Persuasion Time

I’ve never been a huge fan of winter sports (unless you include bowling!).  Despite spending all of my growing up years in the Big Sky Country of Montana, and wading through tons of deep snow, I was never big into skiing, ice skating, hunting, camping, hiking, fishing and the like (misspent youth, I know).  So whenever the Winter Olympic Games rolled around, I met the event with somewhat mixed feelings.  Ski jumping was pretty exciting.  Figure skating had its moments.  But usually the thrill of victory and agony of defeat featured in the Winter Games did not thrill me.

Then I discovered curling.

Wikipedia says it best, “Curling is a team Olympic sport in which stones are slid across a sheet of carefully prepared ice towards a target area.  Two teams of four players take turns sliding heavy, polished blue hone granite stones across the ice towards the house (a circular target marked on the ice). The purpose is to complete each end (delivery of eight or ten stones for each team) with the team’s stones closer to the center of the house than the other team’s stones. Two sweepers with brooms or brushes accompany each stone and use stopwatches and their best judgment, along with direction from their teammates, to help direct the stones to their resting place, but without touching the stones.”

It sounds kind of weird on paper, but watching it is even weirder.  The action (?!) of curling seems like some alternate reality mash up of shuffleboard and sweeping the kitchen floor.  Yelling seems to be a big part of the sport as does looking more like an indie pop singer than an Olympic athlete.  It’s rather difficult to imagine what kind of fitness routine curlers go through to prepare for the games, but I suspect they spend less time in the weight room or on the track than do other Olympians.  I mention none of this to be critical or degrading; I really, truly enjoy watching the sport/game.

For me, there is something elegant in the precision of the game.  It’s clearly a sport which requires more finesse, than flash; more strategy than strength.  The fact that the Norwegians are good at it is also a plus (I’m one-fourth Norwegian).  And the contrarian in me is naturally drawn to off-beat activities such as curling.

As I was watching the match between the US and France, I started thinking that curling is a little like investing.  And as I pondered on this a bit more, I realized that curlers are a lot like professional investors.  I see three points of similarity:

1)      What they do looks easy. If curling were just like shuffleboard, it would not be an Olympic sport.  There is clearly a lot more skill and strategy involved than just sliding a big granite stone down the ice.  Many think that stock picking is also a simple exercise.  Just find a stock with a good story and buy it.  Make money.  The fact the some people with no investment background, training or expertise can make money by buying a stock re-enforces the notion that investing is easy.  It’s not.

2)      They use unusual tools to do their job. Who else brings a broom to an Olympic contest?  What else is on the curler’s equipment check list?  42-pound curling stone? Check.  A pair shoes with different soles (one for sliding, one gripping the ice)? Check. Flashy golf pants?  Check.  The tools for the professional investor may seem as arcane to the average person:  free cash flow analysis, beta, intangibles on the balance sheet, off-balance sheet items, DuPont ROE calculations, earnings yield, insider transactions, sentiment measures, technical analysis, and so forth.  The work behind picking a stock is much more than just finding a good story, but it is work not easily appreciated by the casual observer.

3)      Strategy is paramount. To be successful, curlers need to anticipate the moves their opponents might take a few turns out.  Simply executing the game plan will not be enough to win.  They must be flexible and react to changes in the position of the stones, or modify the plan when they own execution is imperfect.  Likewise, professional investors need to figure out what the market is telling them and what it might do in the future.  Inevitably, the market will make some unexpected moves which require the investor to be flexible, nimble and opportunistic.

I hope that all you curling fans out there will totally enjoy the rest of the Olympic games, and perhaps as you watch a few of the remaining matches, you will take a moment to consider the hard working professional investor who, metaphorically at least, is trying hard to put the stones in the right place in the house.

As the Washington DC area continues to struggle with record snowfall (wither global warming??), the stock market seems to be struggling with its own issues.  At some level, a pause from the dramatic and record-breaking rise from March of last year is needed and even welcomed.  Yet, as the market consolidates a bit, the volume from the bear camp has begun to rise, as it usually does when the market stops going up.  Although we know that corrections and consolidations within the context of a new bull market are normal and expected, when they happen, new concerns inevitably arise. Will the US government budget deficit choke off economic growth?  Will lack of job growth do the same?  Is inflation going to be a huge problem?  Will deflation be a greater threat?  So on and so forth…

One of my recurring themes is the idea that at any point in time there are always positives and negatives to the market outlook.  When the market rises, we tend to de-emphasis the negatives, and in times like these, the positives seem to have less power.  To be brutally logical, nothing in the economy has markedly changed since the S&P 500 hit its recent high on January 19^th.  The US economy is like a big supertanker – it does not make quick turns.  What has changed is sentiment and the appetite for risk.  At the margin, the incremental buyer of stocks has turned less bullish than before. I submit that the reason for this slight shift has more to do with psychology than economics, but since accurately measuring the human psyche is way beyond my skill set, let me reiterate a few of the non-psychological positives as I see them:

1)      Employment. True to my contrarian nature, I put forth the employment situation as my first positive.  Everyone “knows” that the job picture is bad and will probably remain bad forever (!).  The data, however, tells another picture.  The chart below depicts the jobs data from over the last few years.  Although jobs are not yet being created, the improvement in the nonfarm payrolls number from January 2009 and the unemployment rate from July is unmistakable.  Remember that the stock market does not need good news, when less bad news will do.

