What We Think – “Organic – It’s the New Thing”:
People ask us on a daily basis when we think the move up in the markets is going to end, and if they should put money into equities. Our answers are “we don’t know” and “no.” The first answer boils down to the witty line by British economist John Maynard Keynes, “Markets can remain irrational longer than you can remain solvent.” We qualify the second answer a bit, as noted in “What We Recommend”, but generally speaking, we do not like broad-based equity exposure at these levels as we believe risks outweigh rewards in chasing a cyclical bull trend in a secular bear market. That is, we view the equity markets as predominately technically driven and overly optimistic, fundamentally discounting tenuous forward earnings projections based upon the belief that the economic and profit recovery can continue through the end of government stimulus.
And, as we stated in our February 5th Market Commentary, a “black” day or “days” may lie ahead (a market correction of 10% or considerably more) due to the complacency and steepness in the 80% move up in equity markets from March 2009 lows, the propensity for political mis-steps in the U.S. and Europe in dealing with financial reform and the Eurozone debt pandemic, as well as a variety of other near-term risks. As we stated in February with respect to the Eurozone debt pandemic, we see now as in 2007/2008 a failure of people to recognize the very serious nature of the potential contagion that may loom from Greece, to Spain to Portugal, as was the case from Bear Stearns, to Lehman to AIG. We call the contagion that began in Greece the “Black Hand”, and it carries with it mal-affects for economies and financial institutions not only in Europe, but in Asia and the Americas. These mal-effects rage from a slow-down in European growth at best, to a second financial crisis and worldwide reoccurring recession at worst.
Turning to the U.S. economy, we are truly confounded by the number and vigor of “V-shapers” that choose to ignore the true nature of the U.S. “recovery” to date as well as the myriad headwinds that lie ahead. The economic recovery thus far has not been “organic” in that it has not come from resumption in robust “final demand” (consumer demand, private investment, and exports). Rather, the recovery has been a one-time event driven by massive but temporary government stimulus and bailouts, near zero interest Fed Funds rate policy, quantitative easing (printing new money to purchase “toxic assets” from financial institutions as well as provide money to the Federal government through the purchase of Treasuries), and the relaxation of accounting rules and banking regulation providing banks with the ability to remain “solvent”, and indeed prosper to the extent that no other industry has (the darkest of ironies in the story thus far). We call this stimulus-injected economy a “Botox Economy” – one injected at every angle to look how it is supposed to look in recovery. The problem is that as stimulus wears off the wrinkles and sags return. The result of the government stimulus has indeed driven consumer demand off the mat, and corporate profitability has rebounded, but the former is ephemeral without substantially rising employment, real wage growth, improving home pricing and availability of credit (none of which appear on the horizon), and the latter has come at the expense of labor through job cuts and declining real wages.