Moderation will protect us against the twin dangers of visionary expectations from politics and unmanly contempt for politics.”
– Leo Strauss
Economic Perspective
The US economy benefits from being the world’s tallest dwarf; our economic growth rate may be anemic but it puts the recession-bound Europeans to shame and contrasts with decelerating growth in emerging market economies like China and India. Further, the US economy may be stronger than the numbers reveal. Housing starts surged over the past year and median home sales prices rose along with them though at a more muted pace. With home values rising and unemployment below 7.5%, despite a large number of discouraged workers, consumer confidence has surged to a six year high. Retail sales and inventory restocking are on the rise. Nevertheless, solid sales of large ticket items during the year may sap some of the momentum from Christmas shopping. Inflation will remain in abeyance until wages start rising.
For decades Wall Street mavens intoned “Don’t fight the Fed”. Currently, the President of the European Central Bank Mario Draghi and Ben Bernanke, Chairman of the Federal Reserve Board have announced they will do “whatever it takes” to revive their respective economies. While making midyear noises about “tapering”, the Federal Reserve promises to keep short term interest rates low until the recovery is robust and sustainable. Recurring Congressionally induced fiscal crises make the Fed’s work more difficult, even obliging them to postpone tapering. Rising mortgage interest rates may temper home sales activity. Employment growth remains insufficient to dent the rolls of the long term unemployed
Market Drama
The 2013 award of the Nobel Memorial Prize in Economics highlights the contrast between efficient market theory proponents (exemplified by the awardee Eugene Fama) and value investment adherents (Yale’s Robert Shiller and fellow winner). The Efficient Market hypothesis requires investor rationality and the claim that all publicly available information is impounded in stock, or other asset, prices. These are heroic assumptions. (I make some claim to rationality much of the time but I am unwilling to grant that status to most market participants.) As Shiller suggests, in such works as Irrational Exuberance, market efficiency, especially in the long run, is violated regularly by swings in investors’ appetite for risk and shifting market psychology.
Further, history suggests that it is precisely now when indexing is the prevailing orthodoxy that individual stock selection is most likely to succeed. Even if you choose to index, an unconventional tactic like equal weighting, rather than market capitalization weighting, will add value. It added 3% so far this year to returns of the S&P 500.
Since late September market participants have been riveted by events in Washington, DC. A handful of House Tea Party Republicans shutdown the Federal government and imperiled the nation’s full faith and credit. Whatever your politics, no rational person can condone their tactics. (The other day, my daughter Elizabeth asked me if the US dollar would remain the world’s reserve currency. I assured her that it would for the remainder of my lifetime. A Federal government default would imperil that cavalier prediction. Though bear in mind that the Hong Kong dollar has been pegged to US dollar for thirty years.) The euro benefits from uncertainly about our creditworthiness.
Market volatility persists. Gradual economic recovery makes one cautiously positive about stock markets. On a valuation basis, after a great year for the stock market, U S stocks are fully priced.. However, resource stocks in timber and natural gas particularly, technology and pharmaceuticals, and brand name, high quality companies offer compelling value.
Stephen K. Bache, CFA
Sources: Bloomberg Business Week, The Economist, The New York Times, and The Washington Monthly; John Heins and Whitney Tilson, The Art of Value Investing.
