Recovery, or More of the Same? Why?
A knowledgeable reader emailed me to ask why I believe a recovery may be in the making. Because there has always been a recovery is not a sufficient foundation for me. In part because of my exposure to Caltech and a background of examining various funds seeking good investments, I am optimistic. Similar to the New York Yankees solving their business problems (as I mentioned last week), the American society comes up with solutions to many of its problems. Some of the products and services that we produce will not only address our problems but will also be in demand beyond our borders. The iPad, Boeing Aircraft (to economically replace aging plane fleets), Deal Making (we lead the world in those skills), wheat( in a period of growing excess demand), social media (Facebook, etc), US movies and televisions shows (with greater international revenues than domestic) and new drugs and other life-altering medical devices. I will be the first to admit that these products and services, with rare exception, are not massively labor intensive. But they are factors that may help us. For example, the vast majority of immigrants (legal or otherwise) come here to make money. They are strivers and in the long term may be more productive than many of our other residents.
In the future some of our military dollars may be shifted to much needed infrastructure expenditure. In the long run I am confident that we will continue to be a nation of problem solvers.
Four Low Hurdles Before the Outlook
There are four brief periods that we will pass through before most investors will be comfortable enough to look at the long term future. Each of these periods is likely to produce higher than normal volatility as the headlines will scare us one way or another depending on our own biases. The first is the period between now and the general election when the control of Congress, particularly the House of Representatives, will be determined. The next and to me the most worrisome, is the post-election session. A significant number of the members in both Houses will be incumbents who will not likely face voters again. These people are prime candidates for government appointments or key lobbying positions. Watching this sausage machine won’t be pretty. The third period will begin with the new Congress, when there will be jockeying for various committee assignments and chairmanships. Not all of these will be in favor of pro-investment legislation. The final period will be after the President’s budget message. That message will give the Congress the choice of bargaining with the White House or just ignoring the Administration’s wishes. There is likely to be some progress, but the execution of the legislation will still leave a lot to be desired in terms of logical clarity.
Contrarian Outlooks for the Long Term
- The S&P 500 will likely gain at least 200% (JP Morgan points out that historically when a market recovery takes place, gains of 250% can be expected.
- The S&P 500 is likely to somewhat outperform most managers, unlike what it has done over the last ten years.
- One would be better off betting on the lagging groups, particularly the Science & Technology funds than the Emerging Markets and Resource focused funds. The real winners are likely to be the companies that use technology to disrupt the ways others do business.
- For some time bond yields will rise with the stock market
- The US will not default on our debts, our assets are too valuable.
- The lost generation of investors will return to the marketplace.
- At a low enough price level, the housing market will recover. Often prices will reflect intelligent replacement costs.
Our stock market has not been capital productive for ten years. Is this a long enough period of base building to support a market expansion? That depends on whether one sees the ten years as a correction and correction for what. If we are correcting primarily for too high equity valuation, we probably have already done that. Well covered yields on many stocks are now higher than Treasury bonds. If we are correcting from an overvalued currency, that has been happening in fits and starts at least for 20 years. What we have not corrected for is lending practices at the consumer, business and governmental levels. The current approach of just requiring more capital to cushion the bad loans does not irradiate the bad loans, as a matter of fact it probably causes more risky loans, as they produce more profits than safer loans, (the potential profits are greater than the additional capital requirements). We still have the need to correct for the bad loan policies and this could delay our recovery. Another correction we may have to make is that of our use of inflation. Governments have been users of inflation to reduce the purchasing power of their debt repayments. Businesses, when faced with assured but flat demand have often elected to raise prices to increase revenues rather lower prices to increase demand. If we need to correct for our inflation biases, it may take along time. For most of our lives we have lived in an inflating society. Any correction may have to represent something on the order of 1/3rd to 1/2 a normal lifetime. I do not know which correction phase we are in. My guess: for a significant portion of your money, you should invest in the future; it will be better than not over the next ten years.
One clue as to whether the correction phase is ending and the next expansion is beginning, is to look to the mutual funds that are characterized as large cap growth funds. With rare exception it has been very difficult for large capitalization growth companies to make significant progress. While there have been some exceptions (for example Apple and Google), to date there have not been a minimum of twenty of these to drive a reasonably sized growth fund portfolio forward. As a contrarian I would suggest a minor investment in this category might alert you when such a move may begin.
The turn could be sooner than we think. On a rainy Sunday with the New York Giants playing locally, the Short Hills Mall was full of people with shopping bags. These were adults not participating in back to school shopping.
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