News & Insights
Sighs of Relief: Adjusting to the New Reality
As the biggest dangers associated with last autumn’s financial collapse recede from our consciousness, the markets responded with a second quarter rally that was among this young century’s strongest stock market performances. U.S. stock indices were up about 16% from March 31st. Just like swallows arriving in San Capistrano, the optimists began to swarm and speak with the talking heads of V shaped recoveries, heralding a new era of debt fueled risk taking that would take us back to the “prosperity” of just 18 months ago. Thankfully, as we write this quarterly outlook after the market close on July 3rd, the stock markets are reacting to a worse than expected employment report with a 2 ½ % reality check, lest the relief associated with surviving our near death experience turn into an unhealthy euphoria.
The truth, as we see it, is the financial markets have stabilized and are in sufficiently good shape to finance our economy’s current needs. Merger and acquisition activity is up and several IPO’s have been floated successfully. Industrial activity has begun to stabilize and leading indicators are turning up. These positive developments are leavened by the need to repay the enormous overhanging debt incurred by consumers and, to some extent, companies over the past decade. This “great deleveraging” will keep a lid on economic activity for some years to come. This is not all bad. As consumers save more, the U.S. Treasury will borrow more from domestic savers and less from abroad to finance our widening deficit. The slow economic growth (1.8 to 2.5% improvement in GDP) implied by current conditions is decidedly better than the shrinking economy we have been living with for the past year. As long as Washington avoids massive policy mistakes, the economy should right itself over the next several years and move toward robust sustainable growth in the 3% to 3.5% range.
The emanations from our capitol are not encouraging in this regard. Planned increases in permanent government programs for subsidized health care could blow out the structural deficit, leading to higher interest rates, higher taxes or both. However, we do not discount the possibility that this President and this Congress will seize this historic opportunity to put the government back on a path toward balance without raising taxes in a way that punishes long term growth. We are skeptical of this outcome, but refuse to join the camp which believes current trends herald a return of Karl Marx to intellectual respectability. “Das Capital” will remain an historical curiosity. America is a capitalist country to its bones.
Stock, Bonds & Cash
We do not believe the correction that began as the third quarter commenced signals a trip to the March lows. We believe pull backs offer an opportunity to increase exposure to high quality U.S. equities and those of emerging markets. Investment grade corporate bonds still offer a decent alternative to stocks, even though they have rallied quite smartly in recent months. Treasury securities look overvalued but will likely stay this way for the remainder of the year. Inflation protected bonds look like a good value even as inflation remains tamed for the time being.
Altavista Investment Team- Summer 2009