Labor Day Report from Leen’s Lodge

Labor Day Report from Leen’s lodge in Grand lake Stream, Maine

Chatham House Rule says we cannot name the asset managers, fund managers, government officials, and other participants who gathered here on Labor Day weekend. Each of the attendees has to do that for him- or herself. The issues discussed were intense.

What I characterized in an earlier missive, entitled “Dance of the Fireflies,” continues to occur in Europe. There were and still are comments by German officials saying “save the euro,” do not or do buy sovereign bonds, and do not or do overcommit. These officials deliver a mixed message of unprecedented complexity in modern monetary history (no open-ended purchases yes open-ended purchases; no short-term is an exception, yes short-term is not an exception to our rules).

It is clear that Europe wants to do several conflicting things all at once. They want to keep the eurozone intact and have economic growth while imposing austerity budgets. They want to finance and refinance sovereign debt to reduce interest rates, while borrowing increasing amounts and expanding debt/GDP ratios. They want to narrow credit spreads while the economies widen the differential in economic performance. The weaker ones weaken faster. The stronger ones are weakening, too, only more slowly. They want to do all of this at once, without cost, and in each of the participating democracies of 17 different countries. Never before has such a thing been attempted.

My friend John Mauldin emailed me and asked where I got the title “Dance of the Fireflies.” John, I didn’t get it from anyone. It seems to me that this is an appropriate metaphorical description for what is taking place in the eurozone. At night, fireflies blink with different messages in different places, as they play out their natural ritual. They offer a glimpse of an alternative, illuminative, ever-changing mosaic. Turn on the headlights of your car and the fireflies stop their dance at once. As soon as light provides a clear, overwhelming outcome, the dance ceases. Turn off the headlights and the fireflies sense darkness and begin their dance anew.

In Europe the “Dance of the Fireflies” is performed by the leaders of the 17 eurozone countries. Their statements and actions, winking on and off, often seem quite random. Some countries are actively financing the bank runs that are taking place in their jurisdictions. Greece is the most notorious. Emergency Liquidity Assistance (ELA) in Greece now exceeds 100 billion euro. Cumberland will be publishing specifically on ELA shortly.

Others are also experiencing runs. Some banks in Italy, certainly in Spain, absolutely in Cypress, and in other peripheral countries are weakening every day, as depositors take flight with their cash. Who can blame the depositors? The risks are, or appear to be, high.

This month will see an election in the Netherlands, a German court decision, structural issues in the forefront at the European Central Bank meeting, and the question of whether Finland wants to exit the euro. The European drama unfolds act by act, scene by scene.

The conclusions of our Grand Lake Stream, Labor Day gathering is that the present risks in Europe are high, outcomes are unknown, solutions are yet to be determined, and structural impediments are massive.

Political outcomes in the US were also discussed and debated. There were Obama-ites and Romney-ites. The conversations were polite but the differences of views were occasionally fierce. What will be the outcome of this election? It is too close to call. How things will be restructured depends on what the percentages will be in the House of Representatives and the US Senate. The political uncertainty premium is very high. We see this in ever more survey data and in the response of the US business community. We also see it in investors’ heightened awareness that no reliable longer-term structural solution appears to be forthcoming.

In Grand Lake Stream there was also a discussion of the investment outlook. A longer-term, strategic, US-focused view could have a positive outlook, if based on the eventual stabilization, recovery, and improvement of the US housing market. The US energy sector seems to be on a good strategic track, despite what politicians might do to injure its recovery. Our manufacturing is highly productive and innovative, but capital expenditures seem to be lacking. Businesses are waiting. They are hoarding cash, even though the cash earns zero. They are not sure of their future.

Discussions about how to restore confidence led to no conclusion. Discussions about how to achieve a political consensus to replace the ongoing acrimony led to no conclusion. The discussion of the longer-term outlook for growth in the world if China continues to weaken, Europe continues to shrink, and the US continues to plod along at a very slow rate of growth, led to estimates with wide variance, related to the earnings of US companies. How much of those earnings are foreign-sourced? How will that translate when currency relationships change? No conclusion on either question.

What would earnings be in a global slowdown, with some countries in recession (the apparently dominant forecast)? Ranges went as low as $90 on the S&P 500 Index for 2013. If the S&P 500 is truly going to produce a $90 earnings figure in 2013 and if the subsequent outlook is for very slow growth worldwide, then the stock market seems excessively priced. If there is not going to be a global slowdown or recession, if the S&P 500 index produces earnings of $105, $106, or $108 in 2013, and if the outlook is for continuing moderate growth with gradual acceleration, then the stock market seems fairly priced and may be at a level where it should be purchased.

Discussions then turned to valuation techniques. What interest rates do you use to discount? Of what value is the equity risk premium? Does the equity risk premium say when to enter the market, or does it discuss the status of the market at the moment? Does it reflect what is in the market in terms of attitude and sentiment? Or, does it provide a level at which you can comfortably acquire or expand stock portfolios? Another debate took place in Grand Lake Stream – with no conclusion.

The conclusion from our wonderful assemblage on Labor Day is no conclusion, except for one: this is a great place to have the conversation. Leen’s Lodge is most accommodating. The discussions were genuine, polite, safe under the Chatham House Rule, and very thoughtful. Fish were cooperative. The fishing report follows.

The weather at Leen’s Lodge over the Labor Day weekend was perfect. We enjoyed sunny days with high temperatures in the 70s and cool nights with lows in the 50s. it was cool enough that the wood burning stove was called upon to nicely warm the cabin in the mornings.

Fishing was terrific on West Grand Lake, which has a very limited-size bass slot. You could keep two fish per fisherman per day. Each fish had to be between 10 and 13 inches long. Smaller or larger were released. Here are six that made their way onto the lunch table on Labor Day: .

We cleaned the fish and skinned them but did not filet them. We diced tomatoes, peppers, onions, and capers. We put two fish on top of the vegetable mélange in a metal pan and spiced them and added salt and pepper. The pan and its contents were double-wrapped with aluminum foil and put on the campfire while other parts of the meal were cooked. The vegetables melted down. The heat created a moist bed and the vegetable steam cooked the fish. The fish became permeated with the flavors from the tomatoes, peppers, capers, and spices. When they were finished, we put the pan on the picnic table, unwrapped the aluminum foil, and shared this Grand Lake Stream version of a branzino.

The scenery is magnificent on this lake. It is a massive lake that lies at the head of the pristine watershed of this region. The entire watershed is protected by either the Passamaquoddy Indian Reservation or a land trust that is growing and acquiring more property each year.

For the first time, we were able to drift a canoe close to a moose. This moose seems to be about two or three years old. Reports are that it was swimming across the lake and then swam to the island where we found it. It was a little disoriented or fatigued. The wind was such that the moose could not get our scent from the canoe. We were therefore able to get relatively close and take a series of photographs. Here is one of them: . Moose have poor eyesight but sensitive noses. This is the closest I have ever come to a wild one. The photo was taken on my old Blackberry.

Winter will soon come to Grand Lake Stream. The lakes will ice over and the cycle will commence again. There were no fireflies.

If the photos do not open, see under “special” or email me and I will send you a link.

David R Kotok

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