Economic & Market Comments: Third Quarter 2014

July 11, 2014 in Quarterly Comments
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An economist’s guess is likely to be as good as anybody else’s ~ Will Rogers

Economist’s projections have run into a bad patch, at least in the short-term.  Most had first quarter GDP declining one percent due to January’s frigid weather.  It came in with an annual rate of minus 2.9%.  The stock market paid little attention, and bond interest rates actually declined giving twenty year Treasury bond holders a better first half than common stocks.  The lack of concern over the GDP surprise was reasonable given that most of the weakness stemmed from one-off factors.  The drop was concentrated in January, which declined at an annual rate of 5%, the implementation of the Affordable Care Act caused health care spending to decline, and inventories were reduced to low levels.  First quarter automobile inventories went from 120 days to 60 days.  Jobs, consumer confidence, service-sector activity, and business investment were positive, and make an imminent recession unlikely.

The second surprise to economists was the monthly job report showing net job gains of 288,000 when expectations were in the area of 200,000.  There were also small upward revisions to the two previous month figures.  Also positive, albeit of more political relevance than economic, the unemployment rate declined to 6.1%.

With the economy showing consistent, if underwhelming progress, the attention of most investors is focused on the Federal Reserve and the end of quantitative easing.  The Fed has continued to “taper” their buying of bonds and have indicated that the process may end as soon as October of this year.  The tapering of bond purchases does not seem to have had much impact on the economy, but opinions abound as to the impact when this stimulus stops.  Fed funds futures markets predict very gradual interest rate increases through 2016, so a rate shock is unlikely unless economic activity accelerates significantly.

As of the end of June the S&P 500 has gone 32 months without a correction of 10% or more, and ten months without a correction of 4% or more.  Perhaps the stock market has been over-medicated by the stimulus and numb to economic and geo-political concerns.  Valuations have risen, but so have profits, and the over-all market is neither particularly dear nor cheap.  In the absence of the Fed going on the defensive against inflation, and an interest rate shock, the stock market is not likely to be put in bear-market danger, but an over-due correction is likely at some point, and will probably be the result of some development that is not even on our radar screen now.  Even with a correction, stocks should remain the most attractive asset class.

We don’t buy stocks that are “fairly valued”, and a fairly-valued market makes it tougher and tougher to find attractive buy candidates that are a lot cheaper than “fairly-valued”. We agree with Warren Buffet that market fluctuations are your friend, not your enemy, and we have a watch list of stocks which would present opportunities in a correction.  In the mean time we continue to monitor the stocks we own, and maintain the discipline to let them go if they no longer offer the probability of superior returns.  Cash reserves are certainly an irritant when the market goes on up, but we believe attention to risk is important.

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