THE AUTUMN LETTER
To live within limits, to want one thing, or a very few things;
Very much and love them dearly, cling to them, survey them
From every angle, become one with them —that is what makes
The poet, the artist, the human being.”– Goethe
Economic Perspective
Forecasters of a recession next year point to a global geopolitical shock to business sentiment that’s prompting US companies to rein in spending amid uncertainties including US-China trade spats and Britain’s floundering separation from the European Union. Reduced shipping volumes at FedEx and UPS confirm the trend of business softness due to policy uncertainty.
Experts and engineers want the stock market to be rational; frustratingly, it’s not. Twenty years ago, Yale economist and later Nobel Memorial Prize-winner Robert Shiller lent the phrase “irrational exuberance” to then Federal Reserve Chair Alan Greenspan to describe lofty stock market valuations. Prescient, but it was four long years before the tech bubble burst and brought stock prices down. As the great short seller Robert Wilson learned earlier: markets can remain irrational longer than you can remain solvent. Bolstered by easy central bank monetary policy, stocks remain fully priced but perhaps not in bubble territory yet. Though, currently, Shiller sees “bubbles everywhere.”
Bonds. Irrationality, however, governs in the bond market. Any hint of the Federal Reserve failing to follow up on expectations to gradually lower interest rates sends the US Treasury market into panic. The long secular bull market in bonds may finally be winding down and the consequences will not be pretty. Interest rates peaked in 1984 and with only intermittent relapses have trended downward ever since.
The latest results for GDP growth suggest a deceleration in the already tepid pace of growth the US economy has experienced recently. Commodity prices should follow suit.
Market Thoughts
Corporate earnings results, in decline for the past five or six quarters, present a mixed picture. The decline is from spectacularly high rates of profitability for Corporate America. Going forward insurance firms, technology and select industrials should do better in a weaker economy. Insurance bolstered by reduced capital entering the industry (Alleghany, White Mountains). Technology (Google, Microsoft, nVidia) and niche industrials (Illinois Tool Works, Reliance Steel, Wabtec) boosted by better currency comparisons versus the soaring dollar last year. Very long term, we remain positive on the pharmaceutical (Bristol-Myers, Eli Lilly, Merck) and biotechnology (Amgen, Biogen, Gilead) sectors despite temporary political challenges to drug pricing.
Gradual economic recovery makes one cautiously positive about stock markets. On a valuation basis, following a surprisingly good year for the stock market, U S stocks are richly priced. And the impending 90th anniversary of the 1929 Crash adds to nervousness. We will continue our deliberate, prudent and cautious investment strategy.
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Stephen K. Bache, CFA
Sources: Bloomberg Business Week, The Economist, The New York Times, Barry Strauss, The Trojan War; Amor Towles, A Gentleman in Moscow.
