Climbing the Wall of Worry
Posted by Dan Lagan, CFA - 02/13/2012

Worried about investing in stocks? Two popular market pundits seem to think we may be in the midst of a secular bull market. Cramer’s view is based partially on market action, that is the market is reacting rationally to the fourth quarter earnings reporting season. Fink’s is a more fundamental view, stocks are cheap relative to history, and bonds offer little in the way of real returns. Both may be right.

There is no shortage of negative sentiment affecting the market with Europe leading the charge. Housing remains weak and even with January’s surprisingly strong employment report (240,000 new private sector jobs were created) the unemployment rate remains stubbornly above 8%. Offsetting the negatives and often flying under the radar screen are some distinct positives. Corporate profits remain healthy and are supported by substantial free cash flows. The US consumer has reduced their debt levels substantially since 2008 and US banks are much stronger than their European counterparts and stronger than they were a few years ago. The negatives provide a “wall of worry” and impose a healthy level of skepticism on the market. That being said, corporate earnings are up and evidence is mounting that the recovery is gaining steam.

Jambalaya On the Bayou: 1952 Top Ten Hit
Posted by Amy Noyes, CFA - 02/08/2012

What do you get when you combine technological innovation, slow domestic economic growth, and higher vehicle mileage standards? You win the opportunity to move closer to becoming energy independent. This coveted achievement was last held sixty-years ago in 1952. It is again within our sights according to Bloomberg.

The United States’ domestic oil output is the highest in eight years and our natural gas production is so abundant the government may approve an export terminal in Louisiana. Though it may be a bit early to celebrate to the sounds of Hank Williams,’ Jambalaya On the Bayou a 1952 Top 10 hit, the positives toward this enduring change outweigh the environmental hurdles ahead.

According to IHS Global Insight, the shale gas expansion has added 600,000 jobs to our payrolls. It has benefited companies working directly within the energy sector and also those supporting them; hotels, restaurants, etc. The growth in energy independence will certainly help boost GDP growth as well as to help reduce our deficit.

The Rodney Dangerfield Economy
Posted by Al Lagan, CFA, Chairman - 01/27/12

Rodney Dangerfield was known for his catch phrase “I don’t get no respect, I tell ya.” Rodney, who wrote all his own comic material, would then launch into a monologue about his unhappy life portraying himself as a clumsy, bumbling, misunderstood loser who earned everyone’s disrespect. In contrast to his stage persona, in his real life he was described as intelligent, sensitive, and gentlemanly.

Rodney’s lament is analogous to the widely held view of our economic situation today. Our economy has made significant strides in unveiling a new growth path from the darkest days of 2011. The improvement has come despite further deterioration and a probable recession in Europe, a slowing growth rate in emerging nations, fundamental changes in the Japanese economic outlook, and anti-business agenda by the Administration. The fact that the recovery has not shown the strong snap back of previous recovery periods leads many economists to denigrate the recovery and underestimate the underlying strength and sustainability of the advance.

The present recovery is different in many ways from previous episodes. It is led by capital spending, a surprising resurgence of manufacturing, strong exports and recently, rising consumer spending. The change in the manufacturing sector is most dramatic, and is clearly accelerating. Many corporations, both domestic and foreign are expanding and building new facilities in the U.S., and order books and backlogs are very strong and growing. A lot of the new production is intended for export. Clearly American manufacturing is once again cost competitive with the rest of the world. The labor market is healing as new jobs have shown an acceleration in recent months and layoffs have declined. Housing, typically an early recovery vehicle, remains depressed but is no longer deteriorating. The potential for improvement in housing is real, however, as employment and incomes increase, interest rates remain low, and rents continue to increase.

The apparent lack of confidence shown by economists contrasts with improving confidence among business leaders and consumers. We believe the economy will strengthen over the course of 2012 and the advance will ultimately broaden out. The year 2012 promises to be better than is generally perceived. Now is the time to be bullish on America.

