“Success is to be measured not so much by the position that one has reached in life as by the obstacles which he has overcome.”
-Booker T. Washington
This weekend one of my colleagues circulated an article written by Malcolm Gladwell in The New Yorker titled, “How David Beats Goliath”. The gist of the article is that there are actually advantages to being the “David”, or the underdog, in an industry, game, or confrontation. On a basic level, this often occurs because the underdog does not subscribe to the same norms as his or her opponent. In fact, to succeed “David” has to be quicker, more tireless, and, most importantly, more innovative.
In the article, Gladwell uses basketball as a case study to highlight his point. He cites example after example of basketball teams that have beaten more talented teams by aggressively utilizing the full court press. In effect, instead of letting more talented opponents bring the ball down the court and set up their plays, the teams Gladwell highlights aggressively went after their opponents in their own end.
In top level basketball such as the NCAA or NBA, the full-court press is rarely used despite the evidence that it enables those teams with lower talent levels to be much more competitive. One of the more successful basketball coaches to use the full court press is Rick Pitino. Despite struggling as a coach in the NBA, Pitino has had a steller NCAA record of 616 wins and 227 losses, in part due to his use of the full-court press.
So, why don’t more coaches adopt Pitino’s strategy? Well, many actually do reach out to Pitino to come watch his practices and learn from him, but as Gladwell writes:
“The coaches who came to Louisville sat in the stands and watched that ceaseless activity and despaired. The prospect of playing by David’s rules was too daunting. They would rather lose.”
Being an underdog is not easy work.
On Friday the SP500 closed down -1.7% and no doubt many stock market operators felt like underdogs. The last time we had a sell-off in that area code was June 25th when the SP500 was down -1.6%. At a VIX of 15-ish, which is where Friday started, no one was expecting an almost two percent declining in equities, especially when the market is so “cheap”.
One of the key negative catalysts on Friday was #EarningsSlowing – one of our key Q4 investment themes. As is usual when complacency sets in, negative events occur when they are least expected to happen. On Thursday this occurred with Google’s (GOOG) earnings being released earlier than expected and being worse than expected. Although, to be fair, revenue was still up 45% year-over-year, but in the investment business expectations, as always, are the root of all heartache.
Earnings from Google on Thursday were then compounded on Friday with news from Asia that some of Apple’s (AAPL) supply chain was looking to take some margin back from the Cupertino giant. As reported in the Korea Times this morning, Samsung Display has now said that they will terminate its contract with Apple as Samsung is unable to supply its flat-screens at “high discounts”.
On the earnings front this morning one of our Industrials team’s favorite short ideas, Caterpillar (CAT), has come out with disappointing numbers and guidance. According to CAT:
“Cat dealers have lowered order rates to well below end-user demand … Production across much of the company has been lowered, resulting in temporary shutdowns and layoffs.”
The simple thesis for CAT is that next year’s earnings will be lower than this year’s earnings. While many companies may continue to grow earnings in 2013, even if CAT isn’t one of them, a bigger issue goes back to the point of expectations. In the Chart of the Day we highlight the view of margin expansion that is baked into consensus expectations headed into 2013. Needless to say, we do not see an acceleration in margin expansion in an environment where revenue is barely growing at 2% year-over-year in aggregate for the SP500.
Interestingly, CAT also plays into our second key quarterly theme, which we have called Bubble #3. A key tenet of this thesis is that the decade long boom we have seen in commodities driven by loose monetary policy is getting close to the last inning. This is most directly supported by slowing economic growth in China, which just printed one of its worse GDP numbers since the Great Recession.
Coincident with this commodity boom has been mining companies investing well beyond depreciation and amortization for more than a decade. This, too, will mean revert as we are seeing with CAT’s guidance this morning. We are expecting to see more follow through on this theme as more of the mining complex reports in the coming weeks.
Stepping away from earnings, the most significant global macro catalyst in the short term is clearly the November 6th election in the United States. Currently, the race has no underdog. The two candidates are virtually tied in national polls, they are virtually tied in the elector college, and in terms of favorability ratings they are, as well, virtually tied. Intrade still has Obama with a slight edge, but that too may well be fleeting.
In terms of insight into the election outcome, we will be joined this Wednesday at 1pm for a call with Professor Ken Bickers from the University of Colorado. He has crafted an interesting analysis based on state-by-state election economic situations that, according to his analysis, suggest that Romney may win in a run-away. Clearly, this is a non-consensus view. We hope you can join us for the call and will circulate the dial-in to institutional subscribers later this week.
Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $108.67-112.61, $79.15-80.24, $1.29-1.30, 1.73-1.82%, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research