Back in the dark ages, when I was in the 5th grade, my teacher, Mrs. Welch, asked us what we wanted to be when we grew up. I said I wanted to be a peregrine falcon. There are days when that still seems a worthy aspiration…
Fifth grade was also the first time I visited the Lincoln Memorial. It was very moving to read Lincoln’s second inaugural address, inscribed on one wall, and the Gettysburg address on the opposite wall. While these are his two most well-known speeches, a line from one of his earlier speeches, after accepting the Illinois Republican party’s nomination for the U.S. Senate, may be more apropos today. Called the “House Divided Speech,” Lincoln said, “A house divided against itself cannot stand.” Seemed rather logical then, but today, I’m not so sure…
We are a house divided in many respects. Politically, certainly. We seem divided on nearly every issue, even on issues that one might not expect division, like the American flag and our national anthem. The U.S. Congress might be the most divided organization in existence today.
Despite all this, the stock market is soaring. Perhaps the market likes political division, or gridlock. Most large corporations, even after factoring in all lobbying efforts and crony capitalism, would prefer less government involvement in the economy. This preference is even more pronounced when it comes to small businesses, which don’t have lobbyists working on their behalf, nor the ability to hire in-house lawyers and accountants to ensure compliance with all the regulations piled on them during the previous decade.
Yet, it seems clear to me that the mood in the business community has improved, perhaps dramatically. As the regulatory rollback continues and with tax reform looming in the not too distant future, business optimism has bounced from the depths of despair reached during the previous administration. This doesn’t mean there are no problems to solve or reasons for caution, it just means from a business and investor sentiment perspective the glass is now half full.
Switching gears slightly from a half-full glass to a cup of coffee… Despite the stock market’s extended advance, we are always on the look-out for warning signs. I believe I found one today, in an article in the Wall Street Journal – “Enjoy That Cup of Coffee! Your Total Comes to $55.” A high-end java spot, Eleven Madison Park, as these places are apparently called, offers coffee-prepared at your table for $24 per cup. There is even a blend called “Wush Wush” that is $48 for a 10-ounce cup. A California coffee house tops the list with a $55 offering.
In my experience, markets tend to top out when large corporations build colossal new company headquarters, or when large companies make over-priced, ill-timed acquisitions. Now I would add to the list – when restaurants can succeed by selling coffee for fifty bucks a pop.
Greed, or irrational exuberance, is an emotion that prevails at market tops. Over time, markets are defined by emotional extremes. The stock market is rarely fairly valued. It spends some of the time being undervalued, usually getting even cheaper until fear and panic- selling is rampant, forming the basis for an eventual bottom in stock prices. Conversely, the market can become more and more overvalued, for an extended period, until greed has a strangle hold on investor sentiment, which leads to an eventual market top. We are increasingly on the lookout for signs that greed is seeping into overall market sentiment.
The amazing eyes of a peregrine falcon… As it was explained to me once by a bird expert, a hawk can see a mouse one mile away. An eagle can see the same mouse from two miles, but amazingly, a peregrine falcon can from five miles away. As we think about all the disconcerting issues, domestic and global, in the context of the fact that the economy is nine years into the recovery from the 2008 financial crisis, the ability to see farther ahead, to identify risk as well as opportunity, is becoming increasingly important. In this regard, our investment team is constantly testing and challenging the driving forces of this extended advance in stock prices. There is no question that the combination of strong earnings growth, low inflation, and low interest rates supports higher stock prices. Moreover, meaningful tax reform and continued rollback of onerous regulation also bode well for future economic growth and a strong stock market. Nevertheless, the longer and higher the market climbs the more disciplined we intend to be regarding risk and reward on a portfolio and individual stock level. In my experience, discipline and thorough fundamental analysis are the most effective means to avoid insidious, greed-based decisions, which ultimately, result in financial disappointment.
To soar like a peregrine falcon, spotting danger and opportunity before the competition, is certainly an ideal mentality for the current environment. In the meantime, be careful what you pay for a cup of coffee.