Parallel Investment Management Universes

One might be forgiven for thinking that there were parallel investment management universes looking at the robust profits that are being reported by corporations, particularly in the US, and then listening to the political commentary and top down economy projections.

This is what creates opportunities - when the markets are overly influenced by the transitory and ignore the more powerful and long lasting (and more reliable) information that is coming from what is actually happening to the profitability of corporations. This is what we invest in not a bunch on economic projections that have the reliability of Tarot cards (no insult to the cards intended).

With 80% of the results of companies in the S&P500 in, the picture is one of robust and improving profitability. This is the case across a wide range of industries and is most marked in the important areas of banking, major technology companies, and industrial businesses. Particularly, but not exclusively, those companies with export revenue. Perhaps the one area missing is housing (more about that later).

Balance sheets of corporate America are bursting with cash and the buy back of stock is prevalent and will likely continue. The major US banks have so much capital they are concerned about how they will deal with it so as to maximize their earnings per share growth. The indicators of health and profitability are heading in the right direction rapidly.

If you want an antidote to the political commentary listen to the recorded webcasts from JP Morgan, Wells Fargo and US Bankcorp. Then listen to IBM, Apple, Amazon and Microsoft.

A recovery in the US housing industry is probably the thing that underpins a recovery in jobs and sentiment (something that always does recover). It is now over 5 years since construction went into a precipitous fall. At the bottom there was an annualised construction rate of only 300,000 houses.

I don't have any figures on it but given the construction quality of housing in the US (apologies to James Hardie) there were probably more houses falling down than being built!

The projections by market economists that excess inventory will take 2-5 years to clear reflect the sentiment of a beaten up industry; the data used to form these opinions is at best insanely unreliable - the variance between surveys (which themselves are no more than rounding errors in the gigantic 130 million home US market) show greater variation between themselves than the variation to the norm (if one could work that out).

D.R. Horton, the largest house builder in the US (it has survived the last 5 years - a testament to the quality of its management) reported recently and while their numbers were down on the previous year their outlook was modestly optimistic, looking to build market share rather than merely survive. At this late stage we'd be looking for signs of recovery and there seem to be some of those.

Our view is that when all is said and done the most important long-term driver of growth and wealth, the corporation, is strong (and cheap!).

Hugh MacNally, August 2011