The Dawn of a Housing Recovery
Posted by Al Lagan, CFA, Chairman - 01/20/12

Mariners at sea are familiar with false dawn, that very early time when the eastern sky turns slightly gray, but sunrise is still an hour or so away. One of the more intriguing aspects of the U.S. economic picture at the dawn of a new year is the apparent improvement in the beaten down housing market. The macro data have been encouraging for some months now but the details have been inconsistent, leading most economists to believe it is too early to expect a housing recovery. Almost universally, a sustainable recovery in the sector is not expected until 2013, at best.

Still, the signs of stability are unmistakable. Existing home sales rose 5% in December, the highest level in a year. The median sale price showed a modest improvement, up 2.3%. Buoyed by strong trends in apartment building, new construction is stirring. Construction of single-family homes remains depressed as many young people defer forming families until employment conditions improve.

Underlying economic conditions are heading in the right direction. New jobs creation has been improving and layoffs have declined sharply. Indicators of home affordability have never been stronger, and conditions in the mortgage market are more accommodative. Demographics support the expectation of robust single-family house construction at some point.

The U.S. economy appears to be shifting toward domestic demand growth as consumer spending and capital spending rise. A turn in home prices, which would likely accompany evidence of a stronger housing sector, would accelerate this shift in growth at an opportune time. It would also dispel the notion that we are locked in to a subpar growth rate. The upcoming home selling season will go a long way to determine whether improving trends represent the false or real dawn.

Deficit Spending and the Pursuit of Happiness
Posted by Al Lagan, CFA, Chairman - 01/13/12

While no one hailed it at the time a new record was broken at year end. The Treasury closed its books on 2011 with debt outstanding at an all-time record $15.2 trillion. This is an increase from the $14.5 trillion recorded on June 30, 2011, equal to approximately 98.6% of calendar year 2010 gross domestic product of $14.66 trillion. The 2011 year end record breaks the 100% mark relative to gross domestic product. The expansion of the country’s debt in recent years has been meteoric. In fiscal year 2007, the final year of President Bush’s tenure in office, the deficit was $162 billion. We now regularly exceed that level on a monthly basis. The year 2011 is the third consecutive year of deficits in excess of a trillion dollars.

An increase in the debt ceiling is guaranteed under the agreement between the Congress and the Administration, which authorized a “super committee” to identify $1.2 trillion of spending reductions. The failure of the “super committee” set in motion a process which allows the President to increase the debt ceiling without the approval of Congress, with automatic spending cuts kicking in in 2013. A deficit in excess of $1.3 trillion is a sure bet in 2012, and likely in 2013 also.

Numerous studies have pointed to the vast expansion of social spending programs as the primary cause of the run-a-way government spending. Many in Congress and the media would make controlling social spending a political fight between conservatives and liberals, or between the “rich” and the “rest” of us. It is more than that. It has a moral dimension. Total government spending has risen from 27% of GDP in 1960 to over 100% at year end 2011. Between 1986 and 2010 the percentage of Americans who pay zero or negative income tax has risen to nearly 50% from less than 20%. All this was paid for by issuing debt. Our national debt has risen from 42% of GDP in 1980 to in excess of 100% currently, and climbing. We are approaching the point where a minority of people pay their honest share of the cost of government, and the majority become so thoroughly invested in their social welfare state that work is easily avoided without consequence. A real life example of this trend exists today in Greece and a few European states. The ease with which the government uses debt to increase social spending is eating away at our moral and fiscal probity. The political satirist Walter Kelly might have applied the words of his comic strip hero to our national addiction to debt when Pogo uttered “We have met the enemy and he is us.”

