THE WINTER LETTER
Under capitalism man exploits man. Under communism it is just the opposite.”
– Soviet era joke
Economic Perspective
Europe remains mired in economic stagnation and political paralysis aggravated by recent jihadist attacks in Paris and the Russian invasion of the Ukraine. Clearly, KGB alumnus and Russian President Vladimir Putin, the cynic, has learned the wrong lessons from the collapse of the Soviet Union. What the West rightly hailed as the potential dawn of a new era, he laments as a catastrophe. But then his state centric economic policy only confirms his total lack of understanding of the discipline. Putin’s intervention in the Ukraine grows out of his terror that a democratic, capitalist Ukraine oriented toward Western Europe would put a lie to his claim that a large Slavic state cannot thrive (and make a mockery of his kleptocratic regime); his allegations about NATO encirclement are only a smokescreen for his violation of international law.
The euro zone muddled through in 2014. Avoidance of an outright recession only postpones European political leaders’ obligation to work harder for euro reform. The French must work more than 35 hours per week. And, guild-like labor rigidity in Mediterranean Europe must yield to economic liberalization, if they hope to compete with northern Europe, especially Germany, and the rest of the world. Challenged by a sovereign debt crisis and inadequate bank capitalization in selected markets, Europe must stimulate economic growth region-wide. Absent political leadership, the European Central Bank will accelerate bond buying at the end of January. The Swiss uncoupling from the euro further demonstrates lack of European unity.
Oil prices have declined over 60% in the past eight months. OPEC, led by the Saudis, has chosen market share preservation over current revenues. The Saudis will maintain pressure on oil prices for at least the next nine months, possibly longer. The list of state victims of this strategy populates a rogues’ gallery: Russia, Iran and Venezuela lead the pack. The savings to the American consumer exceed $175 billion annually. But, the consumer has chosen to defer spending the windfall. The oil price decline will hit capital spending in the energy sector first before it benefits energy users.
Last year’s stock market advance portends a continued economic recovery but not at last year’s robust rate. Record exports and the smallest trade deficit in eight years. And a slow but steady pickup in job creation. Finally, we see improvement in hiring. Employment accelerated in the final quarter of last year and the first weeks of this. Both jobless claims and the unemployment rate (now 5.8%) dipped to pre-crisis levels. Of course, labor force participation slipped to levels not seen since the late Seventies.
Market Prospects
In the long run, financial markets exist to facilitate the efficient allocation of capital. Short term they give market participants premature ulcers. The Fed has ended tapering. Next on the agenda a possible change in the direction of interest rates. Likely to remain unchanged. Deflationary signs will still the Fed’s hand.
The year opened with a stumble in stock prices. Nevertheless, stocks are likely to advance against a backdrop of Federal Reserve sanctioned low interest rates. Corporate spending is expected to fuel growth as companies’ spoon cash hoards into a belated cycle of replacement business capital investment for information technology and telecommunications equipment. The consumer’s improved balance sheet offers some prospect of improved retail sales.
Geopolitical risks cloud the outlook. The armed insurrections in Syria and Iraq may put more Arab regimes into play. In an effort to navigate the treacherous market waters we emphasize sectors like: more resilient large cap names (General Electric); biotechnology (Amgen, Biogen Idec, Celgene and Gilead); entertainment (Liberty Global, Disney, Comcast); technology (EMC, Microsoft, Cisco and Google), dividend plays like Digital Realty and ONEOK Partners; and specialty manufacturing (Reliance Steel, Wabtec and Xylem).
Stephen K. Bache, CFA
Sources: Business Week, The Economist, Los Angeles Times, New York Times, The Wall Street Journal, John Patrick Diggins, Why Niebuhr Now; John Lewis Gaddis, The Cold War.
