This note was originally published at 8am on September 28, 2012 for Hedgeye subscribers.
“A great number of people think they are thinking when they are merely rearranging their prejudices.”
In investing, there is no hiding from your prejudices. If your prejudices trump your intellectual honesty, then you probably won’t be in this business for long, regardless of whether you are on the sell side, buy side, or the dark side.
Since it is political season in the United States, prejudices are as heightened as they have ever been. Unfortunately, the nature of the two-party system in the United States has evolved to a state where supporting the party trumps rational analysis. The political overlords speak and those who are politicized vote according to party lines. But I digress . . .
In reference to the title of this note, the Oracle of Delphi was an ancient Greek figure that was at the height of power around 1600 B.C. She supposedly spoke for Apollo and answered questions for the Greeks, and foreigners, about many topics including: colonization, religion, war, and power. The Oracle purportedly knew all and people listened.
For a period of time, the Oracle exerted disproportionate influence over the Greek world and was consulted before every major decision. Obviously, most of us do not run our organizations or investment teams based on the proclamations of an oracle. And thank goodness for that.
Ironically, one of the most effective decision making methods is called the Delphi technique, which involves assembling viable options that are then voted on independently until a quorum is reached. As Michael O’Malley wrote in a recent blog for the Harvard Business Review:
“As the Marquis de Condorcet (http://en.wikipedia.org/wiki/Marquis_de_Condorcet) showed (in the collective wisdom proof), good, unbiased decisions are made if a solution space is well sampled and the final judgment is determined by independent decision-makers. One of the attributes that determines the range of options that bees ultimately consider is genetic diversity. The greater the diversity in the bees' DNA, the more sensitive they are to different conditions and circumstances, and the more options the hive is able to gather. More diverse hives are better at everything and more productive than less diverse ones.”
Thus, the key to effective decision making is to assemble a group of diverse individuals with independent voices.
The Federal Reserve does not exactly fit this mode as highlighted by the backgrounds of the current board members:
- Chairman Ben Bernanke – formerly a professor at Princeton and a Ph.D in economics;
- Vice Chair Janet Yellen – formerly a professor at Berkeley and a Ph.D in economics;
- Elizabeth Duke – formerly a senior banking executive at various regional banks;
- Daniel Turollo – formerly a professor at Georgetown and a law degree from Michigan;
- Sarah Raskin – formerly Commissioner of Financial Regulation for the State of Maryland and law degree from Harvard;
- Jeremy Stein – formerly professor at Harvard with a Ph.D in economics; and
- Jerome Powell – formerly Assistant Secretary of the Treasury and law degree from Georgetown.
Clearly, the nature of the Federal Reserve board is more akin to a group of oracles than a manifestation of the Delphi technique. The key error we’ve made in assessing the Fed’s willingness to continue to ease is that we believed they were “in a box” due to the data and the political cycle. Groupthink, of course, is not always rational.
Regardless of whether we agree or disagree with the Fed, we are back to playing the game in front of us. Printing money is inherently an inflationary action and will ultimately slow growth. As we have seen this year, printing money will also inflate equities until the printing presses stop or they get trumped by growth and inflationary concerns.
On the growth front, yesterday the durable goods report dropped -13.2% in August from the prior month. Largely, this was driven by a drop in aircraft orders, so there is probably a one-time negative and likely non-reoccurring factor here, but still it is what it is . . . pretty negative.
As it relates to currency, the Chinese yuan hit a new record versus the dollar this morning at 6.2856. The pundits are speculating that this is due to strong corporate demand and financial institutions getting out of short positions ahead of the week long Chinese holiday. While Hedgeye won’t be taking a holiday next week, our man on China, Darius Dale, will be writing the Early Look next week to give an update on China.
Needless to say, we are still on the sidelines as it relates to the world’s second largest economy. We are also on the sidelines as it relates to the idea that we will see meaningful stimulus from the Chinese in the short term. Despite this, the Shanghai Composite was up another +1.4% today on the back of being up +2.6% yesterday. Up +4% in two days is solid, but the anecdotes from China continue to be negative. On the back of Caterpillar saying construction demand was down -40%, we have Nike saying this morning that demand is worse than expected.
Anemic demand from Chinese is crushing the U.S. coal market. Currently, metallurgical coal from the Appalachian region is trading hands at $52 or so, while it costs $65 - $75 to produce. Given these economics it is no surprise that we have recently seen a bankruptcy in the sector with Patriot Coal recently filing for Chapter 11. In our Q4 themes call next week, we will be discussing more companies that have bagel (bankruptcy) risk.
Regardless of potential bagels, we have plenty of long idea and I’ll send you into the weekend with a couple of our top ones:
- Las Vegas Sands (LVS)
- Urban Outfitters (URBN)
- Paccar (PCAR)
Ping firstname.lastname@example.org for details.
Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1769-1785, $111.44-113.17, $79.36-80.36, $1.27-1.29, 1.61-1.71%, and 1434-1453, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Head of Sales and Research