Normally I think about my blog communications to you throughout the preceding week, then I spend Sunday working on my first draft in order to get a completed version before the end of the evening. As I sit here on Saturday night before the impact of Hurricane Irene is forecast to hit us Sunday, I am concerned that some fallen trees might knock us off the electrical grid. Thus, I am pulling together my scraps of paper and other thoughts about 24 hours earlier than normal. The result is a collection of questions and observations on various bits of news and commentary I have reviewed this week.
Europe: What will it be?
There are two concerns which are keeping investors away from the stock market. The first concern is whether the US will tip into recession (more on this in a minute), and the second is Europe. At its core, the issue in terms of Europe is whether Germany will provide the capital to bail out the Mediterranean and Irish governments, and more specifically, their banks and the banks’ counter-parties in the more solvent countries. The European bureaucrats have maneuvered their creation, the European Central Bank (ECB), into buying sovereign debt issues of some of the peripheral countries in the secondary market. On September 7th, a senior German court will rule as to whether this was in violation of the law (and spirit) of the agreement to create the ECB. Logic from afar suggests that it was in violation, and now questions whether Europe as we know it will continue to exist. Any form of disequilibrium created by these events and discussions will have some unpleasant impacts on US securities, particularly commercial banks.
What does 1% (actually 0.99%) mean to the US?
The latest reading on the growth of the US Gross Domestic Product (GDP) for the second quarter, was a gain of 0.99%, generously translated to be 1%. Subsequent quarters were expected to be higher, with the final quarter generating a 3% growth rate. (Many believe a 3% growth rate or better is required to make a meaningful dent in US unemployment and under-employment statistics.) As disheartening as the 1% figure is to the economy, it suggests other concerns to me. While the financial community will gladly do battle over 1% (or as we most likely will refer to it, as 100 basis points) in this period of declining volume and excess capacity, there is a deeper concern on the part of number crunchers like me. What is rarely discussed (but is included in the full breakdown of the national accounts) is a line item called Errors and Omissions. Considering how often there are significant corrections or adjustments to federal government numbers, I wonder whether there was any growth in the US in the second quarter! My concern was heightened when I read the following excerpt from a fellow member of our blog community who is a corporate environmental counsel and a former FDA counsel. He summarized his interactions with the government:
“The overhead of any program and waste consumes a substantial fraction of the funds allocated. They are spent on feeding the 'perpetual bureaucracy' or temporary managers as administrative costs or the money is simply wasted and does not go to any economically productive use.”
Bear in mind that the government is spending roughly one of every five dollars counted in our economic progress.
Are We Creating a Self-Induced Recession?
Much has been written about the “wealth effect” which states that when people believe that their wealth is growing they will spend more. This was one of the excuses for QE2. It didn’t work in a meaningful way. But are we seeing the reverse, when the uncertainties created by the politicians on both sides of the Atlantic are causing investors to stay away from the market? There are always circumstances when investors desire to sell their securities. In the absence of securities buyers, the forced sales will generate lower prices; that in turn makes bystanders feel poorer, and therefore they reduce their spending for various goods and services.
The “Halo Effect”
Jason Zweig, in his weekend column in the WSJ, places halos on Steve Jobs and Warren Buffett, and then does a good job of reporting on the mistakes each has done without diminishing their overall record. Also, the Financial Times Saturday edition, in reporting on Mr. Buffett’s latest purchase of Bank of America preferred stock with warrants, notes a number of quotes whereby he acknowledges less than perfect foresight into financial services companies. (Disclosure: Berkshire Hathaway is a position in my private financial service fund as well as my personal account.) The halo effect is a constant worry to me in selecting mutual funds to invest for my institutional and high net worth clients. We all find it easier to invest with a successful investor than one who is currently not doing well. We gloss over the past mistakes of our heroes and focus on the mistakes of the current laggard. Mr. Buffet reminds us of his fallibility by maintaining his corporate name on a very bad operating investment he made.
As we are moving into particularly troubled financial, economic and political waters, we should be aware of the risks attached to the halo effect.
Am I Premature?
In a recent investment committee meeting with a number of well-known investment professionals, I was asked whether I was premature when I took contrary positions to the perceived knowledge. My respect for the questioner was such that I had to examine my past thinking on investments in order to answer thoughtfully. As often is the case with this individual, he was right. I tend to look at investments as an entrepreneur rather than as a trader. I look for structural imbalances and opportunities. Most of the time I would prefer to be early than late. Even though it was a favorite song of my late daughter's, when I was expressing frustration about change, I couldn’t relax to go along with her view of “Que Sera, Sera,” but she was a calmer person than me.
Reactions to any of these observations?
Note: We will be in London in late September visiting with investors and managers. Are there additional people we should see if appointments can be arranged?
To read last week’s Blog from Mike Lipper, click here.
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