17 May 2002 The Weighing Machine
Benjamin Graham, called the father of fundamental investing, said, “in the short run the market is a voting machine; in the long run, it is a weighing machine.” A problem investors face today is that the ‘short run’ seems to be more like the long run. Just how much longer the wrenching ups and downs will go, no one can say, but it is clear that the longer it goes, more people leave in disgust.
The stock market crash of 1929 cost many people, among other things, their desire to invest. Its initial steep drop followed by short-lived ‘tease’ rallies ending lower than they started, were tortuous to those who remained convinced things would turn around. Ironically, just when the market was wringing out its last supporters, its greatest opportunities were developing.
For investors, these times are not unlike the market following the Crash of 1929. Clearly, our economy is not in the shape it was during the Great Depression, and we have countless benefits that were not available then, such as an economy supporting a workforce of 94% of Americans who wish to work. But there are lessons to be learned from investors of that time. During the last several weeks one could sense that confidence was being virtually sucked out of the markets. Down days followed down days. Good news was punished as an aberration.
The significant rally of last week was used as an opportunity to sell by many. The declines that followed for the two days remaining in the week seemed to vindicate the bears. But on Monday the market was up again, then Tuesday, followed by Wednesday and Thursday. Early in the week the short-sellers and put buyers were busy positioning themselves to capitalize on the short-lived excitement of yet another ‘bear trap’ (a brief rally of stock prices followed by the steep decline of a more powerful downtrend).
But something very subtle happened this week. The good news was treated as good while more plentiful bad news was ignored. The week started off with very good news as retail sales came in at twice what economists expected. The consumer continues to astound the experts. One of my favorite market experts, Don Hays, says that his #1 economist, the yield curve tells the story better than anything else. He means that short-term interest rates are very powerful motivators for consumer spending. Add that to their ability to spend (rising wages that are not inflationary), made possible by the truly remarkable productivity performance of the past several quarters and you have a winning combination.
By Wednesday the economic data was less optimistic than the retail sales data released on Tuesday, but it was not so bad. The CPI numbers were a bit higher than expected, but not so much to raise any red flags. Another measure of consumer activity is housing. Housing starts showed a fall-off in April, but only modestly from their record setting pace in the months prior. Mortgage rates remain low, so the catalyst for that industry remains in place.
Business inventories were down a bit more than expected, but industrial production was as expected and capacity utilization improved modestly. Business is improving, but at a much slower pace than earlier expected. Consequently, unemployment will remain a topic for concern longer than expected, as it lags recovery.
Our strategy remains the same. We are focused on owning companies that can grow their earnings over the next several years, have excellent management teams, and a capital structure that is sufficient to execute their growth plans. We are particularly aware of the emotions of this market and that investors can change their ‘vote’ about the future very often. But we hold firmly to Mr. Graham’s belief that the long run is viable and that the value of good companies will eventually be ‘weighed’ by the market.