Many of my blogs over the past few months have focused on government policy – fiscal and/or monetary. While this may seem to the casual observer somewhat removed from investment analytics, the reality is that government policy always impacts the financial markets (Ronald Reagan’s massive tax cuts in 1981 ignited the subsequent stock market rally; the passage of the Gram-Rudman deficit reduction legislation resulted in a similar equity market move in 1985). I would assert that rarely has policy action been more important to the functioning of capital markets than during the past several quarters. Of course, a blinding glimpse of the obvious suggests that the global economic environment has rarely been as perilous as in the past two and a half years and thus it is the desire of policy makers to “fix” whatever ails the economy. Of course, the focus on job creation (or the lack thereof) in the US cost many politicians their jobs in the November 2 election and it is assumed that therefore government must do something.
From my vantage point, it has rare been the case when corporate profitability has been better than the last year or so in terms of breadth and depth. Balance sheets by corporations are likewise healthier than they have been in decades with most companies flush with cash and debt levels quite manageable. Worker productivity has been strong. Consumers are paying down (or defaulting) on debts, improving their own financial situation. So, what’s the problem?
Jobs. The unemployment rate in the United States is unacceptably high and this is the situation in other developed countries too. In addition, unfunded liabilities (social security benefits, Medicaid benefits, public pension obligations in Greece and California, etc.) are a ticking time bomb. These vulnerabilities are keeping companies on edge and executives reluctant to hire. As a result, all investment eyes are fixed on Washington, Berlin, London, Paris, et. al. watching to see what will happen regarding policy actions. Uniquely, many other considerations (asset valuation measures, growth opportunities, geo-political risks) as tools of analysis seem to have paled in comparison. This is why we have focused on policy analysis of late.
Indeed, in early 2010 we began to get a sense that the economic outlook might not be as dire as some others (per the December 2, 2010 Wall Street Journal, “Goldman Sach’s, whose forecasters have been among the most downbeat about the strength of the recovery, said in a note to investors Wednesday that prospects for U.S. growth had ‘brightened significantly in recent weeks.’ The bank revised its 2011 growth forecast for gross domestic product to 2.7% from 2.05%”) . In fact, we conjectured in an economic presentation to the National Mensa conference in Dearborn, Michigan in June that we had a constructive outlook on the economy. As a result, we elected to maintain existing exposure to the asset class most sensitive to economic conditions, common stocks, in our client portfolios.
Similarly, we believed that policy makers would address public pension liabilities as a foregone conclusion several months ago and commented as such in our August blog, a development we believed would lead to further improvements in financial markets (and financial markets shortly thereafter took on a more firm tone, affirming our investment posture). As we ascertain future shifts on policy issues of importance, we will modify our investment tactics likewise.
So, policy continues to take center stage and we expect to keep you apprised of what we infer from these developments and how they will influence our investment strategies.
Robert M. Bilkie, Jr., CFA