

I am not suggesting that we do not consider other points of view or information, but that not only must the information must be verified rather than accepted as accurate just because it has been put into print, but the concepts must be reflected on, which takes time and consideration.

Some simple examples that I have seen in just the past two weeks will make for good contrast to the above well-thought-out and informative article.

Much of what we get exposed to these days is filler, drivel or incorrect information.  The media seems to feel that last hour’s news is now as lame as yesterday’s news and so new news is a requirement.  Something – anything – is better than a void.

Here is an example of what is considered “news” in this day and age:  Posted to the online Wall Street Journal on 4/17/19 by Christopher Shea, he writes,

“The intersection of the sets of economists and hipsters may not be large one, but that hasn’t stopped the Twitter meme #econohipster (or #econohipsters) from taking off. Just as alternative-music obsessives stopped liking R.E.M. as soon as the broader world caught wind of them, so do hipster economists brandish idiosyncratic tastes to set them apart….”

I am not sure what the point of this article is, or if the author even understands the point of the game he is discussing.  He goes on to show examples:

“I liked Keynes before Versailles” — @planetmoney

“Planet Money collects a few more. But don’t bother trying to think up any new ones, because the cool kids have moved on to other diversions…”

If you are just dying to read the entire three paragraphs, here is the link: http://blogs.wsj.com/ideas-market/2012/04/17/econohipsters/

Another example of filler from the Wall Street Journal was an incredibly long-winded article on Apple titled “Apple Shares Lose Shine,” published on April 17, 2012.  One might expect in a two-page article that merits the front page of the WSJ, there would be some substance.  But the 1152 word essay can be paraphrased in 41 words:

Apple’s stock has dropped almost 10% in the past week.  Professionals’ opinions on the company’s value run the gamut, and there is plenty of speculation as to why the stock is down, but no one really can point to anything specific.

Finally, one must remember that just because it is in print it does not mean the information is accurate.  The following excerpt is from a Wall Street Journal article published on 4/15/12 on gold.

“Deep into the 12th year of a historic rally, fans are wondering whether the metal is due for a pause. Gold is down 7% from its peak for the year in late February, settling Friday at $1,659.10 per troy ounce, and shouts for gold to reach $2,000 have quieted…”

There is only one problem; the information isn’t terribly accurate.  Below is a one-year chart of gold.  What becomes pretty obvious from the chart is that gold prices, while volatile, have been in a trading range for roughly six months already.

Chart 1: Gold – 1 Year Chart

 

Before anyone starts to think that we have some kind of vendetta against the Wall Street Journal, let me point out that I don’t find that the WSJ is any better or worse than many other sources.

Investors must always question all sources of information for accuracy, completeness and whether the author has a particular point of view they want to promote.  This must be done even from sources that one trusts.

Making some Logic out of the Market Volatility

The combination of short-term thinking, which is emphasized by “headline news” and high-frequency trading, government policy that is driven by political desires more than economic needs, and the over-abundance of questionable information, has led to emotional investing and volatile markets that get over and under extended quickly.

Chart 2 shows the volatility of the S&P 500 over the past year and a half.  Between July of 2010 and April of 2012, the S&P has roughly traded between 1000 and 1400 twice.  In this same short time span, the P/E of the S&P has traded roughly between 14x and 16x twice.  Each time the P/E got down toward the 14 multiple the index has rallied about 30% in a six month time period.  It then corrected by some 20% before continuing its climb.

Chart 2: S&P 500 Index (blue) and P/E (green) courtesy of Standard & Poors Capital IQ

 

Adding to the market volatility has been investor perceptions about the economy.  While this is not new, the lack of clarity is.  The lack of clarity comes from the fact that the normal economic factors are being muted by government intervention.

While arguments could be made on both sides about the value of the government stimulus back in 2008 to keep the economy from falling into a depression, the fact is the economy has not grown much since then.  Most of the government spending has been wasted, as it has not turned into permanent jobs – a fact that can be seen from high levels of unemployment.  Earnings for companies have improved since 2008, but not because of massive increases in employment.

When the Fed employed QE, QE2 and Operation Twist, the additional cheap money did not add to earnings, as the money was not leant by banks but instead used to invest in securities markets.

In fact, by comparing M2, the Fed’s broad gauge of money supply, to the S&P 500 over the past three years, we find the correlation is very low (see Chart 3).  What we did find out is that the expectation of the Fed adding money did have an impact on the markets (I would like to offer special thanks to the folks at NowandFutures.com and Andy Lees of AML Macro for their knowledge and information on M2, M3 and the economic world in general).

Chart 3: S&P 500 vs. Growth of M2 12/31/2007 – 4/23/2012  Data provided by Standard & Poor’s Capital IQ

Going Forward

We continue to believe that portfolios need to be widely diversified by asset class until the political climate becomes less of a factor for investors.  For this reason, we continue to hold a mixture of stocks, bonds, real estate and cash.

Stocks with dividends should continue to be more defensive and offer better inflation protection than bonds over the long term, but will be subject to continued volatility.

Based on weaker earnings going forward and high P/Es, we have started to raise cash, taking profits in stocks that we feel are facing headwinds.  First and foremost, we have been taking our energy stocks off the table.  Slowing economies will reduce some of the demand; and increased supply in the U.S. is also going to lead to lower prices.  Natural gas prices are probably close to their lows, and we think that the differential in natural gas and oil prices will lead to lower oil prices, so we are moving money out of that area.

While gold prices have been trading in the low end of their range, gold stocks have gotten hammered.  However, no one’s behavior has changed.  Governments are still leveraged and continue to spend to placate the voters, and this can only lead to devalued currencies.

Also, as can be seen by Chart 4, the Fed continues to pour easy money into the system, which can only lead to inflation over time.  In addition, we believe that the Fed will come up with some form of a QEN (Quantitative Easing – Next!) by this summer given the pressure a slowing economy and lower markets will bring.  The same is also happening in Europe and Asia and so currency inflation will be happening almost everywhere.  All of this should be very positive for gold in the long run and for these reasons, we will be adding to our gold positions.

Chart 4:  Growth of M2 from November 1980 to April 23 2012

 

We continue to hold short-term corporates as alternatives to stocks for diversity sake and protection against the market volatility.

The Bottom Line:

We will have to continue to deal with market volatility and remain broadly diversified and defensive in nature until politics makes way for economics.  Given that the U.S. economy is in the fifth year of a “rebound” (that is hard to say with a straight face) and that we are potentially facing the end of the Bush tax cuts and increased expenses from the Obama healthcare program at the end of this year, there are plenty of reasons to remain cautious.

Alan E. Rosenfield                                                                                                                     Managing Director

 

May 2012

 

Next month we will review both broad market and specific company earnings reports.  As always, we look forward to your questions and comments.

 

 

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