Quarterly Letter
Ron Muhlenkamp
For two years or more, we’ve been discussing Europe, China, and U.S. politics as drivers for the financial markets. These drivers continue. Europe has reentered recession. That was expected. But it was also expected that, by now, Europe would have found an approach to deal with its problems. It has failed to do so, both politically and financially. Elections have been inconclusive (Greece and Italy), and the responses to the recent banking problem in Cyprus (a tiny country) were more problematic than the banking problem itself. Rather than demonstrate that the central bankers had a plan to deal with the situation, they made matters worse.
China remains in transition. Its economy is expanding, but local leadership is resisting Beijing’s efforts to redirect the economy to greater domestic consumption. We think it’s on track, but will take a while.
In the U.S, the consumer seems to be gradually coming back. Sales growth remains modest, but now includes a pickup in housing and autos. It appears that the increase in FICA taxes (from 4.2% to 6.2% effective 1/1/13) is coming out of savings—not spending—though, in truth, it’s a bit early yet.
Employers remain cautious. For years, businessmen have been reluctant to invest or to hire, waiting for clarification of the rules. The rules are becoming clear: it will be increasingly expensive to hire people. (So far, the regulations spawned by the ACA (Affordable Care Act—Obamacare) form a stack of paper seven feet high.) As a result, we expect that hiring will remain subdued (and for less than 30 hours per week), but it may result in a pickup in corporate investment.
The clarification of the rules and continued Federal Reserve buying of bonds and mortgages (currently at $85 billion per month) have helped drive stock prices to new highs. These factors are aided by a lack of good alternatives, either other countries (see above) or bonds (even bond managers are saying the bond bull market is over).
The above crosscurrents make us nervous. While we’ve done well in the recent rally, we believe stocks, on average, are now fairly priced. (Bonds are overpriced.) We’re trying to stay nimble and protect your (and our) assets.
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