Nonfarm Payrolls: Monthly and Yearly Change

2)      Interest Rates. Although the consensus seems to think that rates must rise, they haven’t yet and this simple fact can aid stock valuations.  Investors are willing to pay a higher P/E for stocks in a low-rate environment.  To the extent that rates do not rise quickly or by a large amount, stocks stand to benefit even more.

3)      Earnings. Corporations have been posting surprisingly strong earnings since early 2009.  Granted much of the gains have been realized by aggressive cost cutting, but in my view that still counts!  The latest round of results has been tainted in some cases by disappointing revenue growth.  Ultimately, sales will need to grow to maintain earnings growth.  Yet, as we approach the anniversary the Q1 2009 results, we will face extremely easy comparisons.  The April results should make the economy look very, very strong.  I am not sure that investors will be able to view these results as anything other than very, very positive.

4)      Cash. Despite record-low yields on cash and other low-risk assets, investors appear to love the stuff.  According to some sources, investors may have as much as $10 trillion saved up in cash and its cousins.  This is roughly the same amount of money as the entire S&P 500.  Granted, not all of this money will find its way into the stock market, but just some of it would be enough new fodder to move share prices higher.  When does this happen?  No idea.  But I suspect that a resumption of good news on earnings (April?) and/or any improvement in the economic data might be sufficient reason for some of this cash to find a new home in the stock market.  We also learned that, at the same time investors are sitting on a huge pile of cash, corporations are generating record cash themselves.  According to Bloomberg News, US corporations in the four quarters ending September 2009, produced $1.29 trillion in cash.  Companies have a number of options with this cash – they can sit on it like investors are, re-invest in their business (which will lead to higher earnings), or use it to buy other companies.  In my view, the latter two options are very bullish for stock prices.

It may take a while for investors to sort out all the mixed signals and emotions they currently face.  Maybe the market will be stuck in a trading range for a while.  I continue to think that the resolution of these crosswinds will be positive for the market.

Although each year brings new and unique challenges and opportunities, the market sometimes displays familiar patterns.  The stock market’s action in 2009 was similar to 2003, which was another recovery year.  Could 2010 be like 2004, a year of consolidation?  Time will tell.  Note that despite all the backing and filling seen in 2004, the market was able to post a double-digit total return for the year.  Here’s a chart for your reference:

In the investment world, certainty is a rare commodity.  Exactly because investing is an exercise in probabilities, we rarely know what’s going to happen.  That’s not to suggest that investors are clueless about the future; indeed we have impressions, feelings, thoughts, concerns and ideas about what may happen, but do we ever really know what’s going to happen?  Rarely.

This is one reason I think Jim Cramer is so popular – he is selling certainty in an uncertain world.  Now, I would never follow any of his investment recommendations, but he certainly exudes confidence and reason about the stocks he recommends.  All the “boo-ya” antics aside, I find him rather entertaining, and I will admit that he has raised awareness among individual investors about the important issues surrounding the investment process.  For more about my feelings regarding those who offer “free” investment advice please refer to this blog.

Because the investment process is encircled by so much uncertainty, investors will often grasp at something that appears to be solid.  The “January Effect” is one example of these “somethings.”  Simply put, the January Effect is the notion that the market usually rises in the month of January and that a good performance by the market in January bodes well for the entire year.  Over the last 60 years, when January logged a positive performance, the market was higher for the full year about 90% of the time.  When the market fell in January, the full year showed a negative return about 55% of the time.

Another similar phenomenon is the “Super Bowl Effect.”  More often than not, the stock market rises in the years when a team from the old National Football League (now the NFC) wins the Super Bowl.  Hence, equity investors may have another reason to cheer for the New Orleans Saints this year.  There are other “somethings” out there like the “Presidential Year Effect,” the “Halloween Indicator,” the “Mark Twain” effect and so forth.  All of these observations are simple attempts to bring more certainty into the stock market.  All of these things are also totally absurd, fun perhaps, but absurd.

They are classic examples of “correlation without causation.” The crowing of the rooster may be highly correlated with the rising sun, but the bird’s cry does not cause the sun to rise.  Every year ice cream sales and accidental drownings show a remarkable correlation.  Does eating ice cream cause drowning?  Clearly not, but they both tend to rise during the summer months.

Just because two effects appear to be correlated does not mean they are related.  Now, I enjoy chatting about the “January Effect” as much as the next person.  In fact, I find all of these observations and anomalies quite entertaining, but I do not use them at all in my investment decision making process.  For that I stick to the things I believe truly matter for the stock market – interest rates, corporate earnings, supply/demand factors, cash levels and sentiment.

And, despite the market’s action in January, I remain encouraged about the outlook for stocks.  This is based on my belief that most of the above factors are supportive and are likely to remain mostly supportive of higher stock prices into the future.