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The Sandy Spring Way

May Observations

May 2nd, 2014 | By Beau Mercer

FredericBurke“The sun shines bright in the old Kentucky home….Weep no more, my lady, Oh! Weep no more today! We will sing one song for the Old Kentucky Home, For the Old Kentucky home far away.”

—Stephen Foster 1853

On the first Saturday in May a bugler steps forward prior to the Kentucky Derby horse race and orchestrates “My Old Kentucky Home.” The race is known as the “The Most Exciting Two Minutes in Sports” for its approximate duration and “The Run for the Roses” for the blanket of roses draped over the winner. The Derby is steeped in history and tradition but the underlying motivation is to win. Winning can mean a sizeable sum of money for the owner and those who wager on the right horse. Selecting the right horse can depend on the weather, track conditions and how prognosticators think the race will be run. Some horse wagerers bet with their hearts and eyes as focused by an uninformed media or a hopeful wish. Obviously hope does not require knowledge but does require a willingness to participate. Wagering on a horse is a bet against other bettors because odds are determined by the amount of money bet on each horse. Objectivity is gone, keep your fingers crossed, and listen to the owner of your favorite restaurant!  Ultimately, the combination of trust worthy data, technology, objectivity, and a willingness to look outside the box can provide the wagered a step ahead of the speculator. Similarities between wagering and investing rest upon ownership, knowledge, luck, and the lack thereof, but the future is uncertain. Ladies and gentlemen, place your bets!

Socrates wrote a long time ago that “I am wiser than this man, for neither of us appears to know anything great and good; but he fancies to he knows something, although he knows nothing; whereas I, as I do not know anything, so I do not fancy I do. In this trifling particular, then, I appear to be wiser than he, because I do not fancy I know what I do not know”. Socrates may have avoided execution if he had prognosticated the winning horse but he never represented he knew anything about horse racing or the markets. Currently there are two approaches to the investment markets. One strategy proffers that the investment markets will continue the five year upward march into the future, and that investors should continue to invest despite possible valuation concerns, increasing volatility, and suspect IPO’s. It is accepted that readjustments can occur during which the fundamentals catch up to valuation.  The first strategy seemingly ignores slow global growth as represented by a stalled US economy. Robust activity may be on the horizon but may be influenced by transitory factors (the weather or Russia). Contrary to 2013, the market is no longer broad but much more opportunity selective. The second strategy infers that the level of corporate earnings may also not justify the present day stock prices. A bubble may exist and the explosion is due any day now. Also the second strategy underlines the influence of the Federal Open Market script calling for the reduction in mortgage backed securities purchases. In effect, the second strategy directs investors to cash. Who is going to win: extreme pessimism or extreme confidence? Ladies and gentlemen, place your bets.

U.S. companies continue to ‘park’ substantial profits overseas due to the U.S. tax rules with the consequent effect of reduced capital investment. The practice has enabled companies to shield more than 40% of their annual profits from U.S. taxes. The parking practice has been discussed ad nausea by legislators with no consequent reforms. Examples abound: Pfizer holds $73 billion, Microsoft holds $60.8 billion, and General Electric holds $108 billion overseas. Business school sense determined that it was only a matter of time until the management of these companies were directed by shareholder value to deploy the capital in a more tax efficient way. Pfizer put the matter into perspective when it purportedly offered $100 billion for London-based drug firm AstraZeneca, a company with only $25 billion in revenues across a diversified product line.  But the question persists: why can’t the tax code be revised to support US job creation? Ladies and gentlemen, place your bets.

—Fred