Why We’re Buying In This Market: Part One

How The Risk of a Double Dip Recession is Being Overblown

Cale Smith
Islamorada Investment Management
Letter to Tarpon Folio Investors
June 2010

Since you’re all out of perspective and no one else seems to have it in this bloody town, I’ll make you a deal: you provide the food, I’ll provide the perspective.
– Anton Ego, Restaurant Critic

Like many value investors, my skepticism of economic predictions and forecasts runs fairly high. There was a time when I rarely devoted any serious time to thinking about GDP growth, unemployment levels, or our government’s fiscal policies. Not because such things aren’t important, but because they are so difficult to accurately predict. Successful investing is much more about solid bottoms-up analysis than accurate top-down forecasting.

In recent months, however, my skepticism about the usefulness of macroeconomics has been dulled by my contrarian streak. When every headline seems to be cause for a sell-off on Wall Street, I find myself reflexively searching for silver linings. And I’m pleased to say that despite recent headlines, there are more reasons for optimism out there than you might think.

But first, let’s review the main drivers of the stock market’s behavior over the last three months. Sovereign debt fears – in Europe of all places – seeped into the market’s consciousness around the same time some of the biggest banks on Wall Street started getting sued and subpoenaed by the U.S. government. Meanwhile, the biggest financial reform legislation of seventy years was being debated in D.C.

Then, the biggest environmental disaster in our nation’s history tragically unfolded live on YouTube. It was ridiculous, infuriating and entirely preventable. Strangely, Goldman Sachs appeared to have nothing to do with it.

All this was going on, mind you, as the country tried to emerge from a recession that began more brutally than the Great Depression. Let the resulting anxiety about jobs, real estate prices, and unsustainable deficits continue to build. Add a thousand click-happy hedge fund traders using leverage like it was table salt. Withdraw a huge amount of government support in the markets. Throw in a few datacenters full of buggy computers causing inexplicable 1,000-point drops in the major indices. Finally, give everyone with an opinion about any of the above a microphone, blog, camera or column.

What we have ended up with is utter information chaos. It is historic, it is unsettling, and is completely irrelevant when it comes to long-term investing.

Fortunately, there is some signal in all that noise. Alas, it can take a bit of wading through some macroeconomics to isolate it. I’ve found that to be a bit more tolerable, though, if you keep three things in mind:

First, to paraphrase one wise economist, the point of tracking economic data isn’t to be able to answer all kinds of questions – it’s to learn how to tell when you’re being buffaloed by an economist.

Second, until proven otherwise, assume all economic predictions reflect a strong, covert political ideology of one stripe or another.

Finally, keep in mind that, as one of my veteran friends recently reminded me, the entire field of economics is BOGSAT. As in: a Bunch Of Guys Sitting Around a Table. They contribute so little to GDP. Step it up, fellas!

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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