Monthly Commentaries

Have we turned the corner? – January, 2011

January was a good month for most equity markets as most were up 2.5%. In contrast, the bond market continued to weaken with yields rising to levels not seen since early June 2010. Better economic news, combined with better corporate financial results, has outweighed concerns about higher interest rates. It has been the ability of the stock markets to reach new highs during a period when bond yields have risen that has surprised many market watchers. To put things in perspective, December U.S. real GDP surpassed the high set in April 2008, yet equity prices, despite being up nearly 80% from the lows reached in February 2009, are still more than 10% below April 2008 levels. For most non-market observers, it still doesn't appear there's been a full economic recovery. Therefore, the most frequently asked question we have fielded lately is, "Have we turned the corner yet?" But what they're really asking is whether or not it is safe to invest. Safety is rarely determined by economic growth but rather the fundamental value of the businesses.

In the late 1990s, the economy looked great but technology stocks were too expensive. Instead, an investor should be more concerned with the condition and prospects of the businesses they own rather than the moment-by-moment reporting of the state of the economy. If the change in the current quarter's GDP growth rate is of paramount concern to you and your investments, then you are speculating and not investing. The question to ask is, "Compared to what I expected, how are the businesses that I am invested in doing?" It should not be whether or not the most recent economic release was higher or lower than expected. To appreciate the distinction, consider that equity investors can expect to generate a return in one of three ways: 1) The free cash flow generated by the underlying business should be reflected in a higher stock price or paid out in dividends. 2) There is an increase in the multiple that investors are willing to pay for the business. 3) The gap between the share price and the underlying business value narrows.

All of these outcomes should happen over a period of time and not on the back of a single quarter's economic news. Remember that as a true investor, you are a business owner and it is the results of those businesses that are the key indicators of value. The moment-by-moment economic statistics are interesting to read and discuss, and may provide a useful barometer of how the economy is performing, but it how those businesses perform that ultimately drives the portfolio performance. Arthur Heinmaa, CFA Managing Partner