Ride the Tide

Texas this time of year swings between northerly blasts almost cold enough to freeze the pipes in the well house and flows off of the Gulf that have us right back in tee shirts and flip-flops, if only for an afternoon. Last week I jumped on a few days of benign weather and strong tides to enjoy the coastal flats. The Market’s anticipation of an intriguing political development (i.e., what appears to be compromise on taxes between the Administration and the Republicans, heralding paroxysms of dismay, disgust and debilitating skulduggery within the Democratic camp) was inflating my net worth in that exuberant sort of way that makes it kind of hard to buckle down and work (tax cuts as disincentive to work, oh my!) One result of this trip, besides a nice bag of sea trout filets, was a couple of reflections that I think have bearing on how we want to be invested as we enter the New Year.

The first of these would be a reminder that however grim the economy, as measured by the statistics we use to denote “normal”, there is still a tremendous amount of economic activity going on. There is a sense in which the patch of ground I covered, the drive through San Marcos, Seguin, Stockdale, Karnes City, Kenedy, Beeville, Skidmore, Ingleside and Aransas Pass is not particularly blessed, bleak. The soil is meager at best, though there are a few spots where wells or tanks indicate hydrocarbon deposits. The heat is oppressive for most of the year, drought is not infrequent and hurricane season is a “might have to get up and leave for a while” reality. Flora leans to species like pin oak and mesquite, fauna to things that bite or sting (or both!). Many of the towns seem to have outlived whatever motivated their settlement, though all but the dinkiest of them have a Dairy Queen siphoning a nonstop flow of $$$ into the pockets of the Sage of Omaha (the contribution margin on a $2.39 dipped cone? No wonder he bought it.) But when compared to the torpor of most of the vast sweep of human experience across time and rest of the globe, this patch of ground that so many just fly over and marvel at its emptiness, if they consider it at all, was throbbing with economic activity.

On the drive down, countless herds of cattle give way to vast flats that whose ideal crop appears to be sorghum. The oil wells and ancillary activities that support them seem a little more so ever time I make the trip, as do the wind farms. Along the coast, petrochemical plants like where Dupont makes what must be a very large share of the world’s refrigerant are lined with miles of railcars. Out on the water, I can see a steady stream of ships moving up and down the coast, and a more erratic procession of shrimp boats coming and going in their eponymous channel. The yards where offshore drilling equipment gets built stretch off towards Corpus as far as the eye can see. Towns like Aransas Pass, which in summer months are overrun with vacationers but then quickly empty out, are starting to fill up again with winter Texans, refugees seeking escape from the scraping of ice, the shoveling of snow and at least some of the ache and pains of advancing years. And all this co-exist with an amazingly resilient ecosystem. Whatever ecological damage was done here by the petrochemical industry is a thing of the distant past, now sanded, silted or barnacled over. Early one morning I was treated to velvety sound of geese winging just over head as I was unloading my kayak, the roar of 10,000+ ducks taking off at once as I was dragging said kayak across too-skinny-to-paddle flats a few hours later, and the startling blast of a porpoise’s blow hole, just a few feet astern, as I was making my way up the channel a few hours after that. The human sounds that day consisted of the highway until I was 1000 or so yards away, a passing power boat now and then, a steady stream of USN training aircraft making their way back to NAS Corpus Christi, and some occasional thundering clangs from miles-away ship (or rig) yards.

What I take away from all this is that however much that construct we call the economy is underperforming its estimated potential, however much collateral damage from the near death experience of Q4 08 still needs to be repaired, we are still a rich and vibrant economy. The heartland has not rolled over and died. Work is being done, resources are being extracted and rendered more valuable, and oh by the way, the ecosystem is getting healthier all the time. To open one’s senses up to all this, and then wonder how many other similarly empty-seeming slivers of our vast country are similarly blessed, is to make short work of disregarding the doomsayers who write and talk as if they never get out of the office or the studio.

The other takeaway from this intra-coastal adventure had to do with tides, ebbs and flows that are inexorable, somewhat predictable and can really effect the risks and rewards of one’s endeavors. The tides in this area are nowhere as strong as what I recollect from the littoral adventures of my youth some twenty degrees further north and now going on a half century ago. A swing of 30” low to high on this trip was unusually strong, on the last trip it was on the weak side at about 4”. Even when it is running strong, one has to look beneath the surface to notice it (unless one has neglected to anchor their boat before getting out, then it gets real obvious in a hurry. This happened to me a couple of years ago, with nearly fatal consequences.) A moment at a time, the tide barely makes its presence known, and yet it can be hugely important. It is usually what stirs up the food chain in ways that register as fish “biting”. Disregarded, it can be a real day-changer for power boat operators, especially at the speeds they seem to want to go. (Kayakers, too, as in the difference between paddling in 4” and dragging in 3” of water, especially if the bottom is muddy.)

