Smooth Sailing Into the New Year?

I gave a presentation in Bethesda Tuesday morning to a group of clients and prospective clients.  Thank you to those of you who braved the bitter cold to attend.  The presentation provided an overview of the economy, the political backdrop, and our outlook for the stock market in 2011 and beyond.  While it was my hope to engender some optimism with regard to the future investing climate, I was also very frank about the numerous challenges we face as a country over the next several years.  Here is a quick summary of the main points from the presentation:

  • The government’s broad-based intervention in the economy and capital markets was successful in rescuing the financial system and providing short-term stabilization in the economy
  • However, the government’s intervention has created many longer-term risks; the severity of which cannot yet be known
  • The most serious risks, in our opinion, are that 1) housing prices have not been allowed to clear; 2) companies remain reluctant to hire new employees due to a lack of confidence; 3) banks remain unwilling to lend due to lingering uncertainty over a number of issues; 4) consumer debt levels remain very high; and 5) soaring government debt may lead to a falling dollar and higher inflation, interest rates, and taxes
  • The recent recovery in incomes and spending appears exceedingly unbalanced, with higher income consumers with large stock gains generating the lion’s share of the growth
  • Higher mortgage rates, record-high delinquencies and foreclosures, underwater mortgages, and the expiration of government support initiatives could lead to a further 5-15% drop in housing prices
  • The recent rebound in consumer spending may not be sustainable in the face of 1) further home price declines; 2) weak job growth; 3) unbalanced income growth; 4) lack of credit access; 5) continued high debt levels, 6) inadequate retirement savings; and 7) low confidence
  • Higher interest rates carry many risks, including lower home prices and increased debt service costs on the massive consumer and government debt outstanding
    • Strong balance sheets
    • Growth and profitability less tied to the US economy
    • Exposure to high-growth emerging markets
    • Lean and efficient operating structures
    • Attractive dividend yields                       
    • Monetary and fiscal policy supportive of share prices (for now)
    • Valuations attractive following a decade of underperformance relative to bonds (and recent     underperformance relative to more speculative companies)
    • Investor psychology currently favors bonds (which is a bullish contrarian indicator for stocks)
    • Stocks offer somewhat of a hedge against inflation (bonds do not)
  • We see long-term returns of 7-8% on stocks compared to the current 3.4% available on the 10-year Treasury bond
  • The aforementioned risks and uncertainties argue for a rotation into high-quality, high-yielding and defensive blue-chip multi-nationals
  • Don’t bet against the USA!                               

Again, thank you to those of you who were able to attend Tuesday.  I truly enjoyed speaking with you all, and I look forward to doing it again next year!  I will be speaking again on February 8 at the University of Delaware.  I am honored to share the podium with Dr. Jeffrey Lacker, President of the Federal Reserve Bank of Richmond, and Senator Don Nickels.  Please come!  Admission is free.