Sunday, May 16, 2010

The Fork in the Road
to your Investment Policies

The fork to the left is pinpointed by real world observations, the fork to the right deals with possible negatives.

As many of the members of this blog community know, one of my critical investment laboratories is Ruth’s and my walks through The Mall at Short Hills. For those of the community who are not familiar with our annual rite, the day and the weekend after Thanksgiving each year find us at this very upscale mall looking at the size and intensity of the crowd as well as the number of labeled shopping bags they are carrying. Another clue to the robustness of the Holiday sales is how far away we have to park compared to our normal spot.


We have just returned from a visit to the mall on a very pleasant sunny Sunday. We had to go to the less convenient level to find a parking place. There were more than the normal numbers of intense shoppers, not walkers. The Apple store (NASDAQ: AAPL) in particular looked busy and the Verizon store (NYSE: VZ) appeared to have a good crowd within. In the past I have commented on the depressing number of vacant store sites. Today there are fewer vacancies and there are a number of large stores advertising their future openings and upscale merchandise. Bottom line: people were buying, merchants were expanding, and mall operators were showing signs of success in filling their sites (perhaps at discounted leases).


In this part of the country, dinners and cocktail parties' participants spend some time on our “local sport.” To my grandson’s dismay, this is not soccer but residential real estate. Increasingly we are hearing about bids being hit or exceeded, but with contingencies for mortgages or prior sale of the buyers’ current homes. Months ago there were little or no such conversations.


The investment implications of this left fork are that the economy is in a state of uneven recovery and some hope has returned. From a portfolio standpoint, investment in depressed consumer discretionary items as well as some ties to home improvements appears to make sense. These moves are based on the return some form of normality, even if it’s the “new normal” of lower returns.


The right fork is more difficult to elucidate. Last week one of the questions that my blog dealt with was, "Why didn’t a number of investors jump in at what appeared to be bargain prices?" As mentioned, sharp market movements in retrospect often are found to be inflection points, marking changes of direction in investment thinking. The immediate concern in the first week of May was the clumsy way the European Community was dealing with the Greek problems. The bounce-back sustained in this past week focused on multi-tiered funding approaches by the EC and the IMF. There were some austerity measures announced for Greece, Portugal, Spain and Ireland. I suspect that these will not be sufficient in the long run. At this point a much bigger potential funding deficit in Italy is not being publicly addressed. A number of commentators have compared the deficit tracks of Greece and the US, which is sobering. What has one concerned is the pattern of governments to socialize, if not nationalize, what in the past has been private responsibilities. As families became clans, then tribes and morphed into nations, the primary need assigned to government was defense from without.


To pay for services by government, taxes were introduced which led to government sponsored coinage and building roads. Over time, provisions for education and retirement became government obligation in some societies. In Europe and now in the US, the provision of health care is being socialized. What is not written in our, or other countries’ constitutions, is the creation and preservation of jobs.

Almost inevitably when a service that has been or could be provided by the private sector is turned over to the government, inefficiency and corruption occur at some levels. These are additional transfers from the private sector to the public sector, not dissimilar to declared taxes. There are differences caused by these inefficiencies and corruptions which build rigidities into the economic systems. Over time these elements act as an additional tax on the provision of these services to the community. Countries, states and cities with higher net effective tax will inevitably lose economic opportunities and therefore jobs to more efficient locations.


Are the problems of just about every country which borders the Mediterranean akin to a flock of canaries in the mine? Did some investors perceive the problem without seeing any significant attempt to structurally reform our own economy? If that is their growing perception, they should start to discount more heavily what they expect to be normalized or peak recovery earnings. In other words, do stocks in the future, not have the same potential capital appreciation that they delivered to us in the past century? (Not counting the last ten years of little to no real growth.)


For those that are looking down the right fork, they should consider using significant recovery rallies, including new highs, as selling opportunities. As long term bonds are already unattractive in terms of income and inflation, they are unlikely to be a long term attractive alternative for equity money freed from the domestic market. What is worthwhile, starting today, is the search for governments that are being more responsible to their citizens and investors. Those that are doing so today are more likely to continue to do so rather than the countries that recover from too much government spending.

The choice of which fork is up to you and for awhile one could attempt to do both, but that will require an alert investment manager. Keep us informed.


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