Tuning into the the tide reminds one that ebbs and flows are very much a part of the created cosmos, and this extends into matters human as well. Markets ebb and flow. There seems to be a norm for the time we have data for (the last century or so) that the stock (liquid, proportionate representations of ownership) rise in value along with their underlying, aggregate value. Every 3-4 years or so (the variability being wrought by shocks like war) this upward trend is interrupted for (usually) a major fraction of a year in a corrective phase we call a Bear Market. Once a generation or so, a larger rhythm makes its presence felt. As if to reflect the departure or diminished influence of those who learned the harsh lessons of the last time around, this cleansing flood overruns it normal banks and chastens us all (see 1929-38, 1973-82, 2000-2009).

I suspect this is well understood by many investors, at least those who have studied the craft seriously and practiced it for more than a few turns of the four-or-so year cycle. But pondering tides (a subset of the challenge of cracking the code on the elusive redfish) got me thinking about another phenomenon that has vexed investors in recent years: the pathetic underperformance, relative not just to other asset classes but to the commercial performance of the enterprises they represent, of so many large cap stocks. This has been well remarked on now for going on a half a decade. As I was experiencing how lunar pull causes huge quantities of water to slosh around the Gulf of Mexico and intricately varied basins and channels that make up the coastal bend of Texas, it got me thinking about other kinds of flows. How when an awful lot of something flows in a closed system for a very long time and then starts to flow the other way, it will probably run for a very long time. So it was with stocks like INTC or MSFT. How many years did they spend getting over-owned by what old time chart or tape followers called “weak hands” (e.g., no-brainer portfolio fill, generic index funds held simply to “own domestic equities”)? These are but two stocks that represent companies that have performed more than credibly over the past decade, have unsurpassed financial flexibility and solid, at least moderate, growth prospects, and yet as stocks they have become “dogs” (no offense to our canine friends).

What I think has been missing from the discussion of this enigma (a discussion usually couched in terms of the brighter prospects of other enterprises who all but certainly are in need of investment bank services) is a very basic principle of stock price appreciation: Stocks don’t go up simply as a function of how ardently investors want to buy them. It also matters how readily owners will come forward and meet that demand. Reasons to sell are much more extensive and quite often much less well considered (e.g., inherited, change of account manager, simple impatience). Every stock that trades is a use of funds for some and a source of funds for others. The trouble with stocks like INTC or MSFT is that the result of spending nearly two decades to achieve “must own” status among a vast array of investors made them widely owned sources of funds for a considerable period thereafter. This disappointment was not obvious right away. They traded down in quite reasonable fashion when the Tech Bubble burst. It was once the recovery commenced, and not-particularly astute investors who had been conditioned to think of them as “sure things” started underperforming in them that the “source of funds” designation became the proverbial immovable object. It may have been specific to the stock itself (“Sell the INTC”) or a function of the dumping of generic index funds to buy something a little more au courant, but in any case it aggregated into a seemingly bottomless well of supply to meet whatever demand there has been for these stocks.

The good news here is that no tide runs forever. This one, this undoing of the biggest “must owns” circa December 1999, is probably about down to its lees. I strongly suspect that Intel’s protracted hiatus in share repurchase activity, just recently ended, was less about economic uncertainty (at least after the first few months) than it was about facing up to this reality. I am also strongly suspecting that as long as the economy doesn’t get blindsided, many of these gone-nowhere-forever big caps are going to surprise. With the “weak hands” mostly gone, the supply will no longer soak up demand so easily. This will register as indications of price momentum, which will trigger the usual self-perpetuating consequences. The no way to predict exactly when this tide turns (actually it does so one stock at a time) or how long or how high it will go. But just as a huge flood (1982-99) set the stage for this excruciatingly protracted ebb tide that has run for going on eleven years, its consequences will surprise all of us, frustrate those who ignore it and exasperate, if not destroy, those who are foolish enough to fight it. Fish On!