Green Shoots - The Will to Believe - If You Sleep With The Dogs - Evergreens

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Green Shoots

For those of you who listen to the financial reporters, read the financial or business news, or simply turn on your computer and browse the internet for information on our economy, the term "green shoots of recovery" is being used in earnest to describe the state of the economy. The mere fact that the phrase is being used by just about everyone (A simple Google search yields over 857,000 references, and probably one more after this letter is posted to our web site) makes me wonder if all of these references are based on reality.  Or are they simply because we as people want to believe that the world's economy has made it through the roughest winter it has experienced in some time? 

Economic facts can be boring, especially when delivered by economists or for that matter, myself.  The use of a spring time analogy gives us a good feeling about the future and is very easy for us to understand.  The term found its origins in a speech given in 1991 during the depths of the early 90's recession by Norman Lamont, then the Chancellor of the Exchequer, UK's equivalent to our own Secretary of the Treasury.  Although he was a bit premature in his outlook, the term "green shoots of recovery" stuck and because it is such a pleasant term it will surely continue to be used in the future.  

The problem we face as investors is determining if these green shoots are the green shoots of recovery or simply a bunch of weeds.  Do these or should these economic facts make any difference in how we invest our money?  The market seems to be telling us that the majority of people are betting on a recovery; however they appear to be putting their money into a bunch of weeds.  Since the March lows, the stock market recovery has been led by companies that I personally would classify as "crabgrass", a particularly nasty weed that takes over your yard in the spring and then dies, leaving nothing but ugly spots throughout the winter only to resurrect itself the following year. 

Here are just a few of the "Green Shoots of Recovery" 

Consumer Confidence:  The Consumer Confidence index is at the highest level in the past eight months.

Consumer Expectation:  Consumers expect improving business conditions, labor markets, and personal income.

New Orders:  New orders for all manufactured goods are increasing.

New Orders for new manufactured durable goods:  up.

Private construction:   increased in April

Public Construction:  Highway construction was up in April.

Housing Starts:  Single Family Home construction increased in April

Single Family Home Sales:  Increased in April

Personal Income:  Increased in April

Productivity:  Increased in the first Quarter

Unemployment:  Less job losses than expected.

The Stock Market:  Positive for two months in a row.

The Will to Believe 

As we ponder these "green shoots of economic recovery" we have to ask ourselves, "Is it different this time?"  Why are the companies that looked just a few months ago as if they would fall into the abyss, never to be seen again, now the darlings of investors?   As I have done so many times in the past, I again turned to those unknown, but not unforgotten friends stored within my bookcase.  

Although I have never met most of the authors I call my friends, they have both shared their thoughts, and stimulated my own as friends working on a shared problem.  I offer you ideas, fitting for the time, from two of these sources, Mr. Fred C. Kelley, and Mr. Claude Rosenberg.   Fred is best known for his Wright Brothers biography, but it was the 1930 publication of his book, Why You Win or Lose: The Psychology of Speculation that has earned his spot on my shelves.  I am going to share with you his essay titled "Perils of the Will to Believe".  The dollar amount used by Fred in his example may be small when compared to today ($20,000), but as he says, it would be enough to buy a house, a new car and send his mother-in-law on a six month tour!

Perils of the Will to Believe 

After vanity and greed, perhaps the most malign influence to one trying to make money from the market is the Will to Believe.  We think to be true whatever we hope is true.  When a reputable doctor tells a man he has an incurable disease, the man is then quite likely to fall into the hands of a quack who says he can cure him.  The patient wouldn't believe the quack ordinarily, but now if he doesn't believe his only hope in life is gone.  Poor sufferers who flock to the grave of a dead priest, expecting to be benefited, wouldn't have such faith if they weren't desperately in need of it, having vainly tried everything else.  Likewise, men pin their faith to poor stocks and expect these to advance 40 or 50 points, because here is their last hope of financial salvation.  When a man declares confidently that a certain stock is going to advance, what he means is:  "Oh, if it only would!"  What sounds like an opinion, based on inside knowledge, is simply a hope, expressed from time to time, to bolster up one's courage.

            I have seen men earnestly listening to the advice of a broker's...porter - because he was telling what they earnestly desired to think was true.  The studious fellows who work over the pages of figures in the backrooms of big brokerage houses could often give valuable advice, well mixed with caution.  But customers seldom take the trouble to hunt them up, for they would rather listen to the chatty floor-men of charming personality who have little time for study but are sure that almost any stock is about to go up.  They are prepared to tell what customers most wish to hear.  I know just one man who saw the October panic coming and when he told his employers about it, what do you suppose they did?  Discharged him!  His story seemed too unpleasant to be true and they decided that he must be hopelessly unreliable.

            A friend of mine made a small fortune in the last big bull market only to lose it, and along with it the savings of a lifetime.  He at one time had a profit of $20,000.  In his imagination he had already spent the money, building a new home, buying a new car and sending his mother-in-law on a tour which would keep her away at least six months.  One morning he discovered which instead of having $20,000, his profits had shrunk to $16,000.  Now, even $16,000 dropped into one's lap out of the stock market is not to be sneezed at; but once having mentally spent his $20,000, he did not like the idea of slipping back to a mere $16,000.  He said to himself, "Oh, well, the drop is only temporary.  When it comes back I'll again have my $20,000.  To be sure of this I'll buy more stock and then only a small advance will give me my original profit."

