This past quarter we’ve witnessed Europe’s fiscal issues finally metastasize into banking issues (Belgium’s Dexia)—long feared—as their politicians, like our own, have made an art form of “kicking the can down the road”.
Most would agree that our current locale is now “down the road”, both in Europe and here in the US; and we’re looking at that same “can” once again. This metaphor perhaps best explains the severe volatility we’ve seen in the markets over the previous few months—and may continue to see in the future.
An unofficial survey of economic prognostications by CCR Wealth Management suggests a roughly 50/50 split as to whether the US is headed into another recession or not. Opinion that we’re already in a recession is plentiful. While such predictions are outside the sphere of CCR Wealth Management’s services, we think a few relevant, less negative points have been lost amid the doleful headline blitz of the last 90 days or so.
- September manufacturing ISM (Institute for Supply Management) expanded for the 26th consecutive month, registering a PMI index of 51.6%.
This is a leading economic indicator, and not a pre-recessionary number! (Below 50 would be)
- September non-manufacturing (service industries) ISM expanded for the 22cnd consecutive month, registering 53%.
Again—not a pre-recessionary number! (Below 50 would be)
- Weekly jobless claim numbers (4 week moving average) issued October 8 decreased 7,000, coupled with a statistically meaningful upward revision to the August non-farm payroll numbers suggest the recent downward pace of un-employment has at least slowed.
- Constant comparisons to 2008 leave out the following:
-US manufacturing and non-manufacturing utilization rates are significantly higher than they were three years ago (i.e. there is much less “slack” in the business system)
-US corporate balance sheets, financial ratios, and cash-on-hand are far and away much improved from 2008 levels.
Something CCR WM has pointed out before in these pages
Of course none of these points presage another economic downturn—or even further market volatility. However, we think they should be computed objectively along side the fact that we are considering current investment and market gyrations in the midst of the statistically weak (and volatile) months of September/October.
To be sure, there are numerous sources of potential headline-volatility (positive or negative) immediately ahead; in addition to the current Q3 earnings releases happening now, and in addition to the normal economic employment releases in the first week of November, we’ll be digesting with interest the evolution of the so-called congressional “Super Committee” budget recommendations that are due out around November 26, and even more so the Sarkozy/Merkel “grand plan” to solve the European dilemma promised before the upcoming G-20 summit.
We’ve outlined what we think are important mitigating factors investors should consider when inundated with negativity regarding the markets and global economics. That said, we eschew the un-deliberated policy of “hold and hope”, and recognize a few real changes in economic facts that should inform our strategy:
For several years CCR WM’s model portfolios have been overweight in small cap equities (12%-20% of equities), with the justification that small cap equities generally out-perform large cap stocks in early-cycle economies. While it is currently unclear where we are in the business cycle (a source of much debate today), it is clear to us that we are unlikely in an early business cycle anymore.
Concurrent with a reduction in small cap equities is a recognition of very attractive dividend yields (and equally compelling fundamental valuations) in many US Large Cap “value” stocks. These equities offer an additional source of return in what could remain “choppy” markets for the foreseeable future. Examples of these yields include: AT&T (6.00%), Verizon (5.50%), Pfizer (4.30%), Altria (6.00%). The yield on the 10-year Treasury note (at this writing) is roughly equal with the yield on the S&P 500. Keep in mind; a 10-year T-Note likely has nothing but amortization ahead, while even modest stock gains in the next decade make this comparison a “no-brainer”.
As referenced above, while we recognize adjustments should be made in shifting markets (and with shifting global economic outlooks), we remain steadfast in our longer term outlook for the world’s growth economies—particularly in comparison to the developed world. For the past 12 months we’ve commented on the aggressive central bank actions in many of these countries—and over the previous quarter, we’ve been reminded of the higher volatility nature of this equity class. The former (central bank tightening) is both healthy policy response to high inflation, and likely near completion. The latter (higher betas) is to be expected.
We’ve returned to this topic frequently this year, and at the current date, no-doubt this segment of one’s equity portfolio has seen the most down-side over the last 3, 6 and 12 months. We continue to be confident that a “soft landing” will manifest in emerging market equities, and economically be of great benefit to the world’s largest economies in the months and quarters ahead.
Perhaps our largest intra-year investment policy change is a reversal of our position on floating rate bond funds propounded on in our January Outlook this year. Economic realities have forced us to re-think our assumptions about the immediate direction of interest rates, further solidified by the Fed Chairman’s mid-August validation that the current rate environment will likely be with us for at least another 18 months.
Gold has clearly backed off its most recent (August–September) highs, yet it remains significantly higher than it was at the beginning of the year (~+18%), and a year ago (~+28%).
We think it a good idea for investors (particularly heavy in gold) to begin to consider some (perhaps) counter-intuitive thought exercises. We note the run-up in stocks over the last week was primarily due to a lack of bad news, rather than any identifiable positive developments out of Europe. France and Germany have announced their intention to finally produce a comprehensive, “grand plan” to deal with Europe’s fiscal/banking/credibility issue on or before next month’s G-20 meeting.
The “thought exercise”, in our view, should be to consider how far, and how fast gold could fall, ifsuch a plan is widely accepted as a plausible solution. A big “if”—we agree (given the prior three months of rancorous disagreement). But we do not take gold’s march to $2,500/oz as a given at this point.
We continue to view oil (specifically Brent crude) as a better fundamental value at current levels. As mentioned, capacity utilization in the US remains high, and we think most investors are pricing in a US (or “developed world”) supply/demand forecast without regard to potential Chinese influence in the next 6 months or so.