03 May 2002 The Labyrinth
My wife recently constructed a beautiful labyrinth in our garden. Labyrinths have been around for thousands of years and are found in almost all religious traditions as well as cultures including Native American, Greek, Celtic and Mayan. Like Stonehenge and the pyramids, they are magical geometric forms that define sacred space. When one walks a labyrinth, he meanders back and forth, turning 180 degrees each time he enters a new circuit. Changes in direction induce shifts in states of awareness.
Both the American Heritage and Webster’s dictionaries miss the concept of the labyrinth defining it as “something highly intricate or convoluted in character, composition, or construction.” They liken it more to a maze, which is comprised of dead ends and trick turns. Sounds more like a bear market, doesn’t it?
The labyrinth has only one path leading to the center and back again, but it is ordered. The journey through the labyrinth is purposeful and fulfilling while the maze invokes conflict and frustration.
The last two years have all too often felt maze-like, fraught with frustrations, dead ends, and trick turns. In this maze I have fought the market’s ugly turns rather than accepting them on their own terms. Our buy-and-hold growth strategy that worked so well during the 80’s and 90’s seemed to be broken. In reality, it was not broken, but it was inflexible and too narrow to find opportunities that were waiting down new and unfamiliar paths.
In the last several briefs I have highlighted a number of changes in the tactics we use to identify opportunities as well as to mitigate risk. In short, we are looking in new areas to find exciting new investment possibilities that work given the current market and economic conditions. We are also invoking measures to stop losses and to reduce volatility and risk. By accepting the realities of today’s markets and adjusting our short-range tactics to better navigate the twists and turns, we are in much better stead than if we held to our more rigid non-market timing approach.
It is difficult to express what a dramatic difference these changes have made personally as well as in our expected results. It is always easier to work with and use forces greater than one’s self than it is to fight them, but all too often we choose to fight. It is increasingly apparent that this market will continue its malaise for months (possibly years) to come. But there are exciting opportunities for appreciation beneath the news headlines of accounting woes, technology bubbles, war, and terror. It is my intention to locate and own these opportunities while minimizing, to the extent possible, today’s market risks in our portfolios. The market feels more like a labyrinth now than a maze.
Economic signs released over the past several weeks have raised more questions than they have answered. The strong GDP number last week of 5.8% was primarily attributed to government spending in support of the war on terror with the added push of the corporate inventory buildup. It was a wonderful surprise on the upside, but most wonder if the business economy can support itself once the inventory build is complete. In other words, will the end demand for goods pick up in time to sustain the momentum enjoyed in the first quarter?
As you can see in the chart below, there are a number of orange coded economic numbers. Though they represent cautionary signals, they are not so bad to indicate the economy is going back into a period of contraction.
Dow Jones & Co. reports that the net of income and losses of 1,146 U.S. companies in their Dow Jones Global Market Index was a loss of $3.2 billion through May 1st. The companies were collectively in the red for the first time since the first quarter of 1992. That compares with profits of $26.7 billion during the first quarter of 2001. The Wall Street Journal points out that most analysts ignore one-time charges altogether. Using this approach, year-over-year declines aren’t as bad as they were in 2001. When looking at the change from one quarter to the next — the approach preferred by economists — earnings might even be improving.
After 417 of the S&P 500 companies reported earnings in April, operating earnings, which exclude write-offs and other one-time charges, were on track to finish the first quarter at $103 billion, according to Thomson Financial/First Call. That would be down 12% from a year earlier, compared with a year-over-year decline of 22% in the fourth quarter. First Call’s first-quarter number is likely to be up from the fourth quarter, a point that economists focus on. Taking accounting changes and seasonal patterns into account, First Call analysts say that operating profits for the first quarter are about flat with the fourth quarter. “We are bottoming,” says Chuck Hill, director of research at First Call. But he adds, “the slope of recovery is up for grabs.”