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For the Rally to Stay Intact, Earnings Cannot Disappoint


Third quarter earnings season kicks off this Thursday with Alcoa.

Last week a particularly wily Wall Street wag asked me, "Hey Jeff, do you know why everyone is underperforming the S&P 500 (INDEXSP:.INX)?" "Not really," I responded. He said, "Because the S&P has no fear!"

That exchange caused me to recall an excerpt from the book The Money Game by Adam Smith. I like this story:

"My solution to the current market," the Great Winfield said, "Kids. This is a kid's market. This is Billy the Kid, Johnny the Kid, and Sheldon the Kid.

"Aren't they cute?" the Great Winfield asked. "Aren't they fuzzy? Look at them, like teddy bears. It's their market. I have taken them on for the duration. I give them a little stake, they find the stocks, and we split the profits," he said. "Billy the Kid here started with five thousand dollars and has run it up over half a million in the last six months." "Wow!" I said. I asked Billy the Kid how he did it. "Computer leasing stocks, sir!" he said, like a cadet being quizzed by an upperclassman. "The need for computers is practically infinite," said Billy the Kid. "Leasing has proved the only way to sell them, and computer companies themselves do not have the capital. Therefore, earnings will be up 100% this year, will double next year, and will double again the year after that. The surface has barely been scratched. The rise has scarcely begun."

"Look at the skepticism on the face of this dirty old man," said the Great Winfield, pointing at me. "Look at him, framing questions about depreciation, about how fast these computers are written off. I know what he's going to ask. He's going to ask what makes a finance company worth fifty times earnings. Right?" "Right," I admitted. Billy the Kid smiled tolerantly, well aware that the older generation has trouble figuring out the New Math, the New Economics, and the New Market. "You can't make any money with questions like that," said the Great Winfield. "They show you're middle-aged, they show your generation. Show me a portfolio, I'll tell you the generation."

The Money Game was penned by an acquaintance of mine, namely Jerry Goodman, who took the nom de plume of legendary economist Adam Smith, author of the groundbreaking book The Wealth of Nations, first published in 1776. I met Jerry a few years ago at the offices of my friend Craig Drill, eponymous captain of Drill Capital, where another icon hangs his hat. That icon (Dr. Albert Wojnilower) is also from an era gone by when he, and his counterpart, rattled markets every time they spoke. Back in the 1970s and 1980s Al Wojnilower was affectionately referred to as "Dr. Gloom," and his counterpart Dr. Henry Kaufman was deemed "Dr. Doom," but I digress.

Expanding on the Great Winfield's wisdom about a "kid's market," he goes on to say, "the strength of my kids is that they're too young to remember anything bad, and they are making so much money they feel invincible." He rented kids with the idea that one day the music will stop (it did partially in 1969-70, then completely stopped in 1973-74) and all of them will be broke but one. That one will be the Arthur Rock (an American venture capitalist who was an early investor in companies like: Intel, Apple (NASDAQ:AAPL), Teledyne (NYSE:TDY), etc.) of the new generation; Winfield will keep him.
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