Here We Go Again
In the past couple of years, it seems that when it is
time to write our quarterly letter we are confronted
with some sort of crisis, which makes it nearly
impossible to look ahead with clarity. Well, here we go
Today, investors are facing a political stalemate in
Washington over passing a budget, pitting the Republican
controlled House of Representatives against the
Democratic White House and Senate. As a result, the
government has been partially shut down for lack of
funding. The House wants something in return for passing
the budget. That’s called compromise. The Democrats say
absolutely not. By the time you receive this letter, the
issue may well be resolved. Meanwhile, for the time
being, the shutdown focuses on non-essential services
and the man in the street is largely unaffected. While
Wall Street is not happy, so far it has reacted with
merely a shrug.
A more serious showdown is due for later in the
month. On or about the 17th of October, Washington will
be unable to borrow additional money as it hits the
statutory limit on its authority to borrow. Unless a
divided Washington comes together (and so far it has
not), the federal government will be unable to pay its
Lacking a compromise to raise the debt limit, the US
could well be forced to default on its outstanding debt.
It would be unable to pay interest or retire maturing US
Treasury securities. This would be a big deal. Although
not rated AAA by all three rating agencies, Treasury
securities are considered the safest and most liquid
securities in the world. As the global reserve currency,
these securities are held by foreign central banks.
China is notable as the largest foreign holder. Default
would conceivably result in frantic selling of
Treasuries and a sharp rise in interest rates. This in
turn could push the economy back into recession. The
stock market would decline. Wall Street would most
definitely not shrug it off.
We will not pass judgment on the issues that divide
Republicans and Democrats. Suffice it to say that the
country is sharply divided. Reflecting this, there is
little appetite for compromise in Washington.
As we head into the fourth quarter, investors are
confronted with the unknowable. Here we go again. We
will just have to get used to it.
Please see our disclosures on page 2 and on our
So, where does the economy stand assuming Washington
figures a way out of its fix?
The good: After the rally from the lows of last
November, stocks have become much more fairly priced.
Recently, there have been a number of highly successful
initial public offerings, which suggests sentiment is
buoyant. There has been a whiff of détente between
Washington and Tehran, which could have enormous
implications for the price of oil.
The bad: The economy is growing very modestly.
Employment is fragile with many of the new jobs created
being in low paying lodging and restaurant industries.
Housing continues strong but the rate of growth has
hesitated recently due to higher mortgage rates.
Meanwhile, the Fed continues full steam ahead with
quantitative easing (easy money, artificially low
Recently, corporate earnings have grown, largely due
to cost cutting and companies buying back their own
stock (fewer shares outstanding means higher earnings
per share). This has driven stocks higher. However, by
now, many companies have exhausted their ability to cut
expenses much further. What business and the stock
market need now is for GDP growth to accelerate thereby
driving corporate revenue and earnings higher.
Currently, inflation adjusted GDP is growing at about
1%, which is too low to drive anything, let alone
corporate revenue. If Washington cannot resolve the
budget and debt ceiling impasse in a timely manner, the
economy will likely sink back into recession. That would
be very bad for the stock market.
Our read of market sentiment is that players are
somewhat complacent. A year ago, we faced the budget
sequester; two years ago we faced the debt limit debate;
five years ago we faced a market meltdown and banking
crisis yet we got through them. “We’re all old hands
now; we’ll get through this too.”
Well, hold on to your hats (and stocks), folks. Here
we go again!
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