"Kee Points" with Jim Kee, Ph.D.

Economy appears to be on solid footing


The Bureau of Economic Analysis released its advance estimate of second quarter GDP on Friday. The number came in at 2.6%, while the first quarter was revised downward from 1.4% to 1.2%. This result was largely in line with expectations of modest acceleration. Second quarter corporate earnings or profits are also coming in fairly strong, with an above average number of companies beating analysts’ forecasts. Large company earnings are coming in dramatically higher than smaller company earnings. Some of this is due to the 7% decline in the trade-weighted dollar so far this year (Federal Reserve Bank of St. Louis), as larger companies tend to generate a greater portion of sales overseas, and a weaker dollar makes their goods more attractive internationally (at least in the short term). That is because people in other countries can exchange their currency for more dollars and buy more US goods when the dollar is weaker. After a while though, prices should adjust, as the act of buying more US goods and fewer of their own domestically produced goods should bid up the price of US goods and lower the price of domestically produced goods until the two are priced the same. That’s called the Law of One Price, meaning that the same goods should sell for the same price after adjusting for differences in the value of currencies (exchange rates).


International investing


As an aside, as a researcher I was once involved in a pretty big effort to leverage this insight (i.e. that small companies generate most of their sales in their local economies) by constructing global country allocation models based upon using (a) small cap earnings (profits), (b) price movements, and/or (c) analysts’ revisions of forecasted earnings. The idea was that if a country was pursuing policies (tax, regulatory, monetary, etc.) conducive to growth, then it should show up first in one or all of these measures of smaller companies, because small companies are “more levered to the local economy”. Using these measures of earnings, prices, and analysts’ revisions as a signal, you would allocate towards or away from different countries accordingly. The backtesting (i.e. testing a strategy against historical data) of this strategy proved it to be of little value, just like many other grand ideas prove to be when confronted with data. Over time this sort of experience has contributed to my preference for peer-reviewed research over investor “storytelling.”


Politics and stocks


The latest attempt by Republicans to pass a healthcare reform bill on Friday failed to get enough votes in the Senate to go forward. Markets seemed to have shrugged this off, perhaps because the more direct impact on corporate profitability and cash flows comes from corporate tax reform, which is still very much alive. Interestingly, the biggest gainer among the 11 economic sectors on Friday was the Health Care sector. I would guess that this was perhaps a relief rally due to the clarity for the sector (one way or the other) that it provided, but that is mere after-the-fact conjecture. The truth is that the Health Care sector has been notoriously hard to predict. One would have thought that the uncertainty prior to and after the passage of the Affordable Care Act, one of the most sweeping pieces of legislation in US history, would have put downward pressure on the sector. And indeed many investors chose to avoid the sector entirely during this period. But over the past 10 years, and even the past 5 years – the period over which uncertainty in health care was highest – Health Care stocks actually outperformed the overall market. I think the lesson here is to be careful that politics do not dictate longer-term investment strategy.


China continues to evolve

Numbers from China, specifically the manufacturing PMI and services PMI (purchasing managers indices) came in a bit below expectations. Not to read too much into a single month’s data, but this seems to reflect the notion that China’s economy is evolving from a single economy growth story to a bifurcated one comprised of a faster growing services side, and a slower growing industrial side.


And the most interesting thing I saw last week would be the Barron’s interview with legendary value investor, Bill Miller. The article talked about how Miller’s underperformance during the 2008 downturn ruined his track record for the past two decades. The same exact thing happened to legendary growth investor Thomas Rowe Price (or really the funds he created) in the early 1970’s. The obvious lesson for investors is the overwhelming importance of always investing in both value stocks and growth stocks.