As many of you are aware, I periodically teach college courses – more for the sheer joy of it than anything else.  Heaven knows I have more than enough with the business to keep me busy, but I really enjoy helping people to learn about how investing works and what makes the world of stocks and bonds go around.

One of the basic theories in the investing world is the idea of “efficient markets”.  That is, stock prices – and, by extension, markets – reflect all relevant information and so represent the true value of the stock or market at any point in time.  The giant mutual fund company, Vanguard, is a big proponent of this theory.  If you subscribe to the idea of efficient markets, then it should be impossible to “beat” the market and you should merely buy a stock (or bond) index fund.  Perhaps this is why Vanguard likes the theory so much – they are one of the largest providers of index mutual funds.

Digging a little deeper into the idea of efficient markets, there are a few key assumptions worth considering.  One is that all investors are rational…. WAIT a minute!  Hold the phone!  All investors are rational?!  In reality, investors tend to be collectively, well, bi-polar (or manic-depressive, if you will).  Benjamin Graham, the father of value investing, noted this phenomenon in the 1930’s and attempted to explain it by creating a mythical “Mr. Market” character.  One day, Mr. Market is hyped up to buy stocks from you at any price.  Two days later, Mr. Market is begging you to buy those same stocks back.  He is willing to mark their prices down just to get rid of them.  The nice thing, according to Graham, is that we, as individual (and hopefully rational) investors, can choose to play his game or not.  The key is to remain calm and rational and focus on intrinsic value, not the whims of Mr. Market.

So just how insane are investors collectively?  Let me give you some examples just from this past quarter.  First, going back to the end of January, the Federal Reserve, the governmental agency that ultimately sets interest rates throughout the economy, released minutes from their January meeting.  What investors took away from these notes was that the Federal Reserve was on track to start raising interest rates and probably by mid-year.  Why would the Fed want to raise interest rates?  Because the economy was showing signs of getting stronger and growing nicely, thank you very much.  How did investors react to this idea?  They sold stocks.  They could not wait to dump them!  Apparently, the prospect of better earnings from the companies they own was a worse prospect than perennially low interest rates and weak earnings.

Fast forward to the end of March.  The government released information about job growth in March.  The expectation was for around 220,000 jobs created in March.  When the statistics were released, the actual number came in around 126,000 instead.  Oh my!  This was not good!  Job growth was very weak.  This must be a bad thing, right?  So, of course, the stock market rose!  Why?  The thought (according to our Mr. Market) is that if job growth is this weak, the economy is not strong enough to sustain rising interest rates, so the Federal Reserve is not likely to raise rates any time soon.  So what is an investor to do with situations like this?

Well, at the risk of giving away all of my secrets, the short answer is – nothing.  I am only partly joking here, of course.  In truth, more often than not, my job is to do absolutely nothing.  No trades.  No harm.  No foul.  There are certainly days when I feel like I have to DO something.  I have to do SOME thing.  I usually lie down until the feeling passes.  Seriously, I have found that more often than not, all I really need to do is little tweaks here and there, such as making sure that a particular stock is not too large of a position in a client account.  If it is, then we sell some shares to reduce the risk to the portfolio.

Apparently, I made some good “no calls” this past quarter.  Things went pretty well for us, as most accounts were up and by a nice margin over the broad stock indexes.  Much of this I attribute to controlling risk.  I would be the last to tell you that we picked all winners or that every stock did well for us.  We still hold, for example, Conoco Phillips (COP) and Marathon Oil (MRO) – two large oil companies that have been hurt by the plunging price of oil.  However, these were offset by holding Kohl’s Corp (KSS), a low price retailer that has actually benefited from the lower oil prices as consumers have spent a bit more in recent months.

This does not mean we are sitting idly watching the volatility pass us by.  We have actually taken advantage of much of the volatility we have seen.  We have used down market days to sell put options – which obligate us to purchase shares of the underlying stock – to collect some healthy option premiums.  We have used big up days to sell call options against stock positions – obligating us to sell the underlying stock.  We have done this on stocks that we are looking to sell out of anyway, hoping to increase our return from the sale by the option premium collected.

We will continue to look for opportunities that Mr. Market sends our way.  However, as Warren Buffett has observed, we really do not have to do anything at all, which gives us the chance to await the proverbial “fat pitch” – the slow pitch right over home plate that we can knock out of the park.  Until then, rest assured that I can usually be found doing nothing.  I could only wish that were true!

As always, we do truly appreciate the trust that you have placed in us with a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.

Sincerely,
Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(410) 864-8746
(866) 857-4095
www.aeriecapitalmgmt.com