Market Commentary

What We've Learned

April 2012

"That people do not learn very much from the lessons of history is the most important of all the lessons of history." – Aldous Huxley

We are intrigued by this winter's concomitant popularity of the TV series Downton Abbey and the film based on the novel The Hunger Games. One is a luscious depiction of the beginning of the end of the period of the greatest potency of the British empire. The other tautly portrays a post-apocalyptic dystopia with barbarian values that seem quite similar to imperial Rome's. Is our popular culture telling us something important?

We conclude that these stories reflect our collective knowledge that we are in the middle of big social and economic shifts that are not so typical. They are hard to see when we are in them, which explains why we have trouble learning from them. These shifts are not typical economic cycles of growth and recession and recovery back to growth. They are more fundamental, they are bigger, and collectively we are facing their ultimate outcome the world ‘round with a great deal of uncertainty.

In Europe, the significant and quite optimistic experiment of creating monetary and fiscal union is fractured. Europe stepped back from the brink of a potential breakup of its common currency in December and in so doing provided relief to a world that was beginning to count on something much worse. However, we expect to see Europe back in the headlines in the coming months. For several weeks now, Spain has been pressing forward as the next headline crisis in the Eurozone. While Spanish government debt levels look reasonable, when you consider the economic health of banks, corporations, and consumers, the overall picture of the world's twelfth largest economy is decidedly negative. Ultimately, these significant problems in Europe will affect the U.S. economy, the U.S. financial system, and U.S. monetary policy.

Here in the U.S., we are pleased that the economy continues to provide modestly positive readings in terms of continued growth in corporate profits and job growth. Unlike Spain, we have healthy corporations with more cash on their books than at any time since the 1950s, and a sustained economic recovery in the private corporate sector. However, at a household level it is a different story: The overall household savings rate continues to trend down, and we are aware now that most of the consumer benefits of the economic recovery wound up distributed disproportionately to the top tier. At a government level, we project a continued trend toward municipal bankruptcies, and the continued problem at the national level of issuing more and more short-term debt and discounted Fed dollars to finance long-term fiscal commitments. Ultimately, the knife's edge that we are on between deflation and inflation will tip, and though we can't know the timing, we think it will be inflation that will ultimately come.

What to do? We are happy that your portfolios and the market have continued their positive performance from the lows last fall. Over this relatively short time span, we are glad that you are participating reasonably meaningfully in this rally. However, we concur with Dave Rosenberg who recently wrote that "a market that lacks breadth, participation, and volume, is not generally one you can rely on for sustained strength, notwithstanding the terrific Q1 that risky assets delivered. We lived through exactly this a year ago." ⁱ

More tactically in the first quarter, we were pleased to see your international bond positions rally sharply back from their December lows. Your stock-focused funds have risen – and your considerable exposure to Japan particularly helped portfolios this quarter where that market and currency provided tailwinds. Your stock funds continue to have some cash and/or gold in them for ballast, and your gold- and gold-oriented investments have underperformed the broader stock market but we think in the coming years they will bring an important contribution to your portfolios.

As these bigger social and economic shifts in the global backdrop emerge, we continue to position you for a diversity of outcomes. You are evenly balanced here and overseas in developed and developing markets in stocks, bonds, and cash and currency-like investments. All your managers have the flexibility to focus on value-oriented opportunities as they develop. Overlaid in the portfolios are gold bullion and gold-focused stocks, so that you have exposure to a metal that is valued the world around as a de facto currency in times of trouble.

What we think we have learned from history is that in the very late stages of a long bear market like this one, there is more pessimism and cheaper stocks than we see right now. We will be watching for the possibility of buying more stock-oriented investments for you at more advantageous prices. But not right now. A piece of advice delivered to the protagonists in The Hunger Games stands out: "Stay alive." We aim to keep your portfolios alive during the coming period. In the meantime, stay tuned.

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

ⁱ"David Rosenberg, Breakfast with Dave, Gluskin Sheff, April 2, 2012.