Quarterly Newsletter January 2010
Commentary: Signs of Continuing Improvement
Merely observing the final results of financial markets in 2009 might lead us to conclude that financial life was…..pretty good. In fact, 2009 was a very tumultuous year where markets moved markedly higher only after plunging into the abyss. Markets are a discounting mechanism that have served better than all substitutes at predicting future economic activity. Economic Trends of late 2009 do suggest better days lie ahead. On the margin, our outlook for 2010 is for positive economic growth and modestly above average returns from equities, but we see some rather ominous clouds looming beyond. If policy makers can proactively tackle the US fiscal deficit problem during this phase of expansion by creating and setting in motion a long term plan of deficit reduction, the markets will react positively.
As 2009 churned forward, market sentiment went from panic to optimism. Our optimism is somewhat guarded given the still very high rate of unemployment, pending refinancing of commercial real estate, the fiscal situation of states and municipalities, the still murky balance sheets of local and regional banks, and the end to several government stimulus programs.
However, all past economic expansions have come paired with their own areas of concern and this cycle will likely be no different. We believe job gains are imminent during the first half of 2010, which will provide some boost to consumer confidence and spending. The ISM Manufacturing report for December showed much better than expected growth in the final month of 2009, with big gains in New Orders, Production, Prices and Employment. This growth came with no contribution from inventory restocking, which suggests 2010 should be stronger than consensus estimates as inventories eventually must be replenished. While the ISM report is only one data point, it follows several positive economic announcements over the past quarter, which together continues the positive trend.
While much has been said about the sanguine consumer’s contribution to GDP and the massive juice provided by the government sector contribution, not enough attention has been paid to the possibility of a significant boost from the business sector. Throughout the early phase of the recovery, corporations saw margins increase primarily through cost cutting. Even modest pickup in demand should contribute significantly to the bottom line due to this new leaner operating environment. During downturns, companies put off investments in new and upgraded equipment resulting in pent up demand to be manifested in better times.
The U.S. Consumer is arguably just a quarter or two away from a triumphant return. The combined debt and energy expense of the average US household has declined significantly and is now below its thirty year average. At the same time, household balance sheets are improving with rising stock markets and more stable home prices. Unemployment remains a drag that will likely improve in 2010.
Of course, nothing is certain, and the risk to our forecast is the prospect of slow jobs growth and the failure of policy to reignite private sector business lending. Many are taking care now to focus on paying down debt. And while banks are in no hurry to extend additional credit, there aren’t a plethora of businesses going begging for new lines.
With the government sector picking up the slack for the private sector, the US Fiscal deficit has ballooned to a level that is unsustainable. US federal spending will grow to 23.9% of GDP in 2010. During the 1990s the US did manage a turnaround in its fiscal positions, temporarily swinging from a 3.9% annual fiscal deficit to a nearly 1% surplus. Ultimately policymakers of all political persuasions will come to the realization that current fiscal deficits (financed at very short term rates) are not sustainable. A combination of spending restraint, economic revival, and tax code modification are inevitable.
This information has been developed internally and/or obtained from sources which Sand Hill Global Advisors, LLC (“SHGA”), believes to be reliable; however, SHGA does not guarantee the accuracy, adequacy or completeness of such information nor do we guarantee the appropriateness of any investment approach or security referred to for any particular investor. This material is provided for informational purposes only and is not advice or a recommendation for the purchase or sale of any security. This information reflects subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. This material reflects the opinion of SHGA on the date made and is subject to change at any time without notice. SHGA has no obligation to update this material. We do not suggest that any strategy described herein is applicable to every client of or portfolio managed by SHGA. In preparing this material, SHGA has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, you should consider, with or without the assistance of a professional advisor, whether the information provided in this material is appropriate in light of your particular investment needs, objectives and financial circumstances. Transactions in securities give rise to substantial risk and are not suitable for all investors. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.