Winter Letter {Part III}

Another tailwind is that our politicians have finally started to play nice.  Witness last year’s tax accord and this year’s budget agreement.  Governmental fiscal constraints should likely be less of a headwind at all levels as a growing economy brings more revenue into the till.  The Federal deficit this year could be less than 5% of GDP, down from highs over 11%.  This is still too high on a sustainable basis but it is heading in the right direction.  Corporations should see record profits this year, as their balance sheets remain pristine.   This should lead to increases in dividends, more capital spending and stock buy-backs. 

Of course there are still concerns.  Unemployment remains stubbornly high.  Rising interest rates could hamper economic growth as well as a possible alternative asset class relative to stocks.  Real wage growth, especially for those in low skill industries, remains elusive and most Americans have little to no savings.  Abroad, the economies of emerging markets have been weak.  Growth in China has slowed.  Europe while improving has little room for error.  Flashpoints around the world remain problematic.  Yet perhaps the largest concern we should have is how positive many are on stocks.  It seems that much of the media and the pundit class have a much more benign outlook for equities than they’ve shown in the past few years.  While many will view this universal bullishness as perhaps a contrary indicator, I would balance that against a market, which we’ve discussed above, is more or less trading at fair value and against all that money that is still sitting in bond funds or money market accounts.  It is that money that I think will buttress any declines this year in the markets. 

I think 2014 has the potential to be a year of growth but I would also note that the last time the market saw a real correction greater than 10% was in the spring and summer of 2011.  Probability suggests that at some point we will see markets decline in excess of that.  Given the hope investors seem to have for stocks this year and given where we stand in regards to market valuations, probability would suggest that we prepare for that sort of decline at some point this year.  Our strategy may be to build up our cash reserves as per individual client risk/reward and strategic mandates as we rebalance accounts.  As always in times like these we will have the defensive pages of the playbook nearby. 

As of this writing Mr. English held positions in ETFs related to the S&P 500 in client and personal accounts.