We were honored to receive an invitation to speak at a local business association’s holiday dinner. The following is an excerpt from the Q&A that followed the formal presentation:
I READ WHERE AN INVERTED YIELD CURVE HAS LEAD TO A RECESSION SOMETHING LIKE 6 OF THE LAST 7 TIMES. ARE WE HEADED FOR A RECESSION?
Today’s inverted yield curve is less about the bond market foreshadowing doom and gloom as it is a reflection of excess global liquidity. We’re running huge trade deficits with China and Japan.
Where else can they invest the Dollars we send them? They have a voracious appetite for long bonds which has pushed down rates at that end of the curve. The inversion was exaggerated each time Bernanke and Greenspan before him hiked short rates.
The wonderful thing about markets is that, most times, they’re selfcorrecting.
We expect The Fed to ease as the rate of economic growth slows. When that easing occurs is anyone’s guess but the next move is clearly down.
SO, TO BE CLEAR, WE’RE NOT HEADED FOR RECESSION?
Aren’t economists wonderful? Always using the double talk!
It’s unlikely we’re headed for economic contraction let alone two consecutive quarters of it. Industry-specific issues such as housing and autos haven’t spilled over into the broader economy. Interest rates and unemployment remain low, corporate profits remain strong and inflation hasn’t reared its ugly head despite The Fed doing its best to scare the heck out of us.
WHAT DOES THAT MEAN FOR MY BUSINESS’S BORROWING COSTS?
We expect short rates to come down and long rates to edge higher to bring about a more normalized yield curve. How you structure your borrowing will dictate your out of pocket costs. If you haven’t done so already, now might be a good time to lock in long-term financing.
IS THE DOLLAR’S WEAKNESS SOMETHING TO WORRY ABOUT?
Hmmm, good question. There’s been a lot written about this and we’ve gone back and forth on the issue. Big picture – we don’t think there’s any cause to panic. What we’re watching for right now is the action of central banks around the world. Current account deficits in the 90’s were fueled by private investment in the US productivity boom. That was fine. But deficits over the past few years have been financed by global central bankers parking their Dollars in Treasuries.
To the extent they decide to diversify their holdings, that’s when we’d step up the concern a bit.
WHEN IS HOUSING GOING TO COME BACK?
We’re not sure it ever left.
Lots of factors contributed to the spike in prices – baby boomers looking for second homes, low interest rates, a strong labor market and speculation to name a few. Most of these factors remain intact.
Most markets aren’t seeing declines but a leveling out of the growth rate. Where you’re seeing declines is in markets where the fundamentals are poor. Think of how the Detroit real estate market is doing with the GM and Ford layoffs.
Mostly, the doom and gloom has been blown out of proportion. Sure, there have been some losers but more often then not it’s been the speculators. That’s how markets work. Those at the fringe take on the most risk and receive the most reward. We can’t cry for them on the downside as many of them did well while the party lasted. Free market capitalism can be cruel and swift but that’s the nature of markets.
WHAT DO YOU SEE HAPPENING TO THE ECONOMY WITH THE CHANGE OVER IN CONGRESS?
Not much. Lots of rhetoric but that’s about it. The Democrats don’t have the votes to override a Presidential veto and, the last time we looked, we still had a Republican in the White House.
The Democrats will poke around in the pharmaceutical and energy industries. There will be revisiting some of the contracts for the rebuilding of Iraq.
Mostly, there will be plenty of jockeying for position ahead of the 2008 election.
We expect little in the way of legislation and definitely nothing that will alter the big picture. Bush won’t get his tax cuts extended but they aren’t going away either. We may see a compromise on immigration and there’s a chance the Democrats will push through their minimum wage agenda.
WITH THE STOCK MARKET AT ALL TIME HIGHS, IS 2007 GOING TO BE A GOOD YEAR?
Well, that’s a bit of a loaded question. What exactly makes for a good year? And are markets really at all time highs? Even so, does that mean personal net worth is at an all time high?
We think the markets will do just fine. Believers in reversion to the mean are focusing on sectors that have underperformed and moving out of those that have done well. That’s not a good sign for bonds, real estate, gold, commodities, emerging markets and so forth.
The scary thing is that lots of investors have been taking on much too much in the way of risk in order to squeeze out a few extra basis points of return. Look at the tight spread between junk bonds and Treasuries. Look at how much money has piled into emerging markets and commodities.
We think a return to safety makes sense. Look for investors to seek out dividend paying stocks and companies that do well in a stable or slowing economy. That means large cap, value oriented stocks.
WHAT’S THE OUTLOOK FOR M&A?
Pretty good actually. Cheap financing, overflowing coffers and a desire to escape SarbOx will keep the private equity boom afloat. Public companies will use expanding PE multiples and a steadier economy to buy market share and pick up struggling companies on the cheap.
ISN’T ALL THAT PRIVATE EQUITY MONEY BAD IN THE LONG RUN?
Again, markets are ruthlessly efficient. Some will win – some will lose.
A system-wide meltdown isn’t in the cards.
An interesting side note is that there’s the potential for a shortage of stock. With public companies going private or stepping up their repurchase programs, fewer shares are available for the retail investor, mutual fund manager and so forth. It’s basic supply and demand. The fewer shares there are outstanding, the higher prices are likely to go.