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Thoughts from the Frontline

Forecast 2014: “Mark Twain!”

January 18, 2014

Piloting on the Mississippi River was not work to me; it was play — delightful play, vigorous play, adventurous play – and I loved it…

– Mark Twain

In the 1850s, flat-bottom paddlewheel steamboats coursed up and down the mighty Mississippi, opening up the Midwest to trade and travel. But it was treacherous travel. The current was constantly shifting the sandbars underneath the placid, smoothly rolling surface of the river. What was sufficient depth one week on a stretch of the river might become a treacherous sandbar the next, upon which a steamboat could run aground, perhaps even breaching the hull and sinking the ship. To prevent such a catastrophe, a crewman would throw a long rope with a lead weight at the end as far in front of the boat as possible (and thus the crewman was called the leadman). The rope was usually twenty-five fathoms long and was marked at increments of two, three, five, seven, ten, fifteen, seventeen and twenty fathoms. A fathom was originally the distance between a man's outstretched hands, but since this could be quite imprecise, it evolved to be six feet.

The leadsman would usually stand on a platform, called "the chains," which projected from the ship over the water, and "sound" from there. A typical sound would be expressed as "By the mark 7," or whatever the depth was. In modern English language, it is interesting to note that the expression "deep six," refers to this old method of measuring water. On the Mississippi River in the 1850s, the leadsmen also used old-fashioned…

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michael tolbert

Jan. 20, 3:47 a.m.

I was on the Mississippi river just last month.  And, was on a flat-bottom paddleboat.

I was told the call of mark twain was understood by the pilot to mean “safe water”.

Michael Tolbert

John White 69443420

Jan. 19, 10:11 a.m.

John - the greenhaus analysis/graph is based on BLS unemployment rate ?? this as we all know is useless and manipulated, as unemployment rate as “:fallen” % adults in work force has dropped to almost historic lows - this invalidates his analysis obviously - something is very verys seriously wrong with our economy if job openings are increasing and MORE people are dropping out off t he labor force, and the obvious answer is we having a growing problem with UNEMPLOYABLE people….one that wont be resolved soon- and ultimately this MUST impact overall economy when we have more people on the wagon than those pulling it,and as harry dent loves to point out, this is in the context of the huge natural demographic tend o baby boomeers retiring CAN stock prices remain elevated in this context ??

Dallas Kennedy

Jan. 19, 9:46 a.m.

An excellent use of long-term trends to forecast markets.

Corporate profits have been trending higher as a fraction of GDP since the mid-1960s. It’s unlikely that has to do with globalization, at least in its current phase. However, automation has been far more important cumulatively. Globalization as we know it now has been important for maybe the last 15 years. The current episode (since 2009) is more extreme than anything we’ve seen and is surely a result of massive fiscal and monetary stimulus. These have fattened corporate revenues and earnings like never before. The deficit of one side is the surplus of the other.

Unfortunately, the labor market is not healing as indicated. The unemployment rate has dropped since its peak in late 2009 mostly because of workers dropping out of the labor force. Instead of saying, job openings have remained steady while jobs are increasing, the correct statement is: job openings have remained steady while workers are continuing to drop out and stop looking.

The right numbers to watch are the labor force participation and working population ratios. The headline unemployment rate is misleading or useless.

John Adamo

Jan. 19, 6:52 a.m.

Good work, John, as usual. But there is one error and one omission of an important point.

The error: “As Reported Earnings” does not refer to earnings as reported to the IRS, it refers to GAAP reporting standards. Earnings reported according to Generally Accepted Accounting Principles are not the same earnings reported to the IRS, which differ in many respects. Most easily illustrated is depreciation, which may have significant timing differences in recognition of expense.

The omission: Though otherwise well-rounded, this discussion of growth in earnings leaves out one very important factor. That is, the role of share buybacks in both reported and “operating” earnings, or “EBIH earnings” as you appropriately call them. (I call them something less delicate.) In 2013, S&P companies will have bought back approximately one-half trillion dollars in stock. This distorts EPS significantly, and despite naïve shareholders’ applauding of this practice, investors don’t seem to understand that this money came from company treasuries and could have been spent on investing in businesses, if such opportunities were available, or dividends, if they were not.

There may be some argument over the tax efficiencies for shareholders of the two uses of cash, but there is no argument that buybacks distort the earnings growth the company is experiencing. Moreover, when a company buys back shares at a P/E of 18 (the average S&P 500 P/E for 2013), it is getting a return of 5.6% on that investment (the reciprocal of the P/E). Although that is the expected return of the market in the coming years from such sages as Warren Buffett and Jeremy Grantham, it is hardly the kind of returns company CEOs want their shareholders to think they are producing for them.

Perhaps you could explore this topic more in a future letter. Keep up the great work.

Myron Musfeldt

Jan. 18, 5:15 p.m.

Those are quite compelling charts.  The prudent thing now is finding the appropriate stops to be initiated and leaving them in place.

Jan. 18, 4:20 p.m.

I think more attention should be paid to ranking all of the alternative available investments, rather than commenting on merely a particular one.  If you choose to “save,” you have to put your money “somewhere.” Putting it in stocks may not be a good idea, because stocks are overpriced from an analysis of P/E ratios, but how good are the alternatives?  Churchill is alleged to have said “Democracy is the _worst_ form of government devised by the wit of man, except for all the rest.”  That may be true of stocks right now.  Because of uncertainty today, people want to save.  The least bad place to put savings for the long term view is perhaps stocks.  If people save by buying stocks, it drives the price up.  I think that’s what happened in prior times when people opened 401k’s, etc., and started saving in earnest.

Frederick S. Holmes, Jr.

Jan. 18, 4:13 p.m.

I wonder how much of the increase in corporate profits vs. labor costs is due to corporate profits including the profits U.S. companies earn outside of the U.S. If these foreign source profits are included they would substantially change the ratios.