April was a friendly month for investors, especially of the precious metals variety. Stocks rose by 2.9% (S&P 500), with bonds up 1.3% (Barclays Aggregate Bond Index). Gold, however, rose by 8.9%, driven by uncertainty about the path of the U.S. Dollar and budget reform, and the increasingly unsettled Middle East situation. Oil and gasoline continued to rise, adding to a consumer squeeze that threatens to derail discretionary spending at a critical moment for the U.S. economy.
Earnings reports for many blue chip companies began to roll in by late April, and were mostly in line, with mid to high single digit earnings growth profiles. Technology company comments were particularly interesting, with many commenting on the changing nature of information consumption (away from PC's and towards tablets and mobile computing devices). This is an important and very fundamental change that is taking place in the critical technology space, and we are monitoring and working closely with our research partners to uncover opportunities in this area.
One of the main topics of debate in the markets in April was the approaching "debt limit ceiling" for the U.S., and the need for Congress to act to raise it. Most voices warned of dire consequences for not raising it (S&P even lowered the "outlook" for U.S. Treasury debt from "Stable" to "Negative"), but some fiscal hawks are tired of endless spending and borrowing and think this is the moment to re-arrange the status quo. The recent election results tend to support a give and take resolution (pair an increase in the debt ceiling with real cuts). As we publish this, Treasury Secretary Geithner has announced that the limit will not be breached until early August, so we can expect to see a lot more debate from the politicians on this topic throughout the summer.
Fed Chairman Bernanke gave a first ever televised "press conference" as April closed, but it was a non-event for investors, as the questions were mostly softballs. The real take away for us is how the Fed is now left to "jaw-boning" the markets to distract investors from the failure of their policies to meaningfully improve the economy. Beginning with Bernanke's November Op-Ed piece in the Washington Post last November about how the Fed was going to raise the value of stock prices by creating more dollars, the only result has been frothiness in financial markets and a further deterioration in the U.S. balance sheet. Most market professionals agree that the real economy is still struggling, and things are worse for the average American: food and energy prices are up noticeably since "QE II" was launched, while wage and job growth is non-existent.
Perhaps the most unnoticed result of the Fed's policy has been the continuing decline in value of the U.S. Dollar, which we have been writing about for some time as one of the primary risks for U.S. based investors, whose purchasing power is eroding. We believe owning gold and precious metals is the natural antidote for this "monetary sickness", but many investors think gold is in a "bubble", or prices are too high. Certainly April price increases had the flavor of a parabola, and are not sustainable at that pace indefinitely, but we find that many participants are bearish on gold (only wild enthusiasm marks market tops). As an example, we had a chance to attend our professional organization (CFA NC Society) Annual Meeting in Charlotte in April, where the featured speaker was Edward Chancellor, head of GMO's Asset Allocation Committee. GMO is one of the world's largest money managers, and the topic of the evening was Financial Asset Bubbles, from tulip manias to dotcoms and now, in his view, to China. When asked about gold, the response was basically that it was 2.5 to 3 standard deviations above its long term trend, that it competed with other assets for investor dollars, and when interest rates moved off the zero line, it would fall. This could all be right. However, the issue which remains unaddressed is how a "store of value" is created and maintained. Currencies have tried to serve that purpose (as well as serving as a "medium of exchange"), but history shows clearly that paper money is prone to degradation and devaluation by overzealous central banks, and that is precisely the position that the U.S. finds itself in now, in our view. We took the time to review the fabulous writer and financial commentator Jim Grant's op-ed last winter from the NY Times about the need for the U.S. to return to the Gold Standard, and we think it is quite a worthwhile read for all of you too:
Meanwhile, other foreign central banks recognize that inflation still matters, and are raising interest rates. On April 7, the European Central Bank increased their overnight rate from 1% to 1.25%, initiating what some think will be a steady tightening policy. This is a clear divergence from U.S. policy, and there is great debate as to whether or not the weaker Euro area economies can withstand higher rates. China also raised short term rates, and India remains vigilant and in a tightening mode.
The European debt situation continues to be underreported by the mainstream media, with Greek two year yields rising to a startling 23% in April after Eurostat announced that they had (once again) miscalculated the Greek budget deficit, now making it out to be 10.5% of GDP instead of 9.6%. Safer German "bunds" stayed at 2%. The markets are effectively pricing in a default for Greece, and the paper of Portugal and Ireland is also in limbo.
More troubling were comments by former Irish PM Brian Lenihan to the BBC about the nearly complete lack of accountability of the ECB, who ran roughshod over Irish officials and made damaging and untrue statements to the press in an effort to accelerate Irish capitulation. Titled "Bailout Boys Come To Dublin", the recently broadcast BBC special explores the events surrounding last year's meltdown in Ireland. Dan O'Brian, economics editor of the Irish Times, commented "...if the things Lenihan had to say about the ECB are true - and many of them are almost certainly true - they raise serious and worrying questions about how the bank exercises its power and the very limited checks and balances to which it is subject...It is abundantly clear that the bank believes it should act quickly, decisively and without much consultation with other actors, including national governments, if it decides the wider European interest is best-protected by bringing countries into bailouts". The same criticism has been leveled in the U.S. at the Treasury and Fed's handling of Lehman Brothers, Merrill Lynch etc., and at the FDIC during scores of forced bank closures. This is taking it to a whole new level, though, when national sovereignty is impugned. No wonder that the True Finns took a majority of Finland's legislature in their election this month, and that far right politicians like Marin LePen in France and Gert Wilders in the Netherlands are riding high in the polls. Our sense is that Europeans are fed up with bailouts and bankers manipulating the system to their advantage. The tin ear of central bankers in both Europe and the U.S. is going to have to be attuned more closely to receive and respond to the needs of the average worker, or a more divisive approach will be pursued.
Also in Europe last month, the first ever meeting of the European Systemic Risk Board (ESRB) was held, vice-chaired by Mervyn King, head of the Bank of England. (The ESRB is their "super-watchdog" of the various financial regulatory bodies within the EU.) His comments were insightful, pointing out the range of risks that are still present in the EU, including off-balance sheet and derivatives risks, the shadow banking system, regulatory capture by entrenched financial interests, the threat of rising interest rates to an already enormous debt service load, and the large regulatory disparities between bank and non-bank financial institutions. He also advised the EU to prepare in advance for the upcoming release in June of the "revised" European bank stress tests, saying that governments needed to be ready to act "immediately" once the assessments are made public, implying an unwelcome reaction by market participants. (Who is going to step in and inject more money into some of these technically insolvent banks anyway? Only the governments can keep them afloat.) Perhaps Mr. King knows something we don't?
In Asia, China continued to pursue its goal of moving the renminbi to a global reserve currency status by authorizing offshore deposits and trading in Singapore. It will now be possible for both Chinese people and foreigners to facilitate cross border payments (especially among large multi-national corporations) by simply opening an account in Singapore. We think this is one of those "off the radar" items that is part and parcel of the coming currency realignment that investors must prepare for.
Thank you again for reading our Journal and we'll report back to you again next month.
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