May 2012 Investor Letter
April was the start of earnings season for the first quarter, which is when public companies report their quarterly results. Earnings season is by far one of the most chaotic times to be an investor because of the sheer volume of data that is being generated by the companies that we follow. It’s a whirlwind of events that lasts for roughly 30 days starting in the second week of April, July, October and January. During this time period a majority of the 5000 publicly traded US companies will issue a press release and hold an hour-long conference call in which management gives a recap of quarterly events and an update on forward outlook. All told, these 5000 companies may generate between three and seven thousand hours worth of data in the span of 720 physical hours. Surrounding the news flow the volatility of individual stocks can become extreme. It’s common that individual stocks will move up or down by double-digit percentage points in one day based on a quarterly miss or beat.
As longer-term investors, we make it a point to not lend too much weight to any single quarter’s results. Still, we operate in a marketplace that is dominated by those who do and therefore our companies will tend to get swept up in the frenzy. In such an environment the most important skill an investor can have is the presence of mind not to make capricious decisions. Decisions made based on half formed opinions can be particularly costly in an environment in which stocks may gain or lose one fifth of their value in a single trading session.
Earnings season is important to long term investors too though. From all this data we gain new insights into the companies that we own, ensure that the reasons that we own them are still valid and also gain insight into the general economy from some terrific management teams.
I wrote last month that I would be watching earnings closely for signs that my initial optimistic forecast for the year needed to be revised even higher. After listening to many companies describe their business and prospects, I am not convinced that it does. In general most companies have reported strong earnings, but not so strong as to justify significantly higher stock prices for the time being. Most companies seem to be reporting that the US is healthy, but that China is slowing and Europe is in recession. While it’s remarkable to see the US leading the global economy, it’s troublesome that two of the three largest global markets are showing signs of weakness. If our own recovery is expected to continue, either Europe or China will have to keep pace. I’m am skeptical that the US can detach from the rest of the world, especially considering that our economy continues to receive a large amount of stimulus in the form of large budget deficits and low interest rates. Looking further out, I am concerned that the European situation is a model for what could happen when stimulus is removed from our economy. In particular, England, which shares many attributes with our economy, entered a recession last quarter partially thanks to budget cuts.
In April, these concerns started to affect US equity prices. The S&P 500 fell 0.75% and was down as much as 3.5% at mid month. While our portfolios were not immune to this pullback, we do have extra cash to capitalize on it, and the good news is that global economic uncertainty has already brought the price of many desirable companies to levels that are attractive for our portfolios. I have been opportunistically beginning to purchase more shares of these companies in April and May. However, I am still conscious of adding too much general exposure to the market until I see a more broad-based selloff. I feel that patience is still key.
Scott Krisiloff, CFA