Q3 Starts With Both a Bang and a Whimper

Good Evening: Better than expected manufacturing data points both here an in China catapulted U.S. stocks higher this morning, but the gains faded as the day wore on. Some other economic releases that weren’t quite as friendly may have caused the first day of the third quarter to end with a whimper after starting with a bang, but it’s also quite possible that market participants took some profits ahead of tomorrow’s employment statistics. With both jobless claims and nonfarm payrolls set to be released at the same time tomorrow, it will be interesting to see whether market participants give these numbers their due or instead decide to head out early for the beach. Investor uncertainty over how tomorrow may turn out, however, presents a good backdrop for considering Seth Klarman’s views about the merits of investing without certainty.

Stock index futures were already in frolic mode prior to the latest surge of economic data this morning. China’s PMI rose for the fourth straight month, proof positive for some that the real green shoots are made of bamboo. This early confidence was hard to shake, even though the early batch of economic data was mixed. The Monster employment report ticked lower, the MBA mortgage purchase index fell more than a little, and ADP’s estimate of job losses in June was worse than consensus forecasts. Then again, the Challenger Job Cut survey was rather benign, and the U.S. PMI — though in line — was once again higher on a sequential basis (see below).

Of all these releases, it was the PMI that encouraged buyers in the early going today, and stocks wasted little time before ratcheting higher by 1%. Weaker construction spending and a pending home sales index that only matched expectations did little to dampen investor enthusiasm for equities, and the indexes were soon up 1.5% or so. But that was it for the upside on Wednesday, as disappointing auto sales kept trickling in all day. The major averages spent the rest of the session giving back various portions of their early gains, and by the close the gains ranged from 0.4% (S&P) to 1.8% (Russell 2000). Treasury investors were uninspired and did little more than put one some curve steepening trades. Yields on the short end fell 7 bps, while those on the long end were fairly stable. Excepting the yen, currencies rallied against the U.S. dollar, though it did little to help energy related commodities. Crude oil and its products pulled back today (also possibly due to profit taking ahead of Thursday’s jobs report), while the grains were firmer on balance. It was left to the metals, both precious and base, to lift the CRB index by 0.5%.

Today’s varied and multiple economic reports did little to coax much volume out of market participants today, so I doubt today’s action mattered very much. Today’s releases were but the undercard to tomorrow’s main event, so I thought it might be nice to review some investing basics, courtesy of Baupost Group founder, Seth Klarman. Once 2008 was finally behind us, Mr. Klarman wrote his annual letter to clients, an excerpt of which you see below. “Uncertainty” bothers many investors, but it’s a situation which Mr. Klarman is grateful to exploit to the benefit of his clients. In “The Value of Not Being Sure”, Mr. Klarman bemoans the short term focus of so many money managers. He prefers to take a longer term approach, one that is unwavering even when Mr. Market downsizes one or more of his recent purchases. To Mr. Klarman, it is certainty and overconfidence about his investment decisions that must be guarded against. Instead of causing him sleepless nights, uncertainty motivates Mr. Klarman to constantly question his holdings and to always remain vigilant.

So what does this famed value investor think of the current investing climate? The final article below indicates that while Mr. Klarman saw numerous profitable opportunities late last year, he is finding far fewer of them after the recent rally. In a recent speech at the annual meeting of the Boston Security Analysts, Mr. Klarman told his audience that the rally off the March lows looks much like what he thought a bear market rally might look like. “Increasingly speculative” is one term he uses to describe the activity that returned smiles to so many investors’ faces in Q2. One of his best insights is “the pressure not to lose has been replaced by the pressure not to miss out”. Taking this thought one step further, he concludes that “the fear of missing out on a rally is greed, not fear”. Mr. Klarman has far more to say in these articles, and my recounting does him little justice. As we face tomorrow’s uncertain outcome once the unemployment data hit the tape, Mr. Klarman’s common sense advice offers us all a framework for making better investment decisions. Thus armed and prepared, let’s see what the BLS has in store for us tomorrow — before it all gets revised next month.

— Jack McHugh

U.S. Stocks Rise Following S&P 500’s Best Quarter Since 1998
U.S. Economy: Manufacturing Shrank Least Since August
U.S. Auto Sales Slide as GM, Toyota Miss Estimates
The Value of Not Being Sure, by Seth Klarman
Seth Klarman: Why Most Investment Managers Have It Backwards

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