After record setting gains in 2009, the stock market has quietly continued to “melt up” during the first quarter of 2010. As is usual with big advances, stocks have climbed a “wall of worry,” comprised of runaway government spending and unsustainable debt which have stunted private sector employment and economic growth. The economy and unemployment are showing slightly positive growth, rooted in the first quarter of 2009; however, the stimulus package, aka, The Economic Recovery Act of 2009 hasn’t created much of anything good. What then is the reason for the big gains? It’s almost always helpful to look at monetary policy. The U.S. Adjusted Monetary Base (AMB) doubled in the last 4 months of 2008, setting the stage for the stock rally that began on March 9, 2009. For the first 9 months of 2009, the AMB stabilized at about 1.7 trillion before growing another 25%. It’s now at 2.06 trillion compared to 841 billion in August 2008. Anytime the AMB is growing, inflation is afoot. If you’re wondering if, or when it will appear, just look at the stock market. Although the recovery appears to be real, it remains very fragile. Monetary life support is giving us a chance to grow out of the Great Recession, but unless government spending is curtailed, we’ll be headed for much bigger problems a few years down the road. We all have a duty to be knowledgeable, involved and vote, in that order!
The recession and market crash of 2008 were caused by investment bankers run amok under the noses of incompetent regulators, a vapid congress and a dangerously naïve administration. Now there’s a rush to legislate additional layers of regulations to ensure that “this never happens again.” By now, we should have all learned to recognize ducks by the distinctive quacking noises they make. Anyone who expects the government to fix the problems is going to be disappointed. They haven’t even identified the causes. Our problem is not insufficient regulations, but rather an absence of character at the nation’s largest financial institutions and the systemic ineffectiveness of our regulators in enforcing the regulations already on the books. To inflame your own personal sense of outrage, I recommend The Big Short: Inside the Doomsday Machine, by Michael Lewis.
Getting angry isn’t enough though. To survive and prosper, we need to learn from our experiences and develop methods to help us decide when we should temporarily move toward the sidelines. Don’t be deluded by the notion that investing is a challenge you can overcome by simply refusing to participate. Inflation is to cash as termites are to a house. Although it may take a little longer, inflation can destroy the purchasing power of cash as effectively as a downturn in the stock market. The intuitive alternatives for those who’ve been traumatized by the volatility of the stock market are just as deadly. Fixed income investments are now in a bubble that, in the next few years, will burst as violently as the stock market did in 2008; but, it will impact far more investors, including those most drawn to them by their illusory promise of safety. In the absence of immediate and compelling personal circumstances, bonds, annuities and packaged investment products promising current income and limited volatility, should be avoided. There will once again be a time for bonds to play a constructive role in our investment strategy, but not for a while.
There are two bogeys on the horizon for the stock market. One is the virtual tsunami
of government debt that has been teed up over the last 15 months. The other is an
inevitable tightening of monetary policy by the Federal Reserve. Although corporate
profits are now out of the cellar, the stock market continues to be driven by monetary
policy. As corporate profitability improves, loose monetary policy will need to
be reigned in to prevent runaway inflation. The collective success of the U.S. and
worldwide economies will depend heavily on the skill of Fed Chairman Ben Bernanke
in draining excess liquidity from the monetary base. Too rapidly and we spiral into
deflation; too slowly and inflation goes viral. The Chairman says he has an exit
strategy. If he’s smooth with the controls, we may experience minimal volatility
in the stock market. If he over-
During the first quarter, we added, Merck (MRK), Pfizer (PFE), Corning (GLW), Intel (INTC) and Express Scripts (ESRX) to our portfolios and lightened up on BHP Billiton (BHP) and Southern Copper (SCCO). In response to the Presidents recent commitment to allow offshore drilling along the outer continental shelf, we reintroduced Transocean (RIG) into our portfolios. Our evolving investment paradigm already incorporates effective methods for the selection of specific stocks and the recognition of market bottoms. Now we’re focused on the identification of economic storm warnings. Although it would have been nice if we had temporarily gone to cash in November 2007, we’re much better off today than if we had headed for the exits a year ago. The DOW is up 66% since the low point reached on March 9, 2009. PCM accounts are up significantly more. But, while we’re enjoying the recent success of our investments, we’re also on high alert for warnings of a potential downturn.
Please call if you have any questions, or comments. We need to know as soon as possible about any changes in your personal situation, or investment goals that might influence our management of your accounts. We are committed to your investment success and most sincerely appreciate your loyalty.
– Dan
The Rising Tide of Monetary Policy
Thursday, April 1, 2010