Par & Market

Forget your opponents; always play against par. - Sam Snead

I don't particularly enjoy watching golf on TV. I play golf, in fact it was the first sport that I learned to play as a young boy, though I don't play very often. This past weekend however, I found myself engrossed watching The Masters. The twenty-one year old phenom, Jordan Spieth, led the tournament from start to finish, tying and breaking records each successive day of the tournament. Pretty impressive in a sport where the most often repeated quote is "you can’t win a golf tournament on the first day, but you can lose it."

As the daily leader each day, Spieth gave numerous interviews, where despite his seemingly perfect performance, he repeatedly remarked on what he needed to do better. This reminded me of something my grandfather - my golf teacher - used to say to me, "golf is not about being perfect, but you still have to practice like it is."

I don't play golf much any more, but when I was a boy I played a lot. I grew up playing on the hard-pan courses of the Central Valley. Valley courses are no Augusta or Pebble Beach, but they had their own unique challenges that those courses don't. Playing on hard-pan is pretty much like playing on pavement, which results in some untraditional course strategies. One of which was not trying to hit the ball too far. Instead, you'd aim for a patch of sun-scorched yellow grass, looking for a hard first bounce to send your ball on a screaming roll down the fairway. This meant that it was far more important to think about where you're ball would end up, than where it would land. If everything went just right, you could easily wind up with drives in excess of 350 yards.

That was the first lesson my grandfather reinforced - always aim. You might "miss," but if you didn't aim, it was a miss before you even swung the club. This proved an invaluable lesson about intentions and consequences. If you did it right however, you just had to rely on two things, "the ground is hard and the ball is round." If it didn't work just right, you needed to understand the same two things.

He was full of observations like this, much of which I didn't appreciate until later in life. Truth be told, while he was an amazing grandfather, he was sort of a mean golf teacher. When he saw me swinging too hard on the driving range, for example, he'd grab a short section of 2x4 and make me hit balls from it until I could hit ten-straight shots without falling off. That was the second lesson, balance.

The third lesson was "don't play a shot you don't have." Today, I'd call this discipline, mainly because of the punishment he'd hold over my head. As a kid, I wanted to hit shots like I saw Tom Watson or Johnny Miller hit on TV. When he saw me try, he'd ask, "should go get 1,000 balls?" The reason was that's how many balls he said it took before you "owned your swing." It didn't take long in the 100-degree plus summers in the Valley to know this isn't something you wanted to do.

The final lesson wasn't so much a lesson, as something I took away from the experience. Learning to play golf isn't the easiest thing to do. Combine this with the temperament of a kid, and it's no surprise that there were occasional tantrums following mishits. When this happened, my grandfather used to say something akin to "get over it." (I think it was actually more like,"pick up your club and get going finding your ball.") When I hit a good shot, that's exactly what I wanted to do, immediately starting after it, anxious to hit it again. He wanted me to do the opposite though, saying, "Hold up. Watch it."

Basically, he was teaching me to not make a big deal out of mishits, but make a really big deal out of the ordinary, simply well-struck shots. What I took from this is that there was no point in emphasizing what went wrong; clearly something did, but there was no point in memorializing it with a tantrum. A well-struck shot on the other hand, should be committed to memory and deserved a celebration; a lot went into making it happen, both in terms of the mechanics and their practice, which came together for a mere half-millisecond at impact.

This is how I learned that golf, like virtually everything else, isn't about "perfect"; that "bad shots" happen, and even "well-struck" shots can wind up in bad places. All you can do is try to do the little things consistently well, giving the good results the best chance of happening.

Playing into the Wind

Following a fairly lackluster stock market gain in the first quarter of the year, corporate earnings season is just getting under way, and it's not expected to be very good. Consensus estimates are for S&P 500 company earnings to decline more than -3% versus last year, something that hasn't occurred in nearly five years.

Most know by now that the main source of current earnings weakness is the energy sector, owing to the sharp decline in oil prices, falling more than -50% compared to last year at this time. All told, energy sector earnings are expected to decline by -63% in the current earnings season.

If we practice a little "see no evil, hear no evil" analysis and exclude the energy sector, S&P 500 earnings are expected to rise 6% from a year ago. We could take this even further to get to 8% growth, as four more sectors (out of the 10 total) are forecast to show declines - again, something not seen in nearly five years. However, we'd be left measuring just 60% of the market, which is a little too rose-tinted for our liking.

