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Market Commentary

The Palantir - Vol 1 Issue 3

Options, Tomahawks & Taper Light by Bryan C. Taylor, CFA

September 2013

“Vision is the art of seeing what is invisible to others”-Jonathan Swift

It is football season, and in the South we take our football seriously.  Regardless of whether one is talking about a group of seven year olds running a “twenty-six jet” or an NFL team setting up a “soft zone – prevent” defense you’re sure to get more feedback than you bargained for.  Cornerstone is based in Atlanta, of course, and on any given Saturday you’ll find us arguing the merits of the South Eastern Conference, debating the merit of South Carolina’s dangerous defensive end, or blasting Paul Johnson for his use of the Triple Threat Option offense.  Which to any red blooded football fan immediately conjures up visions of the Federal Reserve, or at least it should.

After all, it takes a bunch of aspiring engineers at a place like Georgia Tech to properly run the option.  It requires agility, skill, and vision on the part of the quarterback to determine the probable action of the defense and respond accordingly.  He may quickly handoff to his fullback, keep the ball himself, toss to his half back, or even, heaven forbid, pass the ball as the occasion demands.  Alabama, of course, remains comfortable with the old Woody Hayes way… “three yards and a cloud of dust.”  It would seem to be the only offense required to win multiple college championships. 

One can hardly avoid drawing the parallels between the Federal Reserve under say… Paul Volker, “three yards and a cloud of dust,” of course, and our current indomitable Fed Chairman’s own bunch of PhD’s, a technocratic group if there ever was one.  This Fed is obviously perfectly suited to run the proverbial option.  In the Fed’s case the name of the play, if you haven’t guessed, is “Taper Light.”  The play fits the current scenario perfectly.  Reading the state of the field, Mr. Bernanke had obviously planned that handoff to the fullback for a run right up the middle manifested through a significant reduction in bond purchases, but not to worry.  As the economic variables looked weaker than expected, Bernanke faded to the right prepared to keep the ball tucked and break out himself until at least December.  However, as the recent slew of economic data proved to be much more positive than expected, all bets were off.  At least they were off, until the employment data was released.  Now the field is scrambled, and Mr. Bernanke is desperately looking for a hole.  He may indeed keep the ball tucked, or he could determine that a pitch in the form of a very minor reduction in the Fed’s bond purchase program is the order of the day.  Either way, the U.S. remains engaged in an extremely slow recovery that shows little sign of improving quickly.  Rather, slow steady improvement seems the order of the day.  The unemployment rate has dropped to 7.3% mainly through a continued decline in the participation rate.  Macro data in the form of the ISM Manufacturing and Non-Manufacturing indexes has also improved of late, but consumption remains relatively weak and housing has been negatively affected by the recent rise in mortgage rates. 

Fortunately, the U.S. recovery remains the only game in town.  Emerging markets are struggling, and though there have been glimmers of light from the Euro Zone, they are very dim glimmers indeed.  Japan continues to struggle, and its weak currency program has yet to lead to any substantial increase in growth. 

If the football players play for glory on Saturday, then the real money changes hands on Sunday when the NFL goes into battle.  Parallels are evident to the astute observer in this venue as well.  Regardless of the current economic environment, the risk of war, particularly war in the Middle East, raises the specter of higher oil prices, uncertainty, and fear.  Such instability remains the primary risk to equity markets and the global economy in the short term. 

It would seem that the Obama Administration is behaving much like the Atlanta Falcons with a late fourth quarter lead over the Denver Broncos.  When the two-minute warning sounds and Manning has the ball, the Falcons, of course, will show blitz to anchor the offense, but will then drop back into a soft zone designed to allow potential forward progress but prevent the big downfield play.  Mr. Obama seems to be playing the same game.  His aggressive rhetoric regarding potential military action in Syria has quickly morphed into a “soft zone” diplomatic solution designed to stall in the face of poor military alternatives.  It so happens that in this case we, too, favor diplomatic options in Syria.  Americans have little stomach for involvement in the Syrian civil war, and it is difficult to ascertain how strategic intervention through a surgical Tomahawk strike could improve the situation.  Perhaps Mr. Obama’s bluster was credible enough to “freeze” the Assad regime.  Unfortunately, we doubt that will be the case.  The cover of the Economist suggests, “Hit him hard,” and to complete our football euphemism my son’s team chants,”Hustle, hit, never quit!” as they leave the huddle.  The Obama Administration would do well to bear such thoughts in mind when dealing with a character like Assad who certainly has no thought of throwing in the towel and going quietly.  It remains to be seen if the persistent application of a diplomatic solution backed with the threat of credible force will win the day.

Bryan Taylor, CFA

Cornerstone Management, Inc.

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