U.S. Equity Market Cheat Sheet (September 19, 2011)

Sunday, September 18th, 2011

U.S. Equity Market Cheat Sheet (September 19, 2011)

The domestic stock market was higher this week with the S&P 500 Index up by 5.35 percent. The figure below shows the performance of each sector in the index for the week. All ten sectors increased. The best-performing sector for the week was technology which increased 7.05 percent. Other top-three sectors were consumer discretionary and industrials. Consumer staples was the worst performer, up 3.39 percent. Other bottom-three performers were health care and energy.

Within the technology sector the best-performing stock was Tellabs Inc, up 12.56 percent. Other top-five performers were F5 Networks, Jabil Circuit, FLIR Systems and Motorola Solutions.

Strengths

• The publishing & printing group was the best-performing group for the week, up 13 percent, led by McGraw-Hill Companies, which said it would separate into two companies with one focused on education and the other on financial ratings and data.
• The electronic equipment & instruments group outperformed, rising 12 percent, driven by its single member, FLIR Systems A brokerage firm report stated that this week a government website announced a $21 million Army award to FLIR for 48 infrared Star SAFIRE II night vision and infrared camera systems.
• The airlines group rose 11 percent, led by its single member Southwest Airlines. This week at an investor conference, airline executives provided guidance that capacity cuts already planned for the fall would continue into next year.

Weaknesses

• The health care facilities group was the worst performer, losing 5 percent on weakness in its single member, Tenet Healthcare. The company told investors that adjusted EBITDA for 2011 is expected to be toward the lower end of its previously communicated range. Tenet was impacted by an unfavorable mix shift including significant growth in Medicaid volumes (less profitable) and below average levels of Medicare acuity in July and August.
• The residential REITS (real estate investment trusts) group declined 2 percent. A brokerage firm report on apartment REITS said the multiple of price to funds from operations (FFO) is at a 34 percent premium to the REIT sector average, well above the 10 percent relative multiple premium experienced over the past 17 years.
• The oil & gas refining and marketing group underperformed, down 1 percent. The weakness in refiners is likely related to a recent decline in the still relatively high spread between the cost of crude oil and the selling price of refined product.

Opportunities

• There may be an opportunity for gain in merger & acquisition (M&A) transactions in 2011. Corporate liquidity is high, thereby providing the means to pursue acquisitions.

Threats

• A mid-cycle slowdown in the domestic economy would be negative for stocks.
• An escalation in concerns over sovereign debt obligations in Europe would be negative for stocks.

Tags: Airline Executives, Army Award, Brokerage Firm, Conference Airline, Consumer Staples, Crude Oil, Domestic Stock Market, F5 Networks, Facilities Group, Flir Systems, Health Care Facilities, Infrared Camera, Investor Conference, Jabil Circuit, Mcgraw Hill Companies, Performing Group, Printing Group, Safire, Southwest Airlines, Tellabs Inc, Tenet Healthcare
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Howard Marks: “How Quickly They Forget”

Tuesday, June 7th, 2011

Memo to: Oaktree Clients
From: Howard Marks
Re: How Quickly They Forget

***

In January 2004 I received a letter from Warren Buffett (how’s that for name dropping?) in which he wrote, “I’ve commented about junk bonds that last year’s weeds have become this year’s flowers. I liked them better when they were weeds.”

Warren’s phrasings are always the clearest, catchiest and most on-target, and I thought this Buffettism captured the thought particularly well. Thus for Oaktree’s 2004 investor conference we used the phrase “Yesterday’s Weeds . . . Today’s Flowers” as the title of a slide depicting the snapback of high yield bonds. It showed the 45% average yield at which a sample of ten bonds could have been bought during the Enron-plus-telecom meltdown of 2002 and the 6% average yield at which they could have been sold in 2003; on average, the yields had fallen by 87% in just thirteen months. The idea went full-circle in 2005, when Warren used our slide at the Berkshire Hathaway annual meeting to illustrate how rapidly things can change in the world of investing.

And that’s the point of this memo. Asset prices fluctuate much more than fundamentals. This happens because, rather than applying moderation and balancing greed against fear, euphoria against depression, and risk tolerance against risk aversion, investors tend to oscillate wildly between the extremes. They apply optimism when things are going well in the world (elevating prices beyond reason) and pessimism when things are going poorly (depressing prices unreasonably). Shortness of memory plays a major part in abetting these swings. If investors remembered past bubbles and busts and their causes, and learned from them, the swings would moderate. But, in short, they don’t. And they may be forgetting again.

High yield bonds and many other investment media have once again gone from being weeds to flowers – from pariahs to market darlings – and it happened in a startlingly short period of time. As is so often the case, things that investors wouldn’t touch in the depths of the crisis in late 2008 now strike them as good buys at twice the price. The swing of this pendulum recurs regularly and creates some of the greatest opportunities to lose or gain. Thus we must always be mindful.

The Importance – and Shortcomings – of Investment Memory

A number of my favorite quotations are on the subject of history and memory, and I’ve used them all in past memos. Humorist and author Mark Twain talked about the relevance of the past:

History doesn’t repeat itself, but it does rhyme.

The philosopher Santayana stressed the penalty for failing to attach sufficient importance to history:

Those who cannot remember the past are condemned to repeat it.

And economist John Kenneth Galbraith described the shabby way investors treat history and those who consider it important:

Contributing to . . . euphoria are two further factors little noted in our time or in past times. The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.

String together these three pearls of wisdom and you get a pretty accurate picture of investment reality. Past patterns tend to recur. If you ignore that fact, you’re likely to fall prey to those patterns rather than benefit from them. But when markets get cooking, the lessons of the past are readily dismissed. These are nothing short of eternal verities, and their collective message is indispensible.

Why Does Investment Memory Fail?

