"The Market? Worry About Individual Stocks."

Sydney M. Williams

Thought of the Day

“The Market? Worry About Individual Stocks.”

January 20, 2011

At dinner recently a friend lamented that there seemed to be little fear in the marketplace. Being a value investor, fear portrays comfort, the absence of which makes him nervous. Perhaps his sense of complacency is real? I am uncertain but, I feel more agnostic. Certainly the anxiety that enmeshed investors in the fall of 2008, when the possibility of a total meltdown in financial markets was a real possibility, has naturally dissipated. But neither are we experiencing the jubilation that marked the waning months of the twentieth century, or even those halcyon weeks of late 2006 and early 2007 when complacency blanketed investors on the eve of the collapse in credit and housing.

Even longer dated Treasuries fail to evoke, in my mind, a sense of fear or fearlessness. The yield on the Thirty-year is 4.53%, up 100 basis points from last August when fear of stocks was higher (and up 200 basis points from December of 2008 when fear was rampant,) but 30 basis points lower than it was last April and more than 100 basis points lower than June 2007, just before credit problems first manifested themselves. However, a slow but improving economy, a declining dollar and rising food and energy prices suggest to me that 4.5% is not enough of a return for the risks I envision, but I profess no expertise in the Treasury market.

There does seem to be some fear – justly, in my opinion – as to the financial condition of some of our coastal states; though, again, as Laszlo Birinyi would say, when the problem has been as well publicized as this one, they are likely reflected in the prices of municipal bonds.

Commodity prices have generally done well – a function of a weak dollar, improving world economies, and generally low interest rates. Reversals of two of those three trends will likely impact prices. Gold and silver have recently modestly traded lower, though grains and energy trade near peaks. Also, as usual, it is difficult to assess how much of the price reflects real demand and how much represents speculation.

China is another case. They grew their economy 9.8% in the fourth quarter of 2010, better than expected. While China’s numbers suggest some inflation fears, its reported GDP never showed the effect of the worldwide slowdown the rest of us experienced. Nevertheless, the Shanghai Index is down 4.6% so far this year, after being down 14% last year and is 56% below its October 2007 peak. I am no China expert, but one cannot help wondering if their market is getting cheap, or is there legitimate concern that the consistency of their growth resembles too closely that of General Electric during the Jack Welch era?

Curiously, despite being social animals, it is agoraphobia that bothers many investors. We all yearn to be contrarians, afraid of the consequences of being drawn into the crowd. We live at a time when information flows quickly and broadly – with high speed trading platforms making even the most nimble of us looking like tortoises – it becomes difficult to gain an edge. Additionally, it becomes imperative to differentiate between what is relevant and what is not. Virtually instant changing psychologies make sentiment indicators seem like relics of the past. So flying alone seems increasingly difficult; the best way of doing so is simply to focus on individual securities.

Computers can graph charts, spew out prices, consider pre-programmed hedges and ensure that all investors receive the same information at the same moment. But it is difficult to program or quantify judgment, to consider the effect of markets on emotions, or to take the measure of the executive across the table. Stock investing is always about picking individuals names, not letting markets dictate opinions. Despite operating with myriad blinking machines providing instant information in terms of prices and news, investing for most of us is an old fashion business.

Regardless, the investment business should remain a growth industry. When one looks forward there is an enormous lack of liquid capital, capital that will be necessary to fund the retirements of millions of baby boomers. Hedgeye estimates that 102 million Americans have no money in retirement accounts. It has been estimated that 10,000 people will reach the age of 65 every day for the next eighteen years. If each individual required a million dollars in capital – a sum too small to support most in retirement – that suggests a need for $65 trillion, a number larger than the entire capital markets in the U.S. today. Defined contribution plans have effectively replaced defined benefit plans in corporate America. Can anyone doubt that similar pressure will not be felt by state and union workers? Should that come to pass, will not similar plans begin to gradually supplant Social Security? Retiring off the backs of current workers will increasingly be a function of the past. Such a need requires substantial changes in tax legislation. However, the added capital will prove beneficial in fueling entrepreneurs and businesses around the world

Markets never move in straight lines. There will be years of gains and years of losses. It has always been that way and always will. Leuthold Group, in their January 6, 2011 report, had an interesting chart. It indicates that when the Ten-year Treasury outperforms stocks over long periods of time, it is rare and has proven to be a good time to own stocks. The chart goes back to 1926 and, during the ensuing 84 years, there have been only three times when that has occurred – 1933, 1949 and 2009. However, one should never rely solely on charts. Their patterns, like rules, are often broken.

Nevertheless, it provides me some comfort that the environment, no matter how fearful or complacent, should remain conducive to stock picking.