A RIDDLE, WRAPPED IN A MYSTERY, INSIDE AN ENIGMA

A RIDDLE, WRAPPED IN A MYSTERY, INSIDE AN ENIGMA

As you probably know, I like to write to communicate my thoughts.  However, recently I have been suffering from writer’s block.  I think it’s because I am in observation mode about the economy, government policy and business; trying to put the pieces of the puzzle together.  Everywhere I go I ask business owners, “How’s business?” The bagel shop, the dry cleaners, the auto repair shop, clients and neighbors who own a business, etc, almost everyone says it’s okay.  They usually follow up with, “I’m paying the bills.”

To me, this suggests that they are managing to keep the business going and pay their current employees.  They do this without much profit for the risk they take every day with their personal capital to keep those folks employed.

While that’s good, it’s not great for our economic recovery.  That’s because we need our real Gross Domestic Product (GDP) to be above 3.5%, to have a healthy growing economy.

 

Small Business

Small business owners will only begin hiring after they are convinced their business is growing.  As their business begins to grow, the first thing they will look to employ  is technology, that will make their current employees more productive. Only after their current employees are more productive and working overtime, will they look to hire new employees.  At first, the business owner will look to hire temporary or part-time workers.  That’s good but not great.  Only after they have exhausted the temporary or part-time workers and begin having customer service issues, will they look to hire permanent employees.

What this observation tells me is that it’s going to be a very slow recovery, and our unemployment rate will remain close to 10% for 2011 and perhaps longer.

 

Government Policy

Another observation has to do with government policy.  Specifically, the Federal Reserve’s monetary policy of Quantitative Easing 2 (QE2) and the government’s continuation of the Bush tax cuts.  While both of these stimulus programs will add to our Gross Domestic Product for 2011, the increasing price of oil and other commodities looks like it’s going to subtract from our wallets, the additional funds we receive from the 2% Payroll Tax Reduction for 2011.  All of this is fine, but we are failing to address major structural problems.

One such problem is the lack of a meaningful energy policy.  As long as we remain addicted to imported crude oil, we won’t be able to control our own destiny as a nation.  We currently have no meaningful energy policy that will allow us to recover from this addiction.  An energy policy needs to promote nuclear, natural gas and alternative energy.  This is probably the most critical issue for us to solve if our nation is to recover from the severe economic down turn. A meaningful energy policy will create jobs, as well as, get us back to controlling our own destiny.  If we can get this done, it will do more for our economy than trying to lower health care and Medicare expenses, which is also important, but not as immediately impactful.

 

 

Local Government Municipalities

 

Part of the stimulus package (Build America Bonds) to aid state and local governments will expire this spring.   As you know, many municipalities have underfunded their pensions, benefit and entitlement programs.  Without further national government support, they will not be able to survive.  They will have to drastically cut back on services, expenses, pensions and benefits and look to raise revenue (taxes, fees, sell assets, etc) and refinance their debt at much higher rates.  This is a serious issue, because it’s estimated that more than one million municipal workers could lose their jobs, adding to the already high unemployment rate.  With a new, more conservative Congress taking over in the New Year, any aid to local government by national government is going to come with some very strict controls and conditions.  They are going to have to have a plan in place to become solvent again.  Think of this process as essentially the same as a business emerging from bankruptcy.  This time, the bankruptcy judge will be the U.S. Congress.  Our nation can no longer provide their politicians, government and municipal workers with gold plated benefit and pension plans when the public they server, don’t have benefits and pensions that come close to what is now being provided to the politicians, government and municipal workers.

 

Foreign Governments

The Euro Zone is struggling through its sovereign debt crisis.  There is a great political divide between upper Europe and Lower Mediterranean nations; trying to coordinate political and economic failures for the struggling countries like Greece and Spain, will prove to be difficult, since unlike the U.S., they can’t print their own currency.  Germany is the strongest country in the European Union (EU) and can help bail out the failing economies, but that is very unpopular with the fiscally conservative German people.  This could potentially lead to the failure of the EU and the single currency.  Would you like to exchange your Euros for Drachmas’ and Lira?

 

Looking Back

Last year we thought the 2010 economic recovery would be long and slow.  It was actually slightly better than we thought, but not by much.  This year our portfolios did much better than our expectations of mid-single digit returns for 2010.  The vast majority of our portfolios returned double digit low teens for the year.  That’s great when you consider that 3 month treasury bills, money market funds and CD’s (safe money) returned a small fraction of 1% for the year.  It’s also nice to achieve equity like returns when your portfolios are globally balanced, containing stocks, bonds and cash.

Bonds had a good year up until the last few weeks of the year.  Worries about inflation and government policy took away some of the return during that period, but they still gave us very respectable returns for the year as did stocks.  With one or two exceptions, our mutual fund selections performed exceedingly well, even beyond our expectations.  In spite of all the uncertainty, it was a very good year!

 

Outlook and Strategy

Our outlook for 2011 remains cautious, as we were last year.  We will continue with most of our 2010 strategies for 2011, with the exception of bonds and municipal bonds which may present problems.  We have already lowered our allocation to bonds in the third quarter, lowered our bond duration, and may lower it further, especially in the municipal bond area.  We are still formulating our strategy as we gather more information.  As always, we will manage risk first and look for return second.  It has worked well for us during difficult economies, and this has been one of the toughest.

To paraphrase Winston Churchill1“I cannot forecast to you the action of the economy, markets and governments.  It is a riddle, wrapped in a mystery, inside an enigma; but perhaps there is a key. That key is our own national interest.”

Yes, it’s difficult to hold back our “can do” American attitude.  We are resourceful, creative, and entrepreneurial.  We will solve this riddle, wrapped in a mystery, inside an enigma before you know it.  We will get our unemployed back to work and our economy on a more normal course sooner than later, just like we did with the Gulf of Mexico oil spill.  How quickly we forget.  Remember the oil spill, of biblical proportions, in the Gulf of Mexico earlier this year?  It created a dark mood that hung over the nation for months, as we watched the crude oil gushing into the Gulf.  Well, we seemed to have solved an impossible problem, again.  We always do.

We just need the political will to get the policies right.  The November 2010 election sent a very strong message to the politicians in Washington, D.C.  Get it done, or we will replace you with someone who can.  I believe they got the message.

We want to thank you for the confidence you have placed in us by allowing us to guide you and your loved ones during these challenging times.  It has been, and continues to be, our privilege to serve you.

On behalf of our entire staff, I want to wish you a Happy, Healthy and Peaceful New Year.

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