US Economy Battered by Global Headlines

Let’s face it, since the Spring of this year there has been a steady drum beat of negativity that is eerily similar to last spring and summer.  What should we make of this season of ugly headlines?
 
Before we get to this year, let’s start with a brief recap of last year’s spring and summer headlines and predictions.  In the Spring of 2010, we saw headlines about Greece defaulting on their national debt, followed by video of riotting in the streets because of austerity measures that were proposed.  We then saw an endless parade of pundits on CNBC, Bloomberg, and Fox Business talking about how the economy in China was going to slow and cause a double dip recession.  We also saw predictions from several well known bond fund managers that the global economy is slowing and that we should not expect top line revenues of corporations to grow.  The most infamous quote was “you can’t cost-cut your way to profits forever”.  It is true that in 2010 many large and small businesses did institute cost cutting to bolster profits and strengthen their balance sheets; However, their top line revenues grew also – giving them even greater profits than analysts predicted.  As for the world economy, China’s GDP grew at approximately 9.6% and India’s grew at better than 8%.  As for the US economy, we grew at a 3% average for 2010 inspite of no help from the housing or government sectors. 
 
What did the S&P 500 do during this time period?  Well, from April 26th, 2010, to July 1, 2010, the S&P 500 index fell slightly more than 17% in 65 calendar days.  This was the first major correction in the market since the March 2009 lows.  This correction created a lot of fear and shook out many stock investors.  This is sometimes healthy for stocks from both a quatitative and psychological point of view.  What did the market do for the rest of 2010?  Well from the July 1st correction lows the S&P 500 rose 24.5% to close at 1258 on December 31st.
Our client portfolios for the year were up between 10% and 19% depending on allocation and risk tolerance.
 
Now, let me recap this year so far and what I believe will happen going forward into the end of 2011.  We had an nice momentum carry over in the first 4 months of the year as we were riding high from the July 1st lows of 2010.  Now, I will concede that the events that have happened year to date have had a real impact on growth in the world economy, much more so than a lot of the contrived punditry of 2010.  Here are some of the major factors in the economic slow-down that we have seen this year: 
 
Middle East revolutions that cause a spike in oil and gasoline prices (acting as a tax to consumers); A devastating tsunami in Japan that triggered the threat of a nuclear crisis in Japan that was averted; A massive debate in Washington DC between Republicans and Democrats regarding the size of the Federal Budget over the next 10 years; Italy and Spain experiencing a rapid increase in interest rates due to fears over structural changes that may need to take place in their government budgets over the next decade as well.  These spikes in interest rates were followed by some of the same pundits from 2010, calling it a “crisis”, because of the size and scale of the Italian and Spanish economies.  Most of the chatter is primarily speculation based on my research.  They do have one thing correct, these economies are much larger than Greece.  The narrative is similar to that of 2010, that these events will cause a “double-dip” recession, sending the world equity markets into a “bear market”. 
 
The reaction to the 2011 headline narrative for the past 3 months…the S&P 500 has gone from a high of 1370 on May 2nd to a low as of this writing of 1157.  A correction of 15.5%
 
My take away…this is part of a longterm process of deleveraging for corporations (underway since fall of 2007), consumers (underway since fall of 2008), for state and local governments (underway since the beginning of 2009), and finally for our federal government (just getting underway).  It is not a pretty process.  We would all just rather spend money and have a good time, but instead we must tighten belts and sacrifice wants for needs.
 
The silver lining…Corporations are four years into their deleveraging and are lean and mean.  State and local governments have closed deficits and are balancing their budgets.  In fact, Wisconsin now has a surplus going into the August.  Consumer spending has picked up and has not abated much inspite of the headlines.  The US economy is growing slowly due primarily to growth in exports and consumer spending, which is being held back by negative growth in construction, housing, and government spending.  US GDP has grown by just under 1% year to date.  In spite of the deleveraging, I don’t believe that the US is going to experience a recession in the next few quarters.  One day, another recession will hit…but it will not be soon.
 
 Bottom line is that stocks are almost as cheap as they were in March of 2009, albeit with less uncertainty if you can imagine.  Yes…I’ll say it – There is less uncertainty today than there was in March of 2009.  In 2009 the US economy grew at NEGATIVE 3.5%…the only sector of the economy that grew was government.  (Reference: http://www.bea.gov/national/pdf/dpga.pdf )
 
Please hear me on this and please tell your family, friends, and co-workers…NOW IS THE TIME TO BUY AND HOLD.  Yes I said it, just when all the commercials on CNBC are telling you to buy the next hot trading system to protect your portfolio…I am telling you to hold your ownership stake in high quality businesses and enjoy the ride.