The Yin and the Yang of the stock market played out in back to back years as we found that what goes up must come down...and then back up. The decade ended with the S&P 500, the Dow Jones Industrials, and the Nasdaq Composite lower then when it started. A quick look at the chart of the S&P 500 for the decade resembles that of a Six Flags ride you need to stand in line for.
We have to admit the rally of 2009 caught us flat footed as we felt the systemic issues that plagued the financial system and the economy in 2008 would flow over and place a lid on any significant stock market rally. WRONG! Not only did the market step away from the view of the abyss, but propelled itself at a pace not seen in seventy years. The angle of ascent made the 2003 recovery rally look like a walk in the park, but then again that was probably a knee jerk to the over reactive free fall of 2008 and early '09?
Could the smartest financial guys in the world, yes the ones who oversaw the meltdown, have created the antidote for the ills they created? Could the folks who turned the ball over seven times and committed ten penalties make a one handed catch in the corner of the end zone to pull the game out with no time remaining? Will Ben Bernanke go from goat to Time's Man of the Year? The stock market seems to thinks so.
The apparent initial strategy to liquefy and stimulate the system, resuscitate assets, and create a level of consumer/investor confidence has been achieved in relative effortless fashion. Now the challenging work of handing the ball to an economy without a balancing bar or net, well maybe there still is a net, and see if it can continue the drive? We have outlined some of the more major reasons for optimism and a few for concern.
A Half Full View
1. Poor People/Countries Becoming Richer - This is in our mind is the long term positive for the world's economy. The ability for underdeveloped and developing countries to condense the agricultural/industrial/digital evolution we trail blazed creates a quicker leap to middle class which many consider the driving force of a prosperous economy. This is an obvious benefit to those countries, but also to us domestically as we export goods and services to these new found capitalists. These exports help offset what appears to be a more modest American consumer who has become a net saver.
2. Lean, Mean Corporations - Inventories have been worked off, labor forces streamlined, and productivity enhanced; any uptick in the top line will flow directly to the bottom line to create legitimate earnings acceleration. This appears entirely possible with even an 8-10% unemployment rate, especially when you consider those foreign exports.
3. Collective Effort - The more the world economies weave themselves into an enmeshed web, the more leaders realize they must work in concert with each other, especially in crisis. The fact that in 1975 France created the G-6, a meeting of the leaders of the six richest countries in the world, has now evolved into the G-20 is a reflection of the growth of the world's economies and the importance of their integration. In the twenty-five years we have been in the business the movement of the worlds major indices have showed less and less disparity and more of a lockstep movement.
4. Technology – Without a doubt the most exciting sector is tech, with advancements in information, healthcare, security and other industries. This is the strongest card within the emerging country theme as the productivity leaps leverage their entrance into the world economy. Domestically these advances and revenues associated with them can offset some of the systemic issues created over the last few years. Observing the progress of the stocks in this sector can be a barometer of near term future market behavior. They certainly were in the lead pack as the year came to an end.
5. Chart Patterns – The technical look of the stock market is mostly constructive Price is the most important indicator and as a collective the stock market looks healthy. We would rather have seen a slower, steadier rise, but those with 401k's are feeling much better about those accounts than they did a year ago. That breathing room may inspire the consumer to re-emerge; final holiday sales will be a tell.
Half Empty View
1. Effects of Outsized Leverage - It is hard to imagine that all the poor financing decisions made from 2005-07 have been exhumed from the system. Banks and the lender of last resort, our government, own questionable assets on and off their books. The longer term challenge with lending is the reluctance lenders possess and the handcuffs that it puts on economic growth. On a global basis how many more Abu Dabi's are there in the system? The rumor is that Greece might be next?
2. Government Balance Sheet - We read recently that all government debt including (federal, local, state, and GSE's (gov't sponsored enterprises) is 141% of GDP. Only Japan, Lebanon, and Zimbabwe are higher. When you add in corporations and households it is up to 557%. Rising interest rates will make for onerous carrying costs as much of this debt rolls over in the future. We personally do not sense the kind of concern from policy makers that a change to federal spending is coming anytime soon.
3. Lagging Employment - A jobless recovery is a distinct possibility, but the chances of a strong, sustainable recovery without job growth are not good. Within the economic handoff from government to private sector this is probably the most important component as the government has been the job creator of late. Major obstacle is the lack of lending to small biz which historically has been a key generator of jobs.
4. Geopolitical Concerns - With the near catastrophe of Flight 253 on Christmas Day, the reality of another attack on American soil shifts into our purview. Take all the economic issues that currently challenge the bounds of our leader's talents, layer this concern over them and it is a wonder anyone wants the job. Many say the noises Iran are making are only posturing. If someone steps over the line...
Historically the news is good in that our nation has risen above every similar challenging period it has faced. Revolutions, the Civil War, World Wars, Depressions, are the parallel periods that come to mind. Each one of those challenges led to a resurrection with subsequent new paradigms in place. We believe this is easily the most challenging period of our lifetime and the tale that is woven in this recovery will be the learning curve for our kids and grandkids.
Did You Know
Important Exports - The annual revenues of the companies in the S&P 500 stock index are almost evenly produced from both inside and outside the USA, i.e., a 50/50 split. Eight years ago (2001), just 30% of sales for the S&P 500 companies came from outside the USA (source: Financial Times).
Final Thought
“A New Year’s resolution is something that goes in one year and out the other”
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