Since January 2010, there has been a sharp rebound of the US dollar, fiscal tightening policies from China, and a debt crisis brewing in Europe. Washington is following the example of the Japanese government by not allowing the real estate foreclosure process to proceed at a normal pace (partly due to low capital ratios at the banks). What is interesting is that the investment strategists believe 2010 will see an earnings recovery, with the same intensity they believed 2009 would be a “tough year” and 2008 would be a “slow year.” If my memory is correct, the economists believing the US economy would have soft landing in the summer of 2008, are now touting a strong recovery in 2010 (GDP growth of 5%). Looking back to the 1940s, seven out of the last eight recessions saw two quarters of positive “headline” growth (source: Gluskin Sheff). What makes an end to a recession is sustainability, such as increasing retail sales tax receipts.
Any crisis creates a change in behavior. There appears to be a disconnect between the actions of consumers and corporations and the forecasts of investment strategists: 1) home-ownership is no longer considered to be a stable asset, 2) lower gas prices and a strong stock market rebound in 2009 didn’t influence Americans to drive more miles for the second year in a row (source: WSJ), 3) consumers are spending less on non-essentials (source: NYT), and 4) households are paying down credit card debt in never-before-seen amounts. Our government, in order to prevent an all-out-deflationary depression, has had to expand its balance sheet to offset the actions of the American household. The question will be how these two competing actions balance themselves out over the long-term.
Investors are piling into bond assets. Over the last 25 years, investors have a had very low allocation to bonds, around 7%. In 2009 stock mutual funds saw net redemptions of $4.1 billion (source: Gluskin Sheff) whereas bond mutual funds saw a $349 billion in-flow. The grass is not always greener on the other side of the fence and nobody knows with scientific certainty why this change of allocation is occurring (I expect fear and not concrete thought). According to Haver Analytics, stock mutual fund managers are at the low end of their cash allocation (around 3.9%) whereas bond mutual fund managers are at the high end of their cash allocation (3.3% for government bond mutual funds and 7.7% for corporate bond managers).
Bottom line: As the American economy and financial markets re-calibrate to the new realities of a less leveraged world, investing will be a difficult process.
Always Asking, Never Assuming™
Christopher Holtby
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