Newsletter | February 2013

February 19, 2013 – DJIA = 13,981 – S&P 500 = 1,519 – Nasdaq = 3,192

Last week The Wall Street Journal described the global capital markets this way – “These days there’s not a market in the world that some regulator somewhere doesn’t want to meddle in”.   To be more specific, these not-so-invisible hands are busy printing money, buying mortgages, suppressing interest rates, devaluing their currency, and bailing out too big to fail companies after they’ve struck out while swinging for the fences.

Of course the men and women behind these intrusive policies convince us that they are necessary.  Without them, we are told, the world would become a barren wasteland.  The economy would grind to a halt, unemployment would rise, and banks would fail.  Social chaos would quickly follow.  Manipulation, like it or not, is our only savior.

Furthering the confidence of supporters is the fact that we are not in a recession and the unemployment rate has declined.  And indeed more banks would have failed without the Federal Reserve’s rescue efforts which would have had a far reaching impact.  However we might have been better off clearing the deck of the non-competitive organizations and starting to rebuild from there.  And concerning economic growth and the job creation, we will never know if it would have been better with a less active central bank.  To be sure, that strategy would have been very painful which would have resulted in public outcry for Washington to do something. 

Economically speaking, it appears we are getting a much different result from the intended one.  Instead of a sustained expansion, we have tepid growth and widespread caution.  This is not what was wished for.  The Fed’s foot on the yield curve’s throat was going to result in more businesspeople using the cheap money to build new businesses and hire more workers.  Instead they have printed unimagined amounts of money and bought over half of the Treasury’s 10-year notes issued and we have 2.5% GDP growth. 

Low rates are supposed to encourage entrepreneur’s desire to assume more economic risk.  Instead of increased risk appetites we are getting increased financial engineering.  It’s safer to use the cheap money to buy something than take the risk of building something.  It’s safer because everyone remains fearful of the unintended consequences of untried policy and an increasing reach of Washington.  So we end up with Dell going private, we have hedge fund managers demanding that Apple (a model for revolutionary products) distribute its cash, and we have Warren Buffett paying a handsome price for Heinz.  At the same time, we have savers losing out to the actual (not reported) price increases of food, gasoline, insurance, and education.   

If money can’t stimulate the real economy, there’s always Wall Street and the Fed’s policy has benefited the stock market in 2013.  The S&P 500 eked out a small gain last week which keeps it perfect for 2013 on a weekly basis.  The 7 week streak is the longest consecutive weekly stretch since January 2011.

Dow Jones Industrial Average   +6.7%
S&P 500   +6.6%
Nasdaq Composite   +5.7%
Russell 2000 +8.7%

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

Someday stocks will correct.  Maybe even decline meaningfully.  Of course, in a period of meteors crashing and Pope’s resigning, maybe it really is different this time.  We were constructive on equities throughout 2012 despite worries over China, Europe, our presidential election, and the fiscal cliff.  We thought the widespread pessimism had priced in a lot of risk surrounding these issues. 

Looking forward from here, we wonder if the 12.5% rally from the November lows represents the easy part of the move.  Further, it seems that 2012’s worries have been replaced by investor optimism.  While we are not expecting another crisis, this environment contains plenty of landmines and should not be faced with complacency.     

Policymakers have confidence they will know the precise time to reverse stimulus and market intrusion.  Perhaps they, armed with their Ph.D.’s from leading universities, actually do know the proper amount of regulation and market manipulation to guide the economy back to normal growth.  Count us as skeptical because a crisis caused, in part, by too much debt and spending (by the private sector) can’t be solved by further increasing debt and spending (by the public sector). 

The Wall Street Journal, “Rumors of (Currency) Wars”, February 14, 2013, pg a18.

The Wall Street Journal, pg c1

IBID, pg c4