The macro headlines are pretty gloomy: Europe is in trouble, USA deficits, and China slowing down. Should we sell everything and go into cash for safety? Nope, ignore and move forward. First, there is no sure way to figure out how these macro markets are going to unfold. Second, the bad news eventually follows good news and you don’t want to be in cash when events surprise to the upside. Third, even if you could figure out how these issues are going to unfold, there is a pretty good chance that our stocks will not follow the macro prediction. When markets were down three years in a row, i.e. 2000-02, we had some of our best years.
When I say there is no sure way to figure out how macro markets will unfold, I do it with extensive consideration. I will be traveling to FL this summer. I will be checking out our investment in Pantry (PTRY), looking over some real estate St. Joe (JOE) owns and an investment Leucadia (LUK) has made in the area. LUK has purchased the old airport in downtown Panama City. These guys find some interesting things to invest in. Hurricanes can disrupt this area during this part of the year and possibly my trip. What is the ability to forecast a hurricane in the area? The big hurricanes are called Cape Verde Hurricanes. They are born near islands that rest off of the west coast of Africa. To see how they start we have to back up even further to the 500 mile diameter Sahara Desert where the sun beats down on the surface of the desert creating a huge dome of rising hot air. This rising air creates a vortex and high winds that suck in more air and dust as the super heated column of air rises. As these waves of rising hot air move west they come over the ocean at the Cape Verde Islands. Once over the ocean, the clouds seeded with dust can form a hurricane. NASA, NOAA ( National Oceanographic and Atmospheric Administration), European scientist and several universities have committed quite a bit of resources, i.e. satellite images, weather stations, planes to collect data and computer models to figure out this phenomenon and have been at it for years. The effort is called African Monsoon Multidisciplinary Analyses (AMMA). Scientist have a pretty good handle on the ingredients and the physics of weather, but are still lacking some small initial conditions that bands several thunderstorms together over Cape Verde to form the hurricane.
These weather systems are very similar system to the stock market, i.e. systems where small initial conditions can have a big impact eventually. With weather we have a shot at figuring some of this out, i.e. very similar initial conditions repeat over and over again. In the economy/stock market completely new initial conditions are always coming into the equation. New leaders, laws, and technologies are constantly adding brand new initial conditions. Just like a thunderstorm that fizzles over Cape Verde, most initial conditions in the economy just die out, but some reach a tipping point and have a massive effect. The housing bubble was just one of those events. If we look back far enough, it is likely that just a few initial conditions reached a tipping point which resulted in this bubble. You can’t predict which initial conditions will fizzle and which will reach a tipping point. The housing bubble and hurricanes blow out the same way; they just run out of energy. I have extensively studied many economic indicators and stock market models over the last 25 years, some look promising and work for a while, but all eventually fail. This is due to some new initial condition that hits a tipping point and voids the correlation in the model. Since you can’t really predict why they are working, you can’t predict when they will fail either.
Could the slowing in China, the US debt problems or the European Union reach a tipping point and cause large dislocation? Quite possibly, of odds I can’t calculate. Each one of these events would have a different effect. A further deterioration in Europe wouldn’t affect our YUM! investment near as much as a drastic slowing in China. So even if I could accurately calculate the odds of each event, which I can’t, you would end up with too many possibilities to make an investment decision. If, in fact, one of these situations would cause a dislocation, we will look for an opportunity once we get there. Otherwise I don’t pay much attention to the headlines.