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Why Governments Matter!

Sigma Investment Counselors

May 25, 2011

Many of our blogs focus on government policy and actions. We may not always be as clear as we should be as to why we pay such close attention to government policy, making an assumption that this is clear to our readers – that government actions can materially affect the economy and financial assets. A succinct summary of this correlation was laid out in a newsletter that we subscribe to – John Mauldin’s “Thoughts from the Frontline.” In the May 20, 2011 recent issue, Mauldin relays a conversation he had with a very well regarded (by us and Mauldin) analyst, Dr. Woody Brock. We are reproducing a portion of the exchange below as it reflects our own thinking.

Mauldin: “That is why, although we pay attention to politics, including Congress, we run models on our investments. We worry about long-term valuations, inflation/deflation, currencies, etc. Our primary tools for thinking about our investments are economic and financial tools, flawed though they may be. As business people and entrepreneurs, we are more focused on executing our business plans than worrying about politics, although one does pay attention to what they are doing, as regulations can change our plans. As a value investor, I want to know how the executives of a company are going to create cash flow and use that money to grow the business. When I invest in biotech, I want to think about the intellectual property and demand. And so on.

But all that is changing. I mentioned to Woody that it seems like we have to pay more and more attention to politicians and what they are doing and less and less to our economic theory. But that is the nature of the Endgame. And this is not just in the US, but all over the world. The choices that voters make, and then the things the politicians do, are becoming ever more important. Those choices can mean the difference between Muddle Through and a recession here and there, a full-on Depression 2.0, or even hyperinflation in some countries, with voters (and most assuredly politicians!) not thoroughly understanding the unintended consequences of their reactions.

Woody responded that it is now more about political and game theory than economic theory. How do politicians work through the trade-offs they will be forced to make? Can they even make them?”

We welcome input or questions.

Robert M. Bilkie, Jr., CFA

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