Orchestrating the Recovery – April 2012

April 19, 2012

Dow Jones Average: 12,964
S & P 500 Index: 1,377


Orchestrating The Recovery 

The U.S. economy is often described as the bastion of free market capitalism. On the surface the U.S. economy seems less state controlled than the economies of Europe and Asia. This notion is only partly true. The U.S. economy is very far from an unfettered free market system. Every administration that comes to power tries in myriad ways to bolster and control the economy with the next election cycle in mind. Some administrations are more successful than others, even when similar strategies are used to affect the economy. The differences in outcomes are due to timing and forces beyond the control of policy makers.

While many Americans have expressed frustration with the pace of economic activity, we have actually been surprised by the strength of the economic recovery. With the exception of the housing industry, a glutted sector that stood no chance of a quick rebound, the rest of the economy has done remarkably well. When President Obama took office in the winter of 2009 the economy was in terrible shape. Fear of a second Great Depression slashed consumer spending, businesses were firing workers by the millions, and the financial markets were panicking. With interest rates already near zero, the Federal Reserve could not use the traditional tool of simply lowering rates to aid the economy. The situation seemed dire in the winter of 2009, but the government found a way to restore confidence in the economic system.

The Obama Administration decided that the Federal Government had to step into the breach in a big way, spending as much as Congress would allow, while backstopping states, cities, banks, and the auto industry. The Federal Reserve supported the plan as necessary, by printing money to buy U.S. Bonds. The success of this plan was far from guaranteed. It appeared to be the equivalent of pouring more gas into an already flooded engine. Financial experts warned of hyper-inflation if the engine did happen to restart. With no other apparent alternative and a possible depression looming, the government’s economic team kept on priming that engine, and it finally worked. It hasn’t been altogether pretty. But after a lot of popping, backfiring, and blue smoke belching, the engine of commerce has started to run smoothly again.

The deficit spending strategy has worked without apparent side effects, because other capital flows have balanced the infusion of government funds. While the U.S. Government has taken on substantial debt, individuals and businesses have been paying off trillions in debt. The economy does best when total outstanding credit is steady or rising modestly. Ben Bernanke, Chairman of the Fed, has done a good job of maintaining a nearly perfect balance between the forces of credit expansion and contraction. The Fed’s aggressive, potentially inflationary monetary policy has been balanced in part by austerity measures in the Euro Zone, and a slowdown in China. On a relative basis the U.S. is doing better economically than all the other, large developed nations. As they sat around the drawing board back in 2009, it is doubtful that financial policy makers in the U.S. envisioned such a positive outcome.

Current Strategy

After a very flat year in 2011, the stock market resumed its rally during the first quarter of 2012. Strong corporate earnings have fueled the gain in stock prices. Companies are producing more products with fewer employees and selling those products to people who have larger incomes. The unemployed have become marginalized in an economy that no longer seems to need their participation as workers or consumers. The major threat to sustained economic growth continues to be high debt levels, domestically and abroad. The debt crisis in Europe destabilized the markets last summer, and has become a factor again in recent weeks. Economies worldwide will not be on firm footing until debt burdens are addressed in a non-inflationary way.

The best defense in a complex, unpredictable economic environment is ownership of companies that can prosper under multiple scenarios. Companies that sell staples such as food and everyday consumer goods can usually maintain revenue, even in unstable economic times. Additionally, companies that develop a highly differentiated product or service that people want, whether it be a technology device, medical breakthrough, or way of delivering goods (a new retail format), will almost always prosper. After a three-year advance in stock prices there are fewer undiscovered growth companies available at attractive prices. In spite of the generally higher price level for stocks, we were able to find some compelling buys during the past twelve months. We continue to search for companies that have reached an inflection point in their product cycle and stock price.

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