February 23, 2009
The Beat Goes On
The phenomenon of past excessive speculation continues. The hangover from its unwinding lingers without yet evident remedies. The pain that many are enduring because of the overindulgence of a relatively few spreads. This week we (and the rest of the free world) await evidence from Washington that the problems are understood and are being dealt with directly in a manner that has the economy's greater good in mind. As the President unveils his plans before the Congress in a few days, world financial markets will be considering their potential impact and consequences (intended and unintended). Last week's preliminary equity market assessment by investors seemed to be a vote of no confidence.
A Trillion Here, A Trillion There . . ."
Perhaps Washington's announcements this week will prove to be more on point and substantive. Having sold the public on the need to spend our way out of the difficult economic circumstances extant, Congress has just produced "stimulus" legislation larded with special-interest pet projects under the guise of emergency required outlays. The political strategy of fear mongering in order to achieve a legislative agenda has had the perhaps unintended perverse result of further depressing consumer and investor sentiment to the point of a kind of emotional gridlock. Self-serving, sensationalist statements by members of Congress that banks may need to be nationalized only add to the already gloomy outlook harbored by many. Expectations have been lowered to such an extent by policymakers and negative media spinners that many now believe a repeat of the Great Depression is upon us. Visions of a coming economic apocalypse further dampen consumer expectations and muzzle investor confidence; if the cycle is not broken, a cruel self-fulfilling prophecy of its own making may result.
With all players hanging on our government's every next move, one can begin to sense what centralized economic planning could be like. There are many steps entrepreneurs, corporations, business managers, and professionals might be motivated to take at a time like this, if they but knew the rules of engagement. This hesitation on the part of consumers, the business community and investors to act, each awaiting the central government's next move, currently is one of the dominant sources of the financial markets' paralysis.
The American Recovery and Reinvestment Act of 2009 (ARRA): What's in it for Investors?
As is often the case, the title of this $787 billion "stimulus" bill (signed by the President last week) sounds constructive, even promising. However, following the money, the spending trail reveals a sobering reality-it is a special interest payback and wealth redistribution blueprint of the first order. Decision Economics, one of TFC's economic consultants, estimates that $499 billion (63%) of the bill's allocation " . . . are transfers to persons, organizations, or states and localities." Only 20% ($158 billion) are for infrastructure improvements. The concern, of course, is that one person's "infrastructure" is another's pork. Does a 10-year, $8 billion project to build a high-speed rail line from Anaheim (i.e., Disneyland) to Las Vegas inject the immediate stimulus ARRA is supposed to deliver? In Washington, of course, a certain amount of log-rolling is the accepted M.O. "Pork-barrel" spending can be a stimulus of a sort, but "investment" it generally is not.
On the surface, something approaching 42% of the fiscal stimulus injected by ARRA appears to be tax cuts. However, much of this is in the form of temporary credits; very little of this tax relief is permanent and almost all is targeted to lower- and middle-income individuals and families. Generally, economists agree that direct spending on the part of government has a multiplier effect roughly 2.5 times that of tax cuts in the first year, but in the long run, permanent tax reduction has a more leveraged benefit. The fact that these tax cuts expire in the short run will tend to undercut their stimulative impact. Nevertheless, weighing all factors associated with ARRA, Decision Economics concludes, " . . . we think enough firepower has been brought to bear to lead to a bottoming and a modest recovery in GDP later this year . . ." As we have been suggesting in these past e-mails, such a turnaround as it first appears in the U.S. should have a radiation impact on our trading partners, as well as improving investor psychology in the months ahead.
The Value of the U.S. Dollar and Portfolio Investment Strategy
As is well understood, the Federal government through fiscal policy (e.g., TARP, ARRA, etc.) and monetary accommodation (Federal Reserve Board banking system liquidity expansion) has been running the U.S. Treasury's money printing presses around the clock. The current accepted wisdom is that as a result, the dollar is overvalued; the implication being a gradual debasement or overt devaluation is inevitable. Of course, no one today can answer this assertion; future circumstances will dictate. At the same time, it also seems difficult to make a bullish argument for equities, but it is usually just at such times that stock markets quietly begin to anticipate improving economic circumstances.
If the dollar is vulnerable and as a result short-term cash reserves (i.e., CD's, T-Bills and Money Market Funds) are at risk of purchasing power erosion, as would be longer-term fixed income investments (e.g., Treasury, tax-exempt and corporate bonds), where can the individual investor find shelter and/or opportunity? In our view, illiquid alternatives (e.g., hedge funds, private equity, etc.) are not attractive and investment real estate still appears somewhat overpriced and overleveraged.
Equities, although in a psychological funk, seem over-sold, and a well-diversified list of domestic, as well as international funds (unhedged to benefit from possible U.S. dollar weakness) remains a sensible posture in the intermediate and long-term. There will be a time to consider rebalancing portfolios' fixed income allocation in the direction of equities, but today a gradual realignment seems more prudent than a dramatic one-step shift.
As always, your thoughts, comments and questions are most welcome. Please contact us via email at tfc@tfcfinancial.com or call us at 617-210-6700.
Regards,
James L. Joslin
Chairman & CEO