by Hal Eddins, Managing Director, Capital Investment Council
Does pride come before the fall? The Bible suggests that it does and so do historical building patterns. Human nature dictates that people spend money when they are flush - not when things are tough. In the past, New York City has gone on building binges just before the stock market headed south. Here are the last three construction peaks in NYC: 1. the late 1980’s (anyone remember October 19, 1987). 2. The early 70’s before the 1974 bear market. 3. The early 1930’s, right before the great depression. We’ve written over the last few months about London ’s ascendancy in the financial world at New York ’s expense. Well, London appears to be partying like they did on the Titanic right before it met up with the iceberg: at last count, London has over 200 high rises under construction. Is this the sign of a market top? Only time will tell.
I think we can all agree that corporate profits have been fantastic this year. The question is how long can they keep going. There is historical precedent that a peak may be at hand. John Hussman of Hussman Funds notes: “corporate profits make up 10% of Gross Domestic Product. Whenever, profits have moved over 6% of GDP, the next three years have seen corporate profits grow at only 2.1% over the following three years.” Like the Jack Nicholson movie, this may be as good as it gets.
Peter Thiel is an interesting guy. He’s currently a hedge fund hotshot, but before that, he was the guy who ran and sold Pay Pal to Ebay. In other words, the kind of over achiever we all love to hate….just kidding. What I found particularly interesting is his basic theory of how markets work. Thiel’s work is based upon the work of Rene Girard and is called mimetic desire. The simple explanation is that our desire for certain products is driven by the desire of other people for those products. In other words, we want a Mercedes not because it is the best car in the world; we want a Mercedes because our co-worker or neighbor wants one. We can deny this behavior all we want, but that would probably lead us into deeper psychological issues which I won’t even begin to delve into! Thiel also believes that markets work on mimetic desire. People want to own stocks that other people want to own. Of course this usually leads to disaster in the long run, but it’s a good explanation of why housing stocks rallied so well over the last few years….before getting cut in half in 2006. The key is to identify desirable stocks before they become desirable. However, one must time one’s purchases carefully in order to avoid price downside. A good example would be Colgate. We purchased Colgate in late 2004. The economy was going great guns, and no one wanted to own a safety play like Colgate. We were able to buy in the low $40’s. Fast forward two years, and the economy has slowed, safety plays are now desirable and Colgate trades in the high $60’s. It’s all about timing and perception.
Much has been made about the inverted yield curve. The conventional wisdom is that an inverted curve means a recession lies ahead. That may be true, but then again it may not. Since 1970, every recession has been foretold by an inverted curve. The difference this time lies in the how much lower interest rates have been in the period preceding the economic slowdown. Since the curve inverted in July, the average yield on the 10 year U.S. Government Bond has been 4.6%. In the past, bond yields have tended to be much higher before the economy slowed down; in other words, excessive interest rates have been the cause of a slowdown. For example, the 1989 inversion had an average 10 year yield of 8%; that’s quite a difference. The good news is that our current economy may just miss a deeper recession and pull off a “soft landing”.
It’s funny how much marketing affects the asset management business. Anthony Bolton is the fund manager of Fidelity UK’s Special Situations Fund. Bolton ’s 26 year track record of 20.4% per year is within spitting distance of Warren Buffett’s record over the same time frame. However, Bolton is not a household name. That boils down to two factors: 1. He’s European and unlike the U.S.
, they don’t assign fund managers cult status and 2. Bolton does not fit easily into a style box. His mandate allows him to invest across almost all market caps and industries. Bolton attempts to sniff out value where ever he can find it. That’s where the problem lies. His job is to go out and make money, and he does so with ease. The hard part in today’s fund world is “packaging” him. It’s a shame that marketing often wins out over performance. I know that Capital Investment Counsel is sometimes thought of as a large cap manager. This is not true. Our current asset allocation includes a large number of big cap stocks, but stems from the cheap underlying value in those stocks currently. In fact, our latest buy is Fred’s Stores. Fred’s is a discount retailer sporting a market cap of $490 million. Our one constant is to buy companies with balance sheet strength, and that quality is not limited to large cap stocks. Thank you all for a wonderful year. We look forward to doing all over again in 2007.
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