THE AUTUMN LETTER
If I knew my own mind, I would not make essays. I would make decisions.”
– Michel de Montaigne
Economic Perspective
One can barely contemplate the current Presidential electoral race without calling barbarians to mind. Starting school in Francophone Africa, I read an unhealthy dose of Asterix, a comic book about our Gallic ancestors. (Back issues of the Belgian boy detective Tin Tin were a chaser.) So, allusions to barbarians (at the gate or elsewhere) reasonate with me.
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 stock market valuations. Possibly prescient but it was four 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.
Bonds. Irrationality, however, governs in the bond market. Any hint of the Federal Reserve following up on pledges to gradually raise 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. Creeping inflation and higher interest rates present a deafening headwind.
Gold. Gold is a haven in times of heightened political turmoil, but as the bullion generates no income only storage fees, it may prove less attractive in a higher interest rate environment, when a crisis atmosphere only prevails intermittently.
The latest results for GDP growth suggest a slight acceleration in the 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 financial services firms, technology and industrials should do better in a slightly stronger economy. Financials bolstered by higher interest rates and thus wider interest rate margins (Alleghany, Allied World Assurance, White Mountains). Technology (Google, Microsoft, nVidia) and industrials (Clarcor, Illinois Toolworks, Reliance Steel, Wabtec) boosted by better currency comparisons versus the soaring dollar last year. Very long term, we remain positive on the pharmaceutical (Eli Lilly, Merck, Pfizer) and biotechnology (Amgen, Biogen, Celgene, Gilead) sectors despite temporary political challenges.
Gradual economic recovery makes one cautiously positive about stock markets. On a valuation basis, despite the first good year in the past three for the stock market, U S stocks are richly priced. We will continue our deliberate, prudent and cautious investment strategy.
Stephen K. Bache, CFA
Sources: Bloomberg Business Week, The Economist, The New York Times
