How can anyone govern a nation that has two hundred and forty-six different kinds of cheese?”
– Charles de Gaulle
Economic Perspective
The United States economy should rebound in the second half of the year as depleted goods inventories are rebuilt. Housing activity continues robust as the recent spike in mortgage interest rates alerts buyers to greater costs ahead: the result anticipatory buying. A weaker dollar should also assist the export picture and thereby boost the economy. The slowing of China’s economic growth pace will dampen commodities prices for all global customers and assist our economy. While observed price increases abound in the super market, true price inflation requires wage rates rise.
While the past three years have made the pairing of the words “European” and “crisis” natural, EU member state Latvia recently committed to adopting the euro next January. Latvia’s decision reaffirms expectations that the euro will not break up.
Europe remains mired in a politically motivated standoff over euro membership and national budget crises. All participants know what must be done but the European “South” refuses to accept reality and the German paymaster will not release more funds absent real fiscal reforms. The euro zone requires a recapitalization of its major banks, increases in labor market flexibility, higher retirement ages and curbing of overgenerous entitlement programs. Instead, German Chancellor Angela Merkel punishes the profligate with short sighted austerity measures while France’s new President Francois Hollande fantasizes about increased government spending. Perhaps, the European political class will see reason and placate financial markets before precipitating a severe Europe wide recession; so far they have been in the solve the latest panic mode rather than instituting needed structural reforms.
Global economic growth is mediocre, held down by continued balance sheet repair in economies where leverage got out of hand, especially on the household and banking side in the United States and the United Kingdom. Yet global growth should approach 3% this year and exceed that next year. Inflation remains under control and will continue so until employment expands substantially
Market Thoughts
Recent comments by Federal Reserve Chairman Ben Bernanke appearing to contradict his talk of tapering bond buying buoyed the stock market early in the third quarter of this year.
Corporate profitability remains high thanks, among other things, to the low cost of borrowing and wage growth restraint (high unemployment restrains wages). There has been a massive increase in corporate profit margins. Strong profit margins provide substantive support for stocks. However, the quality of earnings in the banking sector, through the reversal of loan loss reserves, leaves a great deal to be desired.
In an effort to navigate the difficult market waters we have re-emphasized more defensive sectors: consumer products (Church & Dwight, Kellogg, Smucker’s); pharmaceuticals and medical equipment firms (Pfizer, Johnson & Johnson, Covidien, Bristol-Myers Squibb, Alere); media and entertainment (Disney, Liberty Media); financials (Allied World Assurance, White Mountain Insurance) and as inflation hedges, energy (Devon Energy, Conoco, Rosetta Resources, and WPX Energy) and timber (Plum Creek Timber, Rayonier and Weyerhaeuser).
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Stephen K. Bache, CFA
Sources: Berkshire Hathaway annual reports, Bloomberg Business Week, The Economist, New York Times, The Wall Street Journal, The Washington Monthly
