October 2012

……………..Thoughts and Comments

Earnings Season – Q3

Earnings season has been in full swing for a month now and in that time, the S&P 500 is down 7%, the NASDAQ is down almost 9% and every sector of the S&P 500 is down as well. Industrials did the best and were down only 0.66% in the time frame.  The P/E on the S&P 500 was 17x last month and now it is 16.0x, lower but still very high.

Third quarter earnings have been unimpressive to say the least: revenues were down, guidance was lowered, and margins were lower for many companies.

Technology stocks reported terrible numbers, with margins and revenues down.  Even Apple disappointed, making it two quarters in a row for them.  The stock has dropped from $670 to $526 as of this writing, vindicating our call last month to go elsewhere.

Industrials fared better but we saw slowing revenues virtually everywhere and, except for a few cases, margins falling as well.  Caterpillar reported weak numbers and lowered guidance for 2013.  We covered our puts and made a nice little profit for investors.

As for our major positions, the gold stocks had very good reports and the industrials decent reports.  More importantly, our industrials were not overpriced and have excellent prospects over the next twelve to eighteen months as well as long term.  Here are some details:

1)  Yamana Gold (AUY):  Gold miners have finally recognized that they cannot maintain a “grow at all costs” mentality.  During the third quarter, many made it clear that profitability is going to be much more of their focus going forward. One of the reasons we like Yamana  is because they have had a dual focus of carefully growing their assets while maintaining profitability and financial strength – read this as controls on capital spending and focus on profits – for some time and their Q3 report confirmed this.

Production was within expectations (up 11%) and costs are among the lowest in the industry at $531/gold equivalent ounces.  They reported record revenues (up 10.2% year over year and 14% sequentially).  Earnings (adjusted for one-time tax issues and expenses) were up 33%.

The next few years should be very good for Yamana as new mines produce and production continues to grow.

2)  Goldcorp (GG):  Just like Yamana, GG has a history of recognizing the importance of staying focused on the bottom line while still growing their assets; and like Yamana, we feel Goldcorp is among the best run mining companies in the world, with among the lowest mining costs and a management team that consistently delivers on their timeframes and expectations.

Production, after having a problem in the second quarter is back on track at GG.  Revenues grew by 18%, earnings were up 45% year over year in the third quarter and total cash costs sere $660/gold equivalent ounces.

3)  Balchem Corp (BCPC):  Balchem reported flat revenues (up 1%) but because of the product mix, profit margins were higher leading to a 12% increase in earnings.

Choline for poultry was weak, while choline for dairy cows was stronger, as was industrial choline, with human choline and specialty industrial chemicals flat.  This is a defensive company (products are needed in good times and bad) but has some exciting potential in Asia, acquisition plans, and potential human choline product launches.

4)  Stepan Co (SCL):  Stepan is also a specialty chemical company that is defensive in nature but has long-term growth prospects that are very exciting.  They reported earning growth of 6% and increased their dividend by 14% and announced a 2:1 stock split.  Revenues were down for the quarter by 12%, of which 3% was due to lower volumes and the rest was due to lower prices and currency translation.  With the markets down 5% in the past month, SCL is flat – exactly for what we want out of a defensive stock.

The common denominator for all businesses is that when economies start to slow, all companies will feel some impact, but not to the same degree.  Thus, results and opportunities at the companies being invested in has to be the prime focus.  Such focus can uncover opportunities that other miss because they are too busy worrying about the wrong things.


Politics, the Election and Investing

Speaking of the wrong things, you may have noticed I haven’t made a single comment about the elections.  That is because, as we have said before, we did not think that it would matter who won the election: the economy is likely to slow and stocks are likely to be priced more cheaply in the next three to six months.

The follow-up questions everyone is asking is: “But what do you expect now that Mr. Obama has been re-elected?  What about the Fiscal Cliff!” (Don’t you love the way the media has got cute names for everything now?)

The job of an investor is to stay unemotional and remain analytical.  Since the start of the recession in late 2008, most of the long-term economic decisions that need to be made — and which the entire media has made the topic of every conversation – must come from politicians. Somewhat logically therefore, investors have focused on political issues.

The problem is, the information that is published – in enormous volumes – is largely misinformation, disinformation, or sensationalized claptrap.  It is good for the media because people buy their products to eat up the latest “news.”  But just as magicians use sleight of hand to get the audience to focus on what the magician wants rather than watching what he really is doing with the coin that he is making disappear, so too do the politicians and media.

An investor’s job is to ignore the sleight of hand and stay focused on the information they can know – which relates to investments, not to political economic decisions.

So to answer the questions, “What about the fiscal cliff?” I answer, “call me when it happens.”  The fiscal cliff is the simultaneous cut in federal spending and ending of the Bush tax cuts.  Such a double economic punch would be hard on the U.S. economy and thus would be very bad for politicians.  Thus, the politicians will do something, although it likely will be mostly sleight of hand.

Thus, you must stay diversified because we think there is an economic slowdown happening.  If they really do nothing, and the automatic cuts and tax hikes take place, then the slowdown will become a recession, in which case we need to have fixed income investments (check – 1/3 of the average portfolio is in fixed income).  If they kick the can down the road, but really nothing or very little (most likely), the markets will relax, and the economy will continue its stop-start on again-off again rate of growth and we will need equities with defensive qualities but also and growth prospects and cash (check again).  This will of course lead to further concerns about inflation, which means precious metals and certain commodities need to be part of the equation (check a third time).

The key is to focus on the investments not on the politicians.  What management is doing to maintain and grow their businesses – this should be 85% – 90% of the investor’s focus with the last bit trained on what is the significance of what worldwide politicians do or don’t do.

This will not only produce better results, but will keep investors from getting too whipsawed in day-to-day volatility.


The Bottom Line…

We expect stock prices to move lower over the next few months but this should lead to some good opportunities.  We already have plenty of cash parked in short-term fixed income investments and money markets to take advantage of the opportunities as they present themselves.

We continue to hold some fixed income even with interest rates low as a hedge to the stock markets.  We also continue to own precious metals and commodities as a hedge for long term inflation – do not kid yourself, it is coming – which is building up regardless of what the “official” numbers tell you.


Alan E. Rosenfield, Managing Director


November 2012



Comments are closed.