As we leave 2009 in the past, it is a good time to consider the future of global economics and the effects on stock, bond and real estate prices and also to give you an update on Main Street Research. We have quantified this for you in a list of our top 10 thoughts:
1. Global Investment Return and Risk
We do not embrace the idea that we are entering a period of below normal returns for financial assets such as stocks and bonds or what some have coined the “new normal”. The past 12 months or 10 years may be indicative of the future for financial markets – periods of strength followed by short, disruptive periods of significant weakness. Therefore, we will continue to focus on risk management and employ our global opportunistic investment style – which has served us well during the last 10 years as well as the past 12 months. The mentality of the 1980s and 90s of buying and holding investments forever is officially gone.
2. Government Regulation and Fiscal Policy
The Great Recession of 2007-09 brought short and long term structural changes to global economics. The important long term change is in government policy. Increased government regulation has already begun (particularly in the financial sector) and is gaining momentum. No one wants an unregulated world. However, too much regulation is simply not good for corporate profits and capitalism. Moreover, with this regulation will come increased corporate and personal tax rates as governments attempt to tax their way out of fiscal deficits. Our investment research is already taking much of this into account as we search for economic sectors and industries that will be less affected by these changes in government policy.
3. Geopolitical Risk
The recent attempt to bring down the Northwest flight headed to Detroit should serve as a reminder to all of us that geopolitical risk is –unfortunately- alive and well. We will continue to use our risk management tools (and explore new ones) in an effort to mitigate this unpredictable risk.
4. Global Economic Growth
The global economy is alive and in some geographic areas doing very well. Our research suggests that, over the next business cycle, there will be significant differences between economic growth rates throughout the world. We envision a US economy that grows a bit slower than normal, while developing economies – such as China, Brazil and India – provide significantly higher economic growth. We will continue to leverage this research to find domestic and foreign companies that are well positioned to prosper from these differentiated economies.
5. Interest Rates
Interest rates throughout the world are at historically low levels. This is primarily due to the crisis of the Great Recession. However, global economies are already in recovery mode which leaves only one direction for interest rates to go – up. It is not a question of “if” but “when” and our research suggests sooner than you think! We will continue to keep bond maturities short and consider how this important change will affect the companies that you own in your stock portfolio. We would suggest that, if you have an adjustable rate mortgage, now is the time to look into locking in these historic low rates with a fixed rate mortgage.
6. Inflation
Inflation –like interest rates – is also at historically low levels. Our research suggests that inflation will gradually return to more normal levels over the next few years. It will take a year or two of solid global economic growth to significantly lift inflation rates.
7. Global Stock Markets
Now that the Great Recession is behind us, our research suggests that global stock markets will outperform bonds and real estate, but with significantly more volatility. Some foreign markets will likely outperform US markets. US companies doing significant business in faster growing, foreign economies will likely perform better than those focused only on the US market.
8. Global Bond Markets
As interest rates rise, some bonds and bond funds will fall dramatically in value. The exception is short term high quality bonds. Therefore, we have concentrated our bond positions in those with short maturities. As interest rates rise over the next 2 years, yields on bonds will rise and we will be able to purchase longer maturity bonds with attractive returns.
9. Global and Local Real Estate
When asset price bubbles burst, like the real estate bubble of the last ten years, prices tend to take a very long time to return to previous levels. We do not think it will be any different this time. Though housing prices have likely bottomed, we do not envision a “V” shaped recovery in real estate, rather one that looks more like a “U”.
10. Main Street Research
We are bigger and stronger than ever. Though we do welcome referrals, we continue to keep a relatively short list of clients to better serve you. We were recently ranked #25 by Investment News, an industry trade magazine, in regard to investment advisor growth across the US. Some of you may recall that last year we were ranked #27 – we are moving up! We attribute this success to our teamwork, research, and risk management, and above all, your commitment to our organization through one of the most difficult periods in financial history.
If you would like to get together to review your portfolio, please let us know. Also, you may recall that each year we are required to submit data about our firm, not our clients, to the SEC via the Form ADV document. If you would like a copy, please let us know.
A happy and safe New Year to you and your family from all of us!
Sincerely,
James E. Demmert
Managing Partner