Our leading indicators for economic growth, and those of our research partners, point to a period of slower growth in the US and overseas. The important question for investors is the degree and depth of the slowdown, and its effects on economic fundamentals (i.e. unemployment) and stock and bond prices.

According to Goldman Sachs analyst Noah Weisberger, economic recoveries historically start off very strong – the past 18 months – then experience a period of softness. Our experience confirms Weisberger’s work. Slowdowns

typically have three phases: deceleration, stabilization and reacceleration. According to Weisberger, and our own work, we are now beginning to experience the deceleration. This is most noticeable in recent manufacturing output data here in the US and abroad. According to our work, this slowdown should be somewhat shallow in depth and be relatively short in duration – perhaps thru the summer.

This change in the pace of global growth will have several impacts on the fundamentals of economies. Most importantly, unemployment will likely remain at high levels as corporations temper their enthusiasm to add capacity. Inflationary pressures and fears, which have accelerated in recent quarters, should subside as well as the level of commodity prices. Lastly, interest rates should temporarily remain at their historically low levels until the economy reaccelerates.

These changes will temporarily affect the price of financial instruments. Most notably, and already in play, is a pull back in stock prices – particularly in those sectors that are most sensitive to economic growth. This would include energy, industrial, technology and material sectors. At the same time, we anticipate and have begun to see consumer staple and healthcare sectors perform well as investors rotate to these less cyclical sectors. A well diversified portfolio, such as yours, should fare relatively well during this phase. The fact that the recent correction in stock indexes is happening while healthcare and consumer stocks act well, suggests that this is not the beginning of a bear market in stocks, but simply “the pause that refreshes”. A period of stocks trading sideways is the most likely outcome until the economy reaccelerates towards the end of summer. For those of us that are long term investors, we do not see this short term economic change as a reason to make significant changes in our investment positions.

The recent temporary decline in interest rates will likely be with us over the next 3-4 months. This will cause us to be very selective in our bond purchases. The next big move in interest rates should be up as the economy reaccelerates in a few months. We will make sure that we are in a position to purchase higher yielding bonds for you at that time.

As we have learned over the past decade, nothing is certain in regard to economies and financial markets. Therefore, we will continue to do our best to manage risk through your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders. Keep in mind that we do not put stop losses on all stocks, only those that are vulnerable to significant economic downturns.

We hope this update finds you well. If you have any questions or would like to meet to review your portfolio, please contact us at your earliest convenience.

Sincerely,

James E. Demmert
Managing Partner