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Written on 10-16-2018 by James M. Esler

Over the past two weeks, markets have hemmoraged value, with the Dow, S&P 500, and NASDAQ indices losing 5.9%, 6%, and 7.4% since October 3rd. Each day, the drop has gotten worse, and the reasons are mostly mercurial temperament. While true, the 10 year treasury rose to nearly 3.3% yield, there is no other reason that I have found for the ruination we have seen.

 
Because of this, I assume technical analysis is the culprit. Many professionals see the drop and cannot make a prognosis, which is, indeed, an incredible task! After poring over years of financial statements, I believe we should hold positions, and even buy more. The reason I consider buying more when there is much ‘blood in the street’ is due to technological innovation, the true catalyst for economic growth. Such optimism must be tempered, however, based on many unknowns.
 
To explain all of these things, I will take them one by one. Please note that I am not going to base any positions on predictions or technical analysis; further that to do such a thing would be identical to flipping a coin on a position.
 
1) 10 year yields: When long term yields rise, in effect this means that professional bond traders expect inflation to increase, selling long term bonds, typically in favor of money market instruments. Because bond traders are revered for ‘having intimate knowledge’, this has become a leading indicator of an economy. This may be true, but a movement from 3% to 3.2% in 10 year yield cannot warrant a drop of 7% in market value for an index. 
 
Conservatively, such a move in yield may reduce market value by as much as 1.5%, but even that is a stretch! Reason being because the cash flows that professionals assume must be static in relation to rising inflation. Each day, I read about reasons that cash flows must increase higher than previous projections. As time goes on, going concern corporations will always hit ‘record’ cash flows, and professionals should treat projections dynamically, not statically. After all, ‘inflation’ is just a fancy word for corporate input costs, and as such, the professional must decide which corporations will in fact have higher input costs! For example, to say that a tariff on consumer staples like fish or grains will effect a digital company as much or more than a company like General Mills is ridiculous. Howeer, a digital company like Salesforce trading at absurd multiples should be sold, though a company like Intel should not.
Thus, when entire indices fall based on rising inflation, many of the companies within the index may have offsetting positive catalysts to cash flow, or may be naturally less affected than other index constituents. 
 
2) Technical analysis: America (and much of the world) is in its longest bull market. Investors that I speak with have difficulty understanding how this time is different. 2008 was a result of horrible capitalism, and regulations have attempted to soften any blow that should befall investors when a real problem does happen. Based on increasing regulation, professionals should not expect such wide swings in market values; a recession of 20% market value reduction simply should not happen in a highly regulated capitalistic structure. 
 
Recessions are almost always caused by overleverage, and while consumer spending has never been higher, I believe this is a result of time and not leverage. Just as Bank of America’s earnings today are higher than in 2008, this does not mean that leverage is higher. Corporations are easily convering debt costs; Intel EBIT is covering over 85 times its interest costs and still returning over 20% net profit. This looks more like a company ready to thrive, rather than on top of a landmine! Similar to above, while an entire index falls based on a massive selloff, there will be companies that should have been sold and others that should not.
 
3) Technological Innovation: We are in the Data Revolution, and we are being forced to embrace it. The issues we are having with hacks and data protectionism are simply growing pains. To say that companies should not have access to our data is absurd in reality. This is tantamount to saying, “I will not wear shoes since there might be bad factory conditions.” The quality of life you receive from being online in exchange for your data is very much a good trade, in my opinion. We are in early days, where consumers still cannot understand that in order to receive a better online experience, it is necessary to provide data. 99% of internet based companies aggregate consumer data, and this will not change as long as people continue to surf the net. 
 
When a company has a hack, I consider it a huge positive in the long run! This means that the company can learn fro its failures. The companies that have the most hacks will create the strongest protections. In the future, consumers will use the companies that both use the most data with the safest data policies. However, most investors are not as open-minded as I am, and will continue to sell news on data misappropriations.
 
4) Knowing what you don’t know: The two largest unknowns are media coverage effects and ‘real’ government numbers. “The media have predicted 10 of the last 3 recessions”… The media coverage on everything, globally, has become outrageous. Professionals have no choice but to consider the effects on a country when the president says the wrong thing, no matter what the result. While coverage is all fact-based, the emotions and decisions that it engenders in investors cause market indecision. True, we are in a very long bull market, but this in itself cannot invalidate growth.
 
Government results like unemployment, inflation, GDP, payroll figures, etc. cannot be used reliably to determine either micro or macro investments. There simply are too many unknowns, causing many professionals to create their own models. The reason is that sources are completely arbitrary and results are not audited. If you reviewed a corporation that was not audited, you could not trust the results since there is such a temptation on their part to paint a rosy picture. Considering a government is an amalgamation of hundreds of thousands of corporations, I would argue that it is more useful to aggregate audited results on output rather than blindly trust enormous census data provided by governments. The IMF is even worse, and investors cannot trust their data as far as they can throw them. This is my conservative opinion, and I could be wrong!
 
For all of these reasons, investors must hold on through these fleeting moments of negativity. Earnings have begun and will likely be very good, once again. Keep in mind that I am not intending you to take positions based on any of the above; consult a professional to learn more and raise discussions. We are in a very good place overall, I believe. Perhaps we are still far off from a recession in general!

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