Preview of Tomorrow’s Talk

I will be speaking to a group of clients and other friends tomorrow morning at 9 AM at the Hyatt Regency in Bethesda. Breakfast will be provided. The topic will be the current investment landscape, including my economic outlook, our fiscal challenges, ongoing deleveraging, the political stalemate, and the prospects for stocks and other investments in the coming years. There is a very limited number of spots left, and we hope you can join us. If so, please email Katherine at as soon as possible and let her know you will be attending.

In the event you are unable to attend, I thought I would provide a short preview of my thoughts for tomorrow. My overall assessment of our economy is that we are mired in a protracted period of sub-par economic growth. In fact, the modest economic growth we have enjoyed since the end of the “Great Recession” in June 2009 has largely been the result of federal government largesse. Federal budget deficits averaging 9% of GDP have been required to generate an average of 2% economic growth over the past thirteen quarters. Gross federal government debt now exceeds GDP. The esteemed economists Ken Rogoff and Carmen Reinhart warn us of very clear negative growth implications when debt levels rise to these levels. We have no reason to believe this time will be different.

While federal government spending has soared in a Keynesian effort to boost growth, the Federal Reserve has also been exceedingly aggressive with its monetary policy. The Fed’s balance sheet is likely to surpass $3 trillion in the coming months as Bernanke & Co. remain committed to a strategy of forcing longer-term interest rates down in an effort to boost consumption and investment. We believe this continued monetary easing will prove of dubious value in achieving the Fed’s primary goal of reducing unemployment. However, the Fed certainly has been successful in boosting asset prices. Most notably, stocks have posted their fourth straight year of gains and housing prices appear to have finally stabilized. The problem, as I see it, is that higher asset prices will not necessarily translate into sufficient consumption, investment and employment growth. In other words, it seems we have reached the point of diminishing returns with regard to monetary policy and the low interest rates that it brings.

The major reason for my expectation for continued weak economic growth is the fact that the process of deleveraging is ongoing and is likely to continue for several years. Whether it is in 2013 or beyond, the federal government must undergo some form of austerity in order to bring down our deficit and debt levels. The problem of long-term structural deficits, stemming from the unaffordable promises we have made in the form of Social Security and Medicare, will have to be part of the conversation. At the same time, the middle class continues to struggle with stagnant income growth, inadequate retirement savings, lack of job opportunities, and too much debt. We continue to worry about the psyche of the middle class, and how increasing feelings of disenfranchisement might affect our collective ability to meet the challenges we face as a people.

But there are some reasons for optimism. Notwithstanding the fears about the fiscal cliff, consumer confidence is rebounding, the housing market is stabilizing, credit standards are loosening, and low interest rates have made debt burdens more manageable (at least in the near term). These positive trends will hopefully work to offset some of the weakness we expect to result from ongoing deleveraging. With regard to stocks, valuations remain reasonable following four years of solid gains and especially in light of the yields available on bonds.

So, faced with considerable challenges, we see continued volatility for the markets in the year to come. In our view, successfully navigating this environment continues to require a somewhat defensive posture. And, by definition, a defensive posture means that investors must reign in their expectations about future returns for a period of time. However, we believe stocks continue to offer the best opportunities for investors to meet their long-term goals. Investors cannot simply hunker down and accept the meager yields available on bonds. Bonds play an important role in offering portfolio stability and income, but the risks associated with bond ownership at this point in the cycle are underappreciated. High quality, blue chip stocks, on the other hand, offer growth, defensiveness, exposure to high-growth emerging markets, competitive (and growing) dividend yields, reasonable valuations, and somewhat of a hedge against inflation.

We hope to see you tomorrow!