As we have been writing for almost two years now, we expect the global economic recovery to be a slow process marked by occasional periods of extreme volatility. Our friends at PIMCO, the world’s largest bond manager, have named this “The New Normal.” The new normal is an economy that is in the process of deleveraging (deprecating asset prices and paying down debt), reregulation (new financial regulations to prevent a 2008 type financial crisis and investor protections) and deglobalization (countries look inward to protect their people and their own economy).
If this were not enough to worry about, we have a government that seems either detached or unaware of the engines of economic growth. With over 9% official unemployment and 17% real unemployment, we need policies that will allow the engines of economic growth to work creating jobs that will begin to bring down the unemployment numbers. The reason I say this is this administration’s policy responses (which they believe will eventually reduce unemployment) has an overriding, very expensive, social and entitlement component attached to them. Don’t get me wrong; both parties’ former and current administrations share the blame.
It looks like we will have to wait until the November elections to see if there is a shift to a more balanced and level headed policy approach to solving this important economic issue. The unemployment numbers will not decrease by any meaningful amount until there is clarity about the government’s policy responses, which outline a clear and sensible plan to reduce government expenses, reduce the deficit, reduce taxes, address the funding of entitlement programs and allow individuals the freedom to choose where they spend their hard earned money.
In the meantime, we have plenty of uncertainty surrounding us between now and the end of 2010.
- Bush tax cuts expire at year end.
- Stimulus package expires at year end.
- New health care bill and the unknown costs and tax increases for the wealthy.
- Europe’s currency crisis.
- Danger of deflation.
- Unemployment remains a big problem.
- Deleveraging of toxic investments at banks (could be a 25 year problem).
- Oil spill in the Gulf of Mexico that can only be characterized as of biblical proportions and its associated clean up costs.
- Retail sales showing mixed results.
- The war in Iraq and Afghanistan.
- Middle East tensions with Israel and Iran.
- U.S. becoming more of a socialist society (entitlements) vs. Europe moving away from socialist policies, which they believe they can no longer afford.
- Interest rates are at an all time low (they will eventually increase).
- Corporate earnings are excellent and growing.
- Cash on corporate books is increasing.
- Cash in money market funds and savings banks is at an all time high (about $11 Trillion).
- Positive but slow GDP growth.
- Interest rates remain low.
- Price of oil is stable.
- Housing market may be bottoming.
- Price of oil is lower than last year.
- Beginning of the death of socialism in Europe.
- Incumbent backlash in Congress and at the state and local Government level.
Faced with all of this uncertainty, we continue to believe we are headed into a global economy that can be best described as one of deleveraging, reregulation, deglobalization, and temporary mistakes in government policy responses. There is a new belief by the U.S. consumer in spending less and saving more for the future. The current saving rate in the U.S. is about 6%. That’s up from 0% only a few years ago. This journey will not be smooth as evidenced by the recent market volatility. All of this points to a slow growth economic recovery that will eventually improve as government policy responses fail and more new rational and logical government policy responses prevail. Economic historians have pointed out failed policy responses, during the 1930’s Great Depression, by the Franklin D. Roosevelt administration, which actually prolonged the depression. Let’s hope we recognize our policy mistakes sooner and quickly set a rational course for economic recovery that puts people back to work doing work that creates value for their customers.
In addition to the policy responses discussed above, there are important possible headwinds early next year, unless Congress acts on the expiration of the Bush tax cuts. Also early next year, most, if not all, of the stimulus package ends. So we remain vigilant to both the economic and political environments.
Our friends at PIMCO have also describe the “New Normal” journey as driving a car without a spare. This is their way of saying it’s not a sure thing and that the state of the global economy is very fragile.
Our strategy is simple. Keep our portfolios flexible, liquid and less correlated to the general markets.
Back in 2008 and early 2009 we made major changes to our portfolios to take advantage of increased volatility in the markets and the changing economic environment. We looked for funds that held up well during the severe market downturn. It turns out that many of these funds had flexible mandates (go anywhere type funds) and flexible balanced funds, that change their allocations between stocks, bonds and cash.
We have positioned our portfolios to take advantage of this changing and difficult environment marked by increased volatility. We did this utilizing the types of funds we just described. We have and will continue to do so by keeping your portfolio nimble and liquid. Our flexible mandate gives us the ability to move around the market to take advantage of the pockets of value that will turn-up from time to time due to this pandemic of uncertainty.
So far the strategy has worked well for us. The majority of these investments have outperformed the equity markets, as well as, the typical balanced portfolio of stocks and bonds. Many of these funds own “insurance” by using options strategies to protect against any exogenous risks in the market place.
Although we expect this journey to take years, not months to complete, there will be cycles of bull and bear markets for us to exploit. There is an old saying on Wall Street “Markets Climb a Wall of Worry”. So when things look bleak, that’s when markets begin to improve. This will happen when confidence begins to return. As we eliminate the uncertainty, clarity and confidence returns. We are confident in our strategy for this environment. We are also confident that we are invested with the very best and the brightest fund managers. We will continue to work hard on your behalf to uncover the next pocket of opportunity.