Growth is Back But of a Different Sort
Posted by Al Lagan, CFA, Chairman - 01/11/2012

The pieces of a sustainable recovery are steadily falling into place, but the shape of the recovery is different from a traditional recovery. Notably, private sector employment has improved for a number of months now leading in its train to modest improvements in the average workweek and hourly earnings. Most encouraging is evidence of an upturn in small business hiring. The ADP employment survey in December indicated that small business hiring showed the largest increase since February, 2006. The unemployment rate has declined to 8.5%, a substantial improvement over the rate one year ago. While this is not likely to satisfy the Federal Reserve or the Administration, the trend is unmistakably positive and a welcome change from the bleak readings in early 2010. As if in confirmation of a better jobs picture, consumer and business confidence have shown noticeable improvements in recent months.

The encouraging trend is somewhat tarnished by the absence of any improvement in housing. Despite record affordability house prices declined 1% according to the latest S&P/Case-Shiller index of prices. The improved status of other housing measures, such as new housing starts and existing home sales, indicates only that the sector is bouncing along a bottom, but sustained improvement is elusive.

The lack of uplift from housing is overcome by the increasing vigor of the factory sector. Both the Leading Economic Indicators and various surveys of manufacturing point to broad based strength and accelerating activity. The latest survey of manufacturers by the Institute of Supply Manufacturers corroborates various regional surveys, which indicate strength in new orders, production, backlogs, and employment. Rising factory activity is the result of improving demand trends both domestically and export. Combined with the need to restock depleted inventories manufacturing will remain a powerful economic contributor for at least 2012.

As we enter a new year our economy is growing and the growth is sustainable. Conditions will remain moderate, however, as there are important sectors which are still dormant. Under these conditions inflation will remain low, and consumer buying power will gradually build. Still, relative to the rest of the industrialized world the U.S. economy is uniquely getting stronger. Rising unemployment in the Eurozone represents too heavy a burden to expect recovery in any reasonable period of time. Recession is the likely result, not recovery, regardless of the status of their debt burdens. It is increasingly apparent that China, up to now drunk on investment-led growth, is turning to satisfying the wants of its growing middle class. Growth will slow accordingly. This leaves the U.S. as the preferred destination for investments. We remain concerned mainly about the possibility of policy overreach in both monetary and fiscal policy. This is a heightened risk in an election year. All in all, the domestic equity market is unusually attractive.

Common Stocks 2011-2012
Posted by Tom Murphy, Ph.D., CFA - 01/05/2012

Despite considerable volatility throughout the year, the major equity indices ended 2011 in positive territory. On a total return basis, the S&P 500 finished up 2.11% and the Russell1000 Growth Index added 2.64%. These modest gains occurred as policy makers, both here and abroad, failed to convincingly address economic issues which are impeding global growth and investment. The U.S. Congress and Administration evaded decisions on fiscal reform and the deficit; the European Community struggled with sovereign debt problems and banking stability; and the Chinese authorities remained preoccupied with property speculation and rising inflation. Importantly, these well-publicized issues, which contributed much to market volatility, have carried over into 2012.

Given this background, it is difficult to envision robust growth for the New Year. Indeed, most observers have Europe falling into a recession in early 2012 and both the U.S. and China growing below potential. By and large, this is an environment in which expectations are restrained; but, at the same time, U.S. corporations are in very good shape. Balance sheets are strong; cash levels are high; and corporate profits continue to rise. Earnings estimates for 2012 have the S&P 500 trading around 11.9x and the Russell1000 Growth Index close to 12.0x. By historical standards, neither seems expensive. Significantly, investors tend to be positively surprised when expectations are low and stocks are modestly priced. While volatility may continue in an election year, common stocks offer further opportunities for gains in 2012.

A New Year Beckons
Posted by Dan Lagan, CFA - 01/04/2012

Few will mourn the passing of 2011 into the financial history books. The S&P 500 returned 2% for the year, but that hardly explains the roller-coaster ride equity investors experienced. At the end of April, the stock market was up 9% only to suffer a 16% decline from May - September. The treasury market rallied as the year progressed with the 10-year yield declining to under 1.9%. US economic data strengthened throughout Q4. With an improving employment and income picture in the US, we believe the economy can withstand prolonged uncertainty caused by Europe's debt and China's growth concerns.