The Weekly Report: A look at the bright side

6 December 2011


Is cautious optimism an oxymoron? We live in a world so uncertain that maybe we even have to question the validity of that phrase so commonly used in business and finance circles.

The market looks very much like a panorama from a perch at the Lady Young or Chancellor Hill lookout during rainy season: the overall picture is fairly sunny, but a very large, very dark cloud system looms ominously on the horizon. That cloud system is, of course, Europe. Will the clouds bring rain and another round of widespread flooding? Or will it hover over the Gulf and then suddenly veer off to Venezuela or points unknown? That is the trillion dollar question that drives the wild swings we have seen in the market.

One could argue that as humans, one of our cognitive biases when confronted with the unknown is fear and despair. Certainly, looking at the media you’d come to the conclusion that we are approaching doomsday—maybe because journalists genuinely believe so, or maybe because bad news sells more copy. A well known adage is that fear and greed are what drives markets. However, Warren Buffett, the most successful investor in recent history, has been known to say you want to be fearful when others are greedy; and greedy when others are fearful. He has certainly been greedy in the last 2 years, making a number of large acquisitions and saying publicly that he is shopping for several more buys (at $10 billion USD each) in the next year.

2011 will end one of the most indecisively volatile market years in the last few decades; at least in 2008 there was a clear direction (down). Many of Carnival 2011’s biggest tunes would be a fitting soundtrack for the year’s market:  the market was acting overly Wotless, at times even Advantageous, forcing many traders to Wine to the Side with losses. To paraphrase Lil’ Rick’s massive Cropover tune, right when you thought the market would keep Going Down, it would suddenly reverse gears and come up, leaving those who were short the market teetering, almost like someone who was a bit too early and enthusiastic in raiding their cooler. I’m sure more than a few traders and investors spent some sleepless nights asking the market who taught it to wine like that—maybe it’s Ben Lion wining down to the ground and mashing up the place in a last act of vengeance, from beyond the grave.

Wry attempts at stale humour aside, the market lost 9 % in the three weeks leading up to the U.S. Thanksgiving holiday, and in fact the Thanksgiving week was the worst one on record for the S&P, which gave up a whopping 4 %. This was spurred by political issues in the ‘developed’ world, where the US legislature failed yet again to agree on the pace and scope of expenditure reductions; and the inherent design flaws of the European Union prevented its various sovereign actors from agreeing on how to resolve a worsening contagion (a fiscal dengue outbreak, if you will).

However, the market has since rebounded 7 % and seems poised to improve further given an encouraging reduction in unemployment to 8.6 %, the lowest number since President Obama took office in early 2009 amidst the worst financial and economic crisis since the Great Depression.

This reduction in unemployment is yet another data point that has seemingly gone unnoticed by the media and the public at large—in the short and medium term, things aren’t quite as bad as they seem and in fact have been gaining momentum to the positive side. New home sales have improved for 5 consecutive months, and existing home sales are also firming up. TARP and the other bailout schemes have been completely repaid and with a lagniappe north of 12 %, even with some institutions still on life support but continuing to make improvements (AIG, we are looking at you).

Maybe President Obama’s next career move should be hedge fund manager? A 12 % return in 2 years on several hundred billion dollars in capital deployed is nothing to sneeze at.

Manufacturing has improved markedly and consistently beat expectations, as Japan continues to come back on stream following the devastating earthquake and tsunami earlier this year. The Index of Leading Economic Indicators, which focuses on short and medium term prospects, has improved for six months in a row and the consensus is that it will continue to do so into the spring. The composite profit margin for companies in the S&P 500 is at an all time high of 8.9 %, and many large companies sit on large accumulations of cash, at times the most cash they have ever had in history (even adjusting for inflation).

To quote one of the best movie villains in recent history: why so serious? Why does the market continue to act so erratically in light of some very encouraging developments? Yes, political certainty is behind a lot of it…but that is short term, and if you believe in humans’ survival instinct and evolutionary tilt towards self interest and self preservation, it’s hard to see how European and American political leaders will allow their respective governments, societies and economies to fail.

Markets tend to discount longer term events very heavily as well, and in fact, this is what gets spoken about even less in the media than the improving economic picture and outlook. Household debt to GDP ratios for Europe and the US are still close to all time highs, despite massive restructuring and deleveraging in the banking system. In the longer term, and speaking very generally, extreme data points tend to revert towards some sort of historical mean or average. If this is the case, we still have a long road ahead, fraught with instability, volatility, and almost certainly more sovereign and financial institution solvency issues.

So what is the takeaway from this seemingly endless blog post?

Canta mientras puedas or sing while you can, as they say in Spanish speaking countries—could be loosely translated into Trini as ‘make mas while you able.’ Enjoy the rallies, position yourself to take advantage of some explosive moves upwards in the coming months, but be prepared for more volatility: either keep your eye firmly on the exit, or firmly on the longer term.

If you want to find out how exactly we’re making mas while we’re able at Firstline, invest with us. Send me an email (michael.cooper@nullfirstlinesecurities.com) or give us a call @ 628-1175.

Michael J. Cooper
Analyst

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