            But instead of advancing again, prices continued to drop.  He now found that he must have far more stock than before to gain$20,000 profit on an average upturn of only one or two points.  The $20,000 though only on paper, had become real to him as if it were in his pocket; and his imaginary expenditures, particularly those for pleasure, had become so much a part of his scheme of life that he thought he simply had to have that money.  So he bought still more stock.  The fact that prices had been dropping should have been indication enough that the peak had been reached and that the toboggan had started down the other side.  But his paper profit had obscured his vision.  His profits dwindled to a mere $2,000.  Somebody suggested to him that instead of waiting for two or three points gain in the next upward rally, he should buy a certain stock about to advance twenty-five points.  In other words, he was lured into buying a highly speculative stock that could move downward as easily as upward.  Ready to grab at straws, he quickly lost nearly all the money he had.  Toward the last he believed any silly story he heard and he was lucky to get out of the market with the clothes on his back.  He was a victim of the Will to Believe. 

If You Sleep With Dogs, You're Bound To Get Fleas

Claude N. Rosenberg Jr. founded RCM Capital Management in 1970.  His book, Stock Market Primer, was originally published in 1962 and can still be obtained as a new copy today.  Over forty years in print indicates that I'm not the only one to call Mr. Rosenberg an "unknown" friend.  In Stock Market Primer he lays down a few rules that he calls his common stock commandments.  These seventeen rules are all worth reviewing; however, it is rule seventeen that I want to share with you.  

17.  Concentrate on quality   While big profits are often made through buying and selling poor quality common stocks, your success in the stock market is far, far more assured if you emphasize quality in your stock selections.  Too many investors shy away from the top-notch companies in search of rags-to-riches performers.   This, of course, is fine for a certain portion of your investment dollars, since mot people can afford an occasional  "flyer."  But a person who starts out looking for flyers usually ends up, not with just one or two, but with a host of poor quality stocks-most of which turn out unsuccessful.  These low-grade issues are certainly no foundation for a good portfolio; instead, the fine, well-managed companies should form the backbone.  And don't for a minute think you can't make money without wild speculation-fabulous fortunes have been made over the years in such high quality, non-speculative stocks as Carnation, Coca-Cola, Procter & Gamble, and others.  In other words, place your stress on the elite, not the so-called "cats and dogs" of the marketplace.  "Remember," said one wise stock market philosopher, "if you sleep with dogs, you're bound to get fleas." 

Evergreens 

Methuselah, a Bristlecone Pine, is the nickname of the oldest living tree on earth.  He  is estimated to be over 4,750 years old. Methuselah is Located approximately 11,000 feet above sea level, in the Inyo National Forest of the White Mountains of California. I have seen this tree in my journeying and it saddened me to hear that on September 4^th of 2008, a fire took the lives of three or four of Methuselah's brothers and sister.

The lure of making up for the past couple of years quickly works its magic on us to the point we desire to invest in order to get our money back fast.  This lure of a quick return is almost overpowering, even though any logical person knows better and should only invest into companies that could be classified as the Evergreens, the "Methuselahs" of the world.  These are the companies with staying power.  The companies that provide the goods and services that the world demands.  These are the companies that have the financial strength to make it through the winter of economic turmoil and prosper during the good times.  These are the companies that Carl Rosenberg describes above and are the backbone of the economy, ours and the worlds. 

I am pleased to say that we have faced these emotions before and have maintained our faith in the Evergreens.   We have maintained records of our stock selections and portfolio returns for times past.   Since the peak of the internet bubble in the spring of 2000 until today it seems this approach has been working.   As always, we measure returns of our "average" account which may or may not reflect your individual portfolio.  However, in order to track the validity of our work, we have to make comparisons, even if that means using an average.  The results are encouraging.  In eight of the past nine years our average account's common stock holdings have provided a return in excess of the S&P 500.  The one year we failed to keep up with the overall level of the market was 2003 where we underperformed by a small amount.  2003 was the last time the "green shoots of recovery" took center stage.  Will the past repeat itself this year?  Time will tell.

Closing Thoughts

Most of our new clients have found us through your referrals.  For this we are deeply appreciative.  But only after they have listened, as Mr. Kelley said, to those "chatty floor-men of charming personality....who are prepared to tell their customers what they want them to hear...that any stock is about to go up."  I hope that we will earn their confidence as we hopefully have earned yours.  Owning a portfolio of evergreens is not exciting.  However, far more fortunes have been made in owning the pillars of American capitalism than have been made by those who have fallen for the "charming personality" and the "will to believe" in silly stories.

Please visit our web site at www.andersongriggs.com.  We post our weekly market commentaries on Monday.  These commentaries along with our radio program "Intelligent Investing" give you our thoughts on a few on the "green shoots", the markets and the economy in general. 

Until next time, 

Kendall J. Anderson, CFA