Earnings season, such as it
is, has begun, and the most significant dichotomy we are witnessing is between
companies that must reduce prices to
incent consumption versus those that must
raise prices to cover costs and remain in business. Neither scenario is very good for
earnings-driven investors, only one works to the benefit of the corporation,
both might accrue, ultimately, to the
consumer. None of them, however, drive
confidence and stock activity.
If you must choose sides, (and
that ultimately is what business I’m in), the right outcome for equity
performance is to select companies that are raising prices. That, at the very least, indicates a modicum
of pent-up consumer demand, and answers many demographic questions about a corporation’s
relevance within a hierarchy of business needs.
It also becomes inflationary, which underscores a host
of other factors regarding viability, borrowing expenses, and profitability.
Portfolio
process.
Although our mandate is to make the correct bet on
earnings outcomes, suffice it to say that individual equity outcomes mean far
less than does the prevailing secular trend within which they exist. On a general
level, we know that demand is down, production values are stretched as tightly
as they can get, and corporate cash levels are less than abundant. Recognizing the current limitations of the
global economy, we have to build both portfolios and portfolio expectations
that accurately reflect the prospects for debt-ridden economic development in the
future.
This sets up a tug of war
between deflation (a reduction in all costs
and expenses) and inflation. The
headwinds facing an economic rejuvenation are quite strong. We are clearly in transition from unabated
spending and consumption towards what pundits call a “new behavioral
paradigm.” The progress we make will be
the direct result of recognizing a new normalcy, a financial upheaval that
yields results and profits for
corporations and citizens, alike.
As a result, I have
significantly rebalanced portfolios to look more short-term oriented. Maturity
scales in our bond portfolios are between 1-3 years in most cases, while stock
trading has supplanted buy-and-hold.
My metrics have become more staccato in the short-term, while longer
term secularity has turned decidedly more bearish. Volatility and diversification are two
hallmarks of equity trading right now.
We all pay.
It is unlikely that my
inflation scenario will manifest anytime soon in conventional reports. But each of us has anecdotal experience with
the dry cleaner, movie theatre, university, insurance company, transit
authority, electric utility, telephone provider, luncheonette, and pharmacy to
indicate that prices are not declining when it matters most. To be sure, the “discounters” might be trying
to incentivize our spending by lowering costs, but it’s not working anyway, at
least to the degree in which economic stimulus ripples past their front door.
Equities, and the economy, are
at a critical spot. Already in a secular
downleg, equities are failing to gain traction on the way down sufficient to
reverse the trend in the near-term.
Therefore, I would expect relative underperformance from stocks for the
foreseeable future.
In the absence of any real
catalysts otherwise, my enthusiasm is restrained by persistent and contagious
corrections within the cycle that we simply have to endure before we might
expect any meaningful upside reversals.
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