Friday, October 25, 2013

I Do Not Like Green Eggs and Ham

From the Desk of Joe Rollins

I have intentionally not published a blog since the recent issues surrounding the 2014 fiscal budget and the expansion of the National Debt. I thought it better to wait until the issues were sorted out before I commented on the state of the financial markets. I couldn’t resist using the above title to this blog as it was so reflective of the dramatic (and stupid) demonstration by Senator Ted Cruz, from the great state of Texas, when he attempted unsuccessfully to filibuster the Senate regarding defunding Obamacare. I certainly intend to cover this as well as the importance of the equity markets during the month of September and the first half of October in this blog. However, first, there are other matters I came across recently that I wanted to share with you.

By chance, I happened to catch an HBO special titled “Muhammad Ali’s Greatest Fight”. Assuming that the show was a documentary about or tribute to one of the great Muhammad Ali’s boxing matches, I tuned in. Quite interestingly, and to my surprise, the special focused on the Supreme Court case of Muhammad Ali, in 1971, and his application for deferment from the Vietnam draft, citing his conscientious objector status on religious grounds against any type of war. We all know that the case ended in Muhammad Ali’s favor, but the politics behind the decision and the connection to the Supreme Court were extraordinarily interesting to me. This case clearly demonstrated that in many instances, the Supreme Court decides many cases not on judicial or legal precedent, but on personal feelings, political bias, or fear of reprisal by the general public. Therefore, it should not go unnoticed that Ali did not win on the merits of the case, but due to a technicality.

Personally, I had not been aware that so much political activity influences the Supreme Court. So, determined to get a better understanding on the matter in order to speak more intelligently on the subject, I noted that much of the HBO show was primarily based upon a 1979 book written by Bob Woodward and Scott Armstrong, titled The Brethren. And, although only about 15 pages in the book were dedicated to this particular case, I found the entire book overwhelmingly interesting. It described the conservative nature of the courts in the 1970’s and the personal idiosyncrasies of the particular justices during that time. I found the book to read completely unbiased toward a specific political agenda, rather simply discussing each case and the background of each decision. It later surfaced after his death that Justice Potter Stewart was actually the inside source of information for the book, since Justice Stewart so highly respected Bob Woodward for his reporting on the Watergate and President Nixon scandals.

In order to become further knowledgeable on the subject, I read another book titled, The Nine, by Jeffrey Toobin. This book, written more recently in 2008, also addressed cases and decisions of the Supreme Court, but at a later time when the Supreme Court was migrating from their once conservative roots to a more liberal bias. I found this book also to be interesting and well-written, however, unlike “The Brethren,” it clearly exhibited a liberal bias which appeared to taint its writer. Despite this bias, the book did an excellent job of illustrating the inner-working of the Supreme Court system.

Finally, I read a third book, written by Howard L. Bingham and Max Wallace in 2000, on which the HBO special, Muhammad Ali’s Greatest Fight, was based. Different from the other books, this particular novel chronicled Muhammad Ali’s life from childhood through the time he was involved in this particular case. While very little emphasis was given to the mechanisms of the Supreme Court, the book focused on Muhammad Ali, his feelings and the influence the case and its decision had on the boxer himself.

I bring this up, not because it has any relevance on economics, the stock market or investing, but as an aside to the political environment and the external pressures on the justices in the Supreme Court. I find that by understanding some of the history and the background behind our court’s major decisions and the magnitude by which these decisions can be impacted by politics, it can shed some light on some of the more current events of our political and judicial systems. I highly recommend these books if you are interested in reading about some of the most influential and important Supreme Court cases and the reasoning behind those case decisions.

I promised you in earlier blogs that when Congress discussed the extension of the federal debt limit there would be high volatility in the markets during early October. These predictions were accurate in early October when this occurred in Washington D.C. The President and the two bodies of Congress reminded me of the way children act on a middle school playground, albeit a political arena; among all of the discussions, there was a lot of political fluster, accusations, misinformation, and at the end of the day nothing really happened. Thus, the reason behind why I typically advise investors to ignore the happenings in Washington; over the last 15 years or so, it appears that Congress has little or no effect on the equity markets over the long term financial picture. Unquestionably there are short term variations and volatility, but over the course of time, the economy controls the movement of equity markets, not politics.

Since little was accomplished regarding the budget and the extension of the debt, there will now be a new deadline for action by Congress of late January or early February, 2014. So once again, early next year you can expect the same volatility, and most likely the same Congressional outcomes, experienced in October. The only saving grace to us as Americans and investors is if this happens, and Congress fails to do anything in early 2014, the sequester will kick in once again and Congress will be forced to reduce expenditures. It has recently been revealed that over the last two years the federal government has spent less money in each respective “new year” than the previous year. This is the first time that a spending reduction has occurred in subsequent years since the Korean War. Although I am convinced that given the opportunity, spending by both the President and members of Congress would exceed all budgetary limitations, we can be thankful that they can be forced to reduce expenditures under the sequester limitations.

Although Congress was able to shut down the government for a few weeks after that embarrassing rendition of Green Eggs and Ham, even that seemingly simple act was screwed up by their ineptness. After the shutdown was over, it was announced that all government employees would receive back-pay for their time off during the furlough and many of those that received unemployment during that time would not be required to pay it back. So basically all that Congress did was provide a two week paid vacation for all government employees as well as an additional kicker of extra compensation. If this is any prediction of how Obamacare will be run then we’re really in trouble, as once again it is has been illustrated that the government does absolutely nothing well.

The markets, however, have been nothing short of extraordinary in 2013. As I write this posting on October 22, 2013, the S&P 500 is up 24.42% for the year. The markets held strong for the month of September, a typically very weak month. The S&P 500 was up 3.1%, the NASDAQ composite was up 5.1%, and the DOW Jones industrial average was up 2.3%. Even more unusual, we are deep into the month of October and the markets are trending even higher at this point.

Also during the month of September, bond performance resulted in some minor gains and international funds earned decent returns thereby making a historically weak performing month a truly unique one. Due to almost assuredly higher interest rates, I do not anticipate these bond gains to be sustainable in the future although I continue to be encouraged that equity markets will continue to rise over the next few months.

In summary, I could write a long dissertation on the progress of the United States economy, but it is sufficient at this point to say things are improving; residential construction is operating at full capacity, employment is marginally up, corporate America is generating profits at record levels, and interest rates continue to remain very low. Although certainly not roaring, the economy continues to make progress and American investors continue to earn welcomed returns.

We are approaching the historically strongest time for equity market performance. Between November and April, the equity markets have historically returned the majority of their profits. I look forward to this investment time and can only hope that the upcoming periods add to the positive investment results we have already experienced during 2013.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins