"Mediocrity" is a toxic word that sends shivers down my spine. I will have none of it in my personal and investing life; that much is for sure. At first, the production of mediocre work goes unnoticed -- because it's just enough to continue driving a business forward. But, over an extended period, mediocre practices transition to something that can choke off a company's innovation and execution prowess.
The interesting aspect here is that mediocrity can also weasel its way into your investment-selection process. One can become content with riding the waves in the market, long or short, so far as the profit motive is aligned with actual profit. It's my humble opinion that investors are trading in their discipline for short-term gains amid rising market optimism. (Tulip mania, anyone?) They have embraced a state of mediocrity in their own processes, and have also ratcheted down expectations on what constitutes a healthy corporate America.
Four Examples of Mediocrity Acceptance
1. Chicago Fed: Somehow, a meager upward revision to the prior month on a historically less-market-moving report trumps the harsher truths that emerged from the Philadelphia Fed and Empire State numbers.
Digging into the Chicago Fed report yielded a cautionary bit of wisdom: "subdued inflationary pressure from economic activity." Economic activity that results in subdued inflation? That sounds as if companies are doing one or both of the following -- inventing cheaper products to steal market share or pricing core products more competitively in order to maintain or steal market share. The statement ultimately fits in an oh-so-snug manner with my comments last week on the general deflationary forces that gripped the Consumer Price Index.
Mental note to tuck away: A "less bad economy" does not mean "good." It does not obviate the risks -- in particular, anemic pricing power and volume consistency -- that could derail sales and earnings.
2. IBM (IBM): The market seemed to like IBM's earnings beat -- a natural reaction in a climate that is seeing life through rose-colored glasses. The following is how the market interpreted Big Blue's numbers. First, unimpressive U.S. sales will probably shift to stronger numbers by the second half. Second, Europe is "weak" but not "weakening," thus confirming those lower periphery bond yields. Third, the BRIC bloc -- Brazil, Russia, India and China -- are a savior once more to low growth in developed countries.
While I appreciate the market's built-in forward predictive powers, and its present la-la-land mindset, remember that the IBM quarter does not completely support the hearty advances in small-caps and transportation stocks. By the way, cautious commentary on transport stocks began to emerge Tuesday. I hope you saw the mention of stretched valuations in these parts a week ago.
3. Railroads: Those were some pretty sweet profits from Norfolk Southern (NSC), CSX (CSX) and Kansas City Southern (KSU). In September I called Kansas City Southern the name to own from the space, and it remains my pick of the litter. But, in similar fashion to an IBM quarter, the volumes for the rails outside of coal -- which we knew were going to be soft -- didn't seem to imply "OMG, the coast is clear." Fourth quarters were fueled another successful three months of pricing and operating efficiencies.
4. Texas Instruments (TXN): This was fairly straightforward. The company told us its customers are basically OK with sitting on lean inventories, rather than planning for X amount of future demand. Hey, why invest precious cash in Texas Instruments' semiconductors in a low-growth environment? If I were a CFO, I would prefer to apply the cash to share buybacks to snag a meaty year-end bonus or acquisitions. Each initiative could serve pump prime growth during volatile economic conditions.
Did you know? The S&P 500's relative-strength index has slightly eclipsed the September 2012 Fed-decision euphoria peak. If you want an overbought indicator, here ya go, stud!
As I have been saying, ride the pony until it begins to tire out. Along the path, however, stockpile real reasons to take the fight back to the bulls. That moment of truth will arrive, and this will likely be quite soon.