Market Commentary

Behind the Rose-Colored Glasses

April 2013

"If you want your children to be intelligent, read them fairy tales.
If you want them to be more intelligent, read them more fairy tales."

– Albert Einstein

A new wave of confidence has the stock market up another leg. We are glad that economic readings are stronger than they have been at any point in the recovery cycle we've been through during the past four years. As you'll see in your reports, your portfolios are up this quarter, a good portion of the way towards their annual return targets.

Unemployment has been down, business results have been good, the Eurozone crisis receded for some months, banks in this country are back to ebullient risk-taking, inflation is low, the Fed is agreeable, and consumers have been more confident in past months. Most importantly, though, the momentum behind the rosy lens through which investors predominantly are currently seeing dynamics is very strong. Sue's seventh-grader recently asked her, 'Mama, what is the difference between investment and a gamble?' A big firm's strategist recently quoted in the Wall Street Journal inadvertently answered her question:

'The market has momentum. I think we go higher until you have an event that suggests that things aren't as rosy as people think.'[i]

In this opinion proffered by a strategist for a firm with $3.8 trillion dollars of assets under stewardship, the market is predicted to go up simply because it has been going up, until it stops going up based on bad news whose timing and content is unknown. Taking action based on this viewpoint would be to engage in a gamble. Put your chips on red, and let the wheel spin. Ride it up, and hope it keeps going up.

Here's what we know about all the previously-mentioned good news. Like most news, it is multi-faceted in its nature. In this case, we think the news is not all good. Like in a fairy tale, you sometimes need to look beyond the bright surface to the darker truths beneath. Unemployment is down because the denominator of workers in the equation is getting smaller – there are fewer people looking for jobs; many have given up. In addition, full-time jobs are more scarce, while part-time jobs are more plentiful – and they are counted in the same way in the numerator. We don't think, looking below the surface of the numbers, either of these phenomena are particularly bullish.

Corporations are flush with cash and yet are building reserves, uncertain as to where to invest. Some companies are issuing debt at low interest rates to buy back stock at high valuations. When taking on debt and interest payments to buy stock at a pretty high and uncertain price, you may profit from momentum but you are piling on risk.

The news that Europe's ministers may ask countries beyond tiny Cyprus to make savers in weak banks 'bail-in' banks with their very own deposited savings has prompted alarm for savers around the world. Here and in Europe, both, banks are not in much different shape than back in 2007. They are too big to fail and too big to jail, as pundits and government officials quip, because of their outsize influence on the workings of our financial system. In 2008 and early 2009, we bailed out the banks but didn't extract commitments from banks to do it differently from that point forward. The bankers are wearing 'new clothes' as in the old fairy tale about the emperor, and the banks they run are just as naked to the next crisis as they were to the previous one.[ii]

The Federal Reserve has provided liquidity for all and plans to continue to do so for some time. However, we think inflation is understated in official reports because energy and food are underweighted, and that there's more inflation out there than meets the measured eye of the official inflation index. This could have a negative impact on stocks in the near to intermediate term and could have a particularly negative impact on the longer-term bond market. Federal cuts are taking hold, consumer confidence has come down in recent weeks, and we expect more muted economic readings going forward.

This is all worth paying attention to, in case things are not as rosy as people think. In terms of your investment portfolios, we believe that stocks are great to own, at the right prices and particularly in inflationary times, because good companies at good prices can reliably grow your money over time past inflation, taxes, and our fee. While your portfolios are up on an absolute basis year to date, they may still trail the broad stock markets for some time depending on how long this momentum-driven part of the market cycle lasts. You continue to own a corpus of strong stable companies acquired at good prices. We also continue to strongly emphasize shorter-term, high quality international debt in countries with strong economic positions and cheaper currencies. The price of gold has stayed; that's okay with us as we don't expect gold to do well in all environments and it is there as a long-term insurance policy and not there for speculation. Portfolios also have stable investments set aside for when the opportunity comes to be more fully invested at better prices.

We are investors, not gamblers. While there is an element of a gamble in every investment, because the world is a complicated and uncertain place, we think of our investments for you as carefully calculated risks. We put your money productively and cautiously to work in places where we are convinced it will be well-treated and grow the value of your purchasing power over a long period of time. Your managers scour the globe for these opportunities, and we continue to be patient, somewhat cautious, and await an environment where we think it will pay to be more opportunistic.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

i BlackRock Inc. strategist Russ Koesterich, quoted in Wall Street Journal, 3.6.13, 'Investors Ask: Will this Last?'

ii A readable write-up of this phenomenon was recently published. The Bankers' New Clothes: What's Wrong with Banking and What to Do About It Admati & Hellwig, Princeton University Press, 2013

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