It's always
darkest before the dawn (of earnings reports)
What to make of the last three months? Stocks hit a peak for the
year on April 23rd with a YTD gain of 9.8%. Over the next 10 weeks,
stocks fell 15.6%. Over the last week, stocks gained 7.2%, leaving
stocks down 0.7% on the year (all returns calculated on the S&P 500,
including dividends.) Net, our clients are nauseous! We think
stocks should reasonably grow 8%/year, but staying the course is tough
when stocks rise or fall 1-3%/day.
Investors in recent years have been trained to react (and over-react) to
every bit of daily data. In our opinion, three months is the
smallest useful unit of time for evaluating stock investments.
Why? Corporations only report revenues and earnings once every
three months. The data that comes out along the way may be useful
in tuning your analysis, but why would you buy a stock at 10AM and sell
at 3PM if you truly were an investor. (If you're a trader, short
term buys and sells are the norm, but in the current environment, you'll
probably be eaten alive.)
80% of earnings reports are delivered starting in the second weeks of
January, April, July and October, which means most companies are blacked
out on news in the proceeding 4 weeks. Occasionally, you'll get
pre-announcements about earnings, which are generally negative. So
we have learned to gauge the upcoming earnings reports based on the
volume of negative pre-announcements. In March 2010,
pre-announcements were few, and April earnings reports generally exceeded
expectations. In June 2010, pre-announcements were mostly
positive, which contrasts sharply with the bearish "macro view"
espoused by most analysts. Now we're a couple of days into earnings
reports, and Intel just released the best quarter in entire 42 year
history of the firm, with revenues and earnings exceeding forecasts, and
with bullish guidance for the rest of the year.
Zacks forecasts 2nd quarter earnings to gain 21.6% compared to Q2 2009,
and earnings for the year to grow 36.4% compared to 2009. The rate
of increase will slow in 2011, but will remain positive. So now all
the traders that shorted the market aggressively over the last weeks are
rushing to cover, and up stock prices go!
Macro analysis versus Micro analysis
We have long opined that "50% of stock returns come from being in
the markets, 30% come from sector performance (e.g. technology,
utilities) and only 20% comes from the individual stocks." On
that basis, many portfolio managers have abandoned researching individual
companies and simply make "Macro bets" where they will buy or
sell only at the sector or market level. Thanks to ETF's, you can
move your money that fast, but we're not convinced that you can generate
excess returns. Would you trade your house or your job or your
spouse on a day by day basis? No! People would think you were
crazy.
So why all the focus on macro investing? Since 2000, the research
departments of the major sell side firms have evaporated. We never
paid much attention to buy, sell or hold ratings, but there was much
useful detail in analysts' reports. Now you have to do your own
research, which is a lot harder than people think. Nuance does not
communicate well on television, which is the primary news source of most
investors these days. For example, the primary narrative on CNBC
these days is "whether the risk trade is on or off." If
the risk trade is on, then investors are supposed to sell Treasury bonds,
sell the dollar, sell gold, buy stocks (particularly emerging markets)
and buy other commodities. If the risk trade is off, then do the opposite.
You can have someone like Paul Krugman, Nouriel Roubini, Nassim Taleb or
Bill Gross sketch a bearish case for world GDP in 2 minutes. You
need 30 minutes for someone to explain how Intel's investments in state
of the art manufacturing facilities 5 years ago enabled the production of
leading edge chips that go into laptops with built in video conferencing
over Skype. Does anyone remember that AT&T first demonstrated
the "PicturePhone" at the 1964 World's Fair and that video
phone technology was featured in the 1968 2001:A Space Odyssey? The
future is here! And no one even notices.
Of course we pay attention to the macro picture. But we still think
there is value in micro analysis - researching individual companies at a
detailed level and trying to determine which companies have a reasonable
chance at growing faster than the overall market, but still have
reasonable valuations.
Strategy
The gold market looks like yet another bubble. Over the last
three years gold gained 85% while the broader Commodities Index (CRBI)
declined 19.8%. Most commodities trade based on industrial demand
(e.g. houses require copper for wiring) and even gold responds to demand
for jewelry and electronics. The current surge, however is more
related to the "fear factor" trade compounded by huge hedge
buying of gold futures. Where have we seen this before? Oil
touched $145/barrel in July 2008 based on hedge fund buying. 6
months later oil traded at $31.41/barrel before settling into the current
trading range of $70-$85/barrel.
Even after the rally of the last week, stocks still look cheap to
us. We expect the S&P 500 to close out 2010 with a gain of 8%,
which is 9% higher than current levels. The biggest psychological
burden on the stock market right now is the continued poor recovery of
the US jobs market. However, corporations flush with cash and with
surging revenues and earnings, are a buy. If we waited until
unemployment fell back to 4% before investing, we would most likely miss
out on huge gains in stocks.
As always,
please don't hesitate to call with questions and concerns.
Yours sincerely,
David
Edwards
President
The HERON FINANCIAL GROUP Financial Markets
Commentary is published following month end and when market
conditions require comment. The views expressed in this letter represent
HFG opinion and strategy as of the date published and can change at any
time upon receipt of new information. Data quoted in this letter are from
sources deemed reliable, but no guarantee of such data is implied.
HERON
FINANCIAL GROUP, LLC, is an SEC registered investment
advisor providing fully managed investment and wealth management services
to individuals, families, trusts, defined benefit plans and
corporations.
