A Short Letter
A short letter…no, we are not suggesting that
investors go short the market (betting on a decline)
though that may be a profitable trade. We refer rather
to the fact that since the latter part of 2014 little
has changed, whether it be stock prices, geopolitical
events or macroeconomic conditions. There is little to
say that we have not discussed already over the last six
Since the end of 2014, stock prices have basically
gone sideways. The media has hyperventilated over
occasional new highs but the fact is that those new
highs have so far been marginal to the extent that they
are inconsequential. The market remains bifurcated. The
strong sectors like healthcare, particularly biotech,
have out-performed the wider market by a substantial
margin while old tech (Microsoft, Intel) and energy have
Mergers continue to be in vogue. In a slow growth GDP
environment of 2.5%, managements apparently feel the
need to merge to create economies of scale in order to
cut costs. Unfortunately, cutting costs usually means
worker layoffs. Regrettably, such actions do not enhance
economic growth in the aggregate.
And there seems to be a new spin on corporate
mergers. Since the US has the highest corporate income
tax rates of any major country, there is an incentive
for US companies to lower taxes by merging with foreign
companies and moving the corporate domicile outside the
U.S. Such tax considerations have become a key part of
the cost-saving justifications for M&A deals.
Geopolitically, there has been little cooling in the
hotspots around the world. Russia continues to challenge
Ukraine and NATO member states. ISIS seems to be running
away with the fight against a 32-member coalition
rounded up by the US. The negotiations with Iran over
its imminent nuclear capabilities continue to be
deadlocked as deadline after deadline comes and goes.
President Obama can claim one world-shaking success:
diplomatic ties with Cuba.
From a macroeconomic view point, it is the same old,
same old. While growth is persistent in the US, it is
only 2-2.5%, lower than the typical rate during
recoveries. Europe appears to have stabilized though
meaningful growth has yet to materialize. Three cheers
for the euro-zone for not getting worse.
Stock market bulls point out that while annual GDP
growth has been anemic since the bottom of the last
recession in 2009, the duration of the upturn has been
long by historical standards. Cumulative growth has been
more potent than is generally acknowledged and has
contributed to growth in corporate earnings and stock
prices. There is little reason to expect the slow
grinding growth will not continue into the year ahead.
This could, bulls argue, prolong the bull market for
some time to come.
As of this writing, it remains uncertain as to
whether Greece will remain as part of the euro-zone.
Because of its small size, 11 million people, the
economic repercussion of Greece leaving is not material.
It is said that China creates the economic equivalent of
Greece every six weeks. The issue is psychological. Had
Abraham Lincoln not fought and won the Civil War to
preserve the Union, there would not be a United States
of America today. Similarly, should the Greeks
successfully secede from the euro-zone, it could
encourage weaker members, Italy, Spain and Portugal, to
also resist the structural, economic and social reforms
needed to assure long term prosperity. Such contagion in
the future could threaten to render apart the European
We remain cautious on the stock market. Portfolio
cash positions remain high awaiting more reasonable
valuations that may come with a correction. Earnings
period is soon upon us, which could give the market some
short term direction. Meanwhile, excesses (bubbles?)
build. Artificially low interest rates continue to
stimulate a misallocation of capital. To our mind, the
question is not if problems are coming, but when. It
could be some time.
Please read our important notice
about these letters and the securities they mention.