The reality is that there are several factors adversely affecting corporate earnings at the moment. Numerous winter storms nearly crippled economic activity, particularly in the heavily populated Northeast. In the West, port shutdowns caused sizable delivery and inventory management headaches, while the continued strengthening of the dollar served as a strong headwind to exporters and companies earning a sizable portion of their profits abroad.

Mr. Par & Mr. Market

Despite this less than rosy backdrop, the market as a whole is still trading within mere tenths of a percent of its all-time high. This is somewhat remarkable given the rash of lowered earnings expectations since the end of last year, not to mention the steady run of disappointing economic data.

Some explain this divergence by pointing to the Federal Reserve being willing to keep interest rates lower, longer, due to recent economic weakness. Another view is that absent storms, port shutdowns and a further surge in the dollar, economic activity will pick up later this year. Both views remind me of standing on the tee box with the mere hope of hitting the ball, then hoping it lands somewhere on the course. The real question might be, if these two views are widely held, and since they are opposing arguments, doesn't this portend a rise in market volatility on the horizon?

...we're of the view that you're not really an investor unless you have the same time horizon as the company that you're invested in.

As said in the past (here, here and here), I'm not big on trying to predict "the market." There's simply not much value in trying. The market isn't just made up of stocks, but also, everyone's opinions about them at any given moment.

As I learned through golf, to not aim is a miss before even swinging the club. It's not about hitting the golf course, it's about picking your spots on the hole you're playing - aiming there - and putting your best swing on the ball. The goal is to do this consistently well, so as to put yourself in more good situations than bad ones.

Our "aim" isn't the current quarter, the next one, or even a year from now, but on the business opportunities that we're invested in. Accordingly, whether the Fed does something or nothing, or if the dollar strengthens further, or oil prices suddenly reverse direction, we know that we're not "invested" in any of those events. Rather, we're invested alongside our companies, their management teams, and their goal of building and providing real things and services for real people.

This might sound like we don't care about any of these other market-influencing events - which is somewhat true - but in actuality, they're not events that alter our investment view of the companies that we're invested in. You see, we're of the view that you're not really an investor unless you have the same time horizon as the company that you're invested in.

During bouts of market volatility, such as we wouldn't be surprised to see in the near term, its easy for the the specifics of the business and its investment opportunity to get pushed aside. The frequent result is many an investor trying to "swing too hard," or feel like they need to do something "more." For us, research is our "2x4." In order to invest in the company, we need to understand the company. We need to understand how a company executes on its strategy, so that we can recognize when management is performing well, or not, toward the longer-term objectives that we're aiming for.

Through research we come to understand the 4P's that we wrote about last quarter. They're what keep us focused on the longer-term opportunities that we're aiming at alongside the companies that we're investing in. Research is also what keeps us from investing in things that don't make sense, or we simply don't understand; keeping us focused on our discipline and not attempting "shots we don't own."

We'd be the first to tell you that even after doing all of this, it would be crazy to expect perfection. Investing isn't perfect; "tantrums" happen in the market, even to those doing the research and exercising discipline. The difference being however, that those doing the work are better able to distinguish "mishits" from a mere "unfavorable bounce."

Finally, a little perspective, not on golf, but how we're thinking about investing now, and what we expect in the months ahead. As we mentioned, we're not big on forecasting "the market," though we are big on how the market comes to value specific investment opportunities over time. We are of the view that that the economic backdrop will likely improve, albeit modestly, owing to a lessening of the earlier impacts from bad weather, and port closures. We also view the fall in energy prices versus last year as favorable - clearly a negative for much of the energy sector, but we feel a more meaningful boost for the much larger consumer sector, as well as other energy-dependent sectors of the economy.

When looking at the individual companies in our strategies today, we are primarily focused on two aspects: how susceptible their business is to broader economic activity, and what the ongoing opportunity appears to be for a given company to continue investing at high rates of return.

In terms of the latter, we tend to frame the opportunity something like, "will their addressable market continue to expand; 'will more people and businesses shop/consume services online,' or 'will electric vehicles make up a larger share of the auto market,'" irrespective of whether the economy or stock market is higher or lower at some point in the future?

Importantly, what I'm trying to get across is that we aren't looking for the rising tide of "the market" to serve as a tailwind for investment success. We're merely relying on it to confirm what it does so well; that market's are efficient, that money is money, and always seeks the highest return regardless of current fads or concerns. In other words, trying to do the little things consistently well, and giving the good results the best chance of happening.