July, 2010
The U.S. economy has entered a soft patch with economic indicators showing growth, but at a slower pace. Fears of a double dip recession are emerging, resulting in a 15% decline in the S&P500 from its April peak. ISI Group, a leading forecaster, has lowered their GDP growth rates for the U.S., but to a reasonable 2.5% for 2010 and 2.0% for 2011. Also, many headline issues are frightening skittish investors: the Gulf oil blowout, the continued financial difficulties in Europe and several U.S. state governments, persistently high unemployment, anti-business rhetoric in Washington, pending tax increases and low risk tolerance evidenced by the flight to U.S. Treasury Notes. As investors, what are we to do? Do we panic and sell on fears of a double dip recession…or is that now already discounted? We believe that recent events are merely a correction in a market recovery and we should be near the bottom of expectations given all of the nasty feelings that have surfaced recently.
With rates at near zero and trillion dollar budget deficits as far as the eye can see, investors are wondering what magic tricks the government may have left to stimulate growth. One is to let the dollar fall, making U.S. goods less expensive in global markets. Unfortunately, the old “J” curve that you learn about in Economics 101 says there is about an 18 month lag before currency changes have an economic impact. Another would be to actually talk about cutting tax rates….but we think the politicians will save this option for the Presidential election, not now. Unfortunately, there really is little our huge government can do at this time. European data shows signs of weakness as well but forecasters still see 2.5% growth there this year. In the U.S., the rise in unemployment claims and weaker consumer confidence numbers acted as fuel for the fire, raising fears of a double dip recession. Groups sensitive to economic activity have been hit the hardest in the correction this quarter, especially technology.
While aware of the negatives, we remain optimistic that the U.S. and Global economies are still on the road to recovery, albeit anemic ones in the developed world. For example, despite the current gloom The Institute of Supply Management index for U.S. manufacturing was reported at 56.2, down from 59.7, but any reading above 50 indicates expansion. So while growth has slowed, we are still moving forward. Mortgage rates are at their lowest levels ever and should provide ample incentive for new home purchases once buyers sense that employment has stabilized. Many companies are seeing improved demand for goods and services and developed nations are rebuilding inventory for the first time in three years. Once financial reform is quantifiable, the supply of credit, especially to the expanding corporate sector, should be enhanced thus helping to stimulate growth.
The most important issue today in the global markets is economic growth in Asia; China in particular. Factory output there has slowed from the torrid pace seen recently. Stephen Roach of Morgan Stanley feels this slowdown is welcome given the first flames of inflation emerging there lately. But he still sees China growing at an 8-9% rate, just not the 11-12% rate seen recently. We are dependent on Asia to keep global growth going and the Chinese know this. Soon they may feel compelled to reverse restrictive policies to show the world they are not going to lead us all to ruin. Beijing has plenty of fiscal and monetary policy room to stimulate…and they will. So we should not fret about what Washington will not do during this current correction. We will be listening to what China says and does.
Looking forward, an opportunistic investment approach remains the most appropriate course to take rather than traditional asset allocation. The key to finding successful investments will be uncovering companies that are regaining or accelerating their business momentum. Banking and hospitals may become good investments again after years of struggle. Corporate productivity plus internet capacity needs will drive technology demand. Psychology shifts in healthcare with the bill passed plus a new product surge should drive new opportunities here. And when the dollar reverses course, gold and oil related industries should make substantial progress. We believe that once this current market correction concludes, our investments will respond positively to their improving fundamentals despite the lackluster economic climate.
|