Common Language

Many long time readers have learned to love or tolerate my enthusiasm of the language arts. Over time I have found it useful in pondering all the data that comes in aid (or hindrance) of the investing process; parsing what people are saying and why they are saying it now is a critical skill in macro investing. Don’t get me wrong, I respect all those “bottoms-up” investors who toil in the fields of individual stock analysis. We even invest with some of them.

But I like the bigger picture stuff because I believe that the global and economic trends that drive corporate earnings are, in the aggregate, more trustworthy and reliable than what is going on in an individual company. Not all corporate chieftains lie about their company’s future prospects, but there sure are some meaningful financial inducements built into the pay system (mostly in the U.S.) to do so. Sector fundamentals were enough to tell us in 2000-01 that natural gas (Enron) and telecommunications (Quest) were on their way down. God bless the rare company that can buck economic trends all by itself. For core equity holdings, I had rather own the sector when the economics look good and sell it when they sour than take large bets on single stocks.

What got these individual companies in trouble was that the corporate leaders were saying some things publicly (prospects are great), but were apparently believing something else (we need to find some earnings or I’m selling stock now). Wouldn’t it be great if that were cognitively impossible?

Don’t laugh. A recent New Yorker article chronicled a linguistic expert’s experiences with an obscure Amazonian tribe called the Piraha, a tribe that appears to live entirely in lingustic and intellectual present tense. They exhibit virtually no memory functions—there are no handed down generational traditions, no food storage (what drought last year?) Additionally, when hunting and a member of the hunting party goes around the river bend, there is no verbal notation for his whereabouts (like he’s “upriver” or he is ahead of us) ---he is simply gone, literally out of sight, out of mind. Now imagine the Piraha CEO—he only knows or only has linguistic facility to say what is going on today, right now, and that is what he will tell you. He cannot reinterpret the past (backdating stock options would be impossible) and he certainly cannot tell you the future—no rosy forecasts from this fellow!

So let us return to the common language we share—what is going on in the economy that explains where asset prices are now and what that may mean for the future. A good place to start is with inflation. Long time U.S. investors recognize that the real enemy for most U.S. policymakers is deflation, where the inevitable end to a bad recession begets, (shall we say it?), a depression.

Therefore, the inevitable conclusion is that the U.S. Central Bank (known to most as the Federal Reserve or the “Fed”), tolerates a certain amount of price inflation in managing against economic slowdowns.

The question of course is, has that tick-up in prices in the fall of 2005 become “sticky” and are we revisiting another ramp up right now? This is a key issue, because the Fed wants to be able to cut interest rates when the economy slows appreciably, which may have already begun.

The situation is a lot more complicated than January 2001, the last time the Fed began cutting interest rates in the U.S. For starters, many big American multinational corporations are exceeding earnings expectations because their international business is going gangbusters. Second, and this has been a recurrent theme here, global economic growth has outpaced U.S. growth for a while now—and there are no signs that this is about to reverse.

The clear implication is that we need to stick by our secular investment forecast—oil and materials will stay in demand (global and large company prospects) and equities and short term fixed income assets are going to outperform bonds. We will stay overweight in foreign markets because we believe that there are better growth prospects there.

Stock analysts and some money managers are trained to hang onto every word of corporate spokesmen, and then look for interpretation and meaning. But there is no common language where everything becomes clear and everything is right in front of you. This is because our languages are suffused with thoughts and phrases reflecting the personal experiences and future desires of the speakers. Maybe the Piraha have got it right: there is no reason for past or future tense because only the present counts for anything.