Think back to the emotions you felt so strongly during the recent financial crisis, and the terrifying events that brought them on. You swore at the time that you’d never forget, and yet their memory has receded and nowadays has relatively little influence on your decisions. Why does the collective memory of investment experiences – and especially the unpleasant ones – fade so thoroughly? There are a number of reasons.

• First, there’s investor demographics. When the stock market declined for three straight years in 2000-02, for example, it had been almost seventy years since that had last happened in the Great Depression. Clearly, very few investors who were old enough to experience the first such episode were around for the second.

For another example, I believe a prime contributor to the powerful equity bull market of the 1990s and its culmination in the tech bubble of 1999 was the fact that in the quarter century from 1975 through 1999, the S&P 500 saw only three minor annual declines: 6.4% in 1977, 4.2% in 1981, and 2.8% in 1990. In order to have experienced a bear market, an investor had to have been in the industry by 1974, when the index lost 24.3%, but the vast majority of 1999’s investment professionals doubtless had less than the requisite 26 years of experience and thus had never seen stocks suffer a decline of real consequence.

• Second, the human mind seems to be very good at suppressing unpleasant memories. This is unfortunate, because unpleasant experiences are the source of the most important lessons. When I was in army basic training, I was sure the memories would remain vivid and provide material for a great book. Two months later they had disappeared. After the fact, we may remember intellectually but not emotionally: that is, the facts but not their impact.

• Finally, the important lessons of the past have to fight an uphill battle against human nature, and especially greed. Memories of crises tell us to apply prudence, patience, moderation and conservatism. But these things seem decidedly outdated when the market’s in a bull phase and risk bearing is paying off, and if practiced they appear to yield nothing but opportunity costs.

Charlie Munger contributed a great quote to my recent book, from Demosthenes: “Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true.” In other words, there’s a powerful tendency to believe that which could make one rich if it were true.

I’ve tried to spend the last 42 years with my eyes open and my memory engaged. As a result, a lot of what I write is based on recognition of past patterns. It’s time to put my recollections to work, because I’m definitely seeing a trend in the direction of Galbraith’s “same or closely similar circumstances.”

The Not-So-Distant Past

It seems it was impossible – unless you were John Paulson – to escape entirely unscathed from the financial crisis of 2007-08. Most investors could only hope to have turned cautious in the run-up to the crisis, sold assets, increased the defensiveness of their remaining holdings, reduced or eschewed leverage, and secured capital with which to buy at the bottom in order to benefit from the subsequent recovery.

What might have prompted investors to do these things in advance of the mid-2007 onset of the crisis? Almost no one fully foresaw the impending subprime meltdown, and few macro-forecasts and market analyses were sufficiently pessimistic. Rather, I think investors would have been most likely to take the appropriate actions if they were aware of the pro-risk behavior taking place around them.

Tags: Asset Prices, Berkshire Hathaway, Berkshire Hathaway Annual Meeting, Busts, Darlings, Depressing Prices, Euphoria, High Yield Bonds, Investment Media, Investor Conference, Junk Bonds, Pariahs, Pessimism, Risk Aversion, Risk Tolerance, Snapback, Target, Thirteen Months, Warren Buffett, Weeds
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U.S. Equity Market Cheat Sheet (February 28, 2011)

Sunday, February 27th, 2011

U.S. Equity Market Cheat Sheet (February 28, 2011)

The figure shows the performance of each sector in the S&P 500 Index for the week. One sector increased while nine decreased. The lone sector with positive performance was energy, up 1.07 percent. Sectors with the lightest declines were utilities and consumer staples. The industrials sector was the worst performer, down 3.31 percent. Other bottom-three performers were financials and materials.

Within the energy sector, the best-performing stock was Chesapeake Energy, which rose 16.23 percent. Other top-five performers were Range Resources, Cabot Oil & Gas, Consol Energy and Rowan Companies.

Strengths

• The specialty consumer services (H&R Block) was the best-performing group for the week, up 4 percent. The tax preparer said it expects “near break-even” results for its fiscal quarter-ended January 31, 2010.
• Five of the top-ten best-performing groups were energy-related (oil & gas exploration & production, oil & gas drilling, coal & consumable fuel, oil & gas storage & transportation, and integrated oil & gas). These groups rose between 0.8 percent and 4 percent as the price of crude oil rose during the week.
• The packaged foods group outperformed, gaining 2 percent. The CEO for H.J. Heinz Co. said at an investor conference that the company expects third-quarter profit around 84 cents, beating expectations. Heinz also increased its full-year profit outlook.

Weaknesses

• The gold group (Newmont Mining) was the worst-performing group, down 7 percent.
• The homebuilding group underperformed, losing 7 percent. The Commerce Department reported that January new home sales declined 12.6 percent from December to 284,000 units. This was below the 305,000 unit consensus estimate.
• The airlines group (Southwest Airlines) was down 6 percent. The price of jet fuel is rising due to rising crude oil prices and is threatening airline profits.

Opportunities

• There may be an opportunity for gain in merger & acquisition (M&A) transactions in 2011. Corporate liquidity is high, thereby providing the means to pursue acquisitions.

Threats

• Should investors’ expectations for an improving economy not come to fruition on a reasonable time frame, it could be a threat to stock prices.
• Quantitative easing currently being implemented by the Federal Reserve might result in unintended consequences.

Tags: Airline Profits, Cabot Oil, Chesapeake Energy, Consensus Estimate, Consol Energy, Consumer Staples, Crude Oil Prices, energy, Gas Drilling, Gas Storage, Gold, Gold Group, H J Heinz, H J Heinz Co, Investor Conference, Newmont Mining, oil, Performing Group, Price Of Crude Oil, Profit Outlook, Range Resources, Rowan Companies, Southwest Airlines
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