“Stocks up 12%, best quarterly start since 1998.” Now, that is a headline to be grateful for. The market has confounded the pessimism of most of 2011 with a great start. The Dow is up 8.14%ytd and the NASDAQ is up a whopping 18.67%ytd.
Now what? Well, it will never be easy. You can expect that the political events leading to the presidential election of 2012 are going to be very tough for the market.
The reality is that it is ALWAYS tough. This is the market that we have and this will be the world that we live in for the next cycle. It is an environment filled with great fiscal challenges in the US and Europe. The path toward US fiscal stability is the key. The guidelines of the Bowles-Simpson commission may be a true and viable solution that will ultimately guide the cuts and tax policy that we need in this country to regain fiscal stability. See http://www.taxpolicycenter.org/taxtopics/Bowles_Simpson_Brief.cfm for the details.
The debt negotiations are going to be very difficult. With all the fossilized elements of favoritism in the US tax code, there are many who believe that we are simply going to fall off a “Fiscal Cliff” and descend into a period of decline for the United States. This dark vision of failure is something that has been predicted in various ways for our country since the birth of the United States.
The proposition of decline of the USA has always been a losing gambit. It is always easiest to worry and see all that can go wrong. Let’s update the list of negatives…
Euro crisis (Greece seems to be of less interest to the market)
Iran nuclear ambition
$15t US federal debt
Continuing decline in US single family home prices
China slowdown
Afghanistan
Structural unemployment challenge in US and globally
The list could go on for many pages. History is filled with terrible events and challenges that somehow are overcome. The decline of home values in the US is a prime example. Many have lost homes and great amounts of wealth.
When you look at the trends of acceleration in home prices from 2002-2007, the rate of appreciation was obviously not sustainable. The housing market has placed a brutal beating on those that entered the market late, or took on aggressive loans and leverage. We are now beginning to see signs of stabilization.
As the ratio of owning versus renting swings back more near to equilibrium, it seems easy to predict that there will be many millions of people that will want to own US residential real estate. A sure sign of this is the frequent discussions of how it is better to rent than own. Higher demand for apartments drives up price relative to supply and ownership is trending back to more of a favorable option for many potential buyers.
It seems reasonable to predict that in the middle and long run many people will chose to settle in the USA.
The positive path of improvement of living standards is hard to perceive as we muddle through the challenges of the times that we live in. Study the history of the 1960s in the United States you will see the tragic assassination of President Kennedy, Race Riots and the Vietnam War as some watershed events that seemed to be grim and hopeless at the time. And yet we have made great progress as a country since then.
I think that it is most illuminating to study history as we look at today’s problems to see that this too shall somehow pass. When is the last time that you thought about Vietnam or heard anyone speak of it? It is a very sad commentary that all of those soldiers and civilians and their families who were harmed are paid very little of the attention that they most certainly deserve.
In my view the biggest trend that is not often grabbing headlines is that of the natural gas boom in the US sparked by huge leaps in natural gas production technology.
At a recent conference conducted by the Wall Street Journal (http://economics.wsj.com/program ) former governor of Pennsylvania Ed Rendell said this about Natural Gas, “Just to give you one idea of the scope of this, in 2007 we had requests for 71 permits for Marcellus Shale Drilling in Pennsylvania. In my last year as governor, 2010, we had more that 3,000 requests for permits.”
Natural gas prices are lower than they have been since the 1990s. Gas prices have been one of the big headlines for Q1 2012. Rising gasoline prices to be precise. The impact on the American driver has become a frequent segment on the nightly news and throughout the mainstream and financial media complex. This is of course a serious and troubling development.
The drag on consumer spending and behavior that is created by rapidly rising gasoline prices is a constant threat to the United States economy. The recovery that is so very fragile after the financial crisis of 2007-09 could surely be impacted by this gasoline threat. There is a popular theory that the Presidential election of 2012 may be swayed by high gas prices. Newt Gingrich has even created a logo that features $2.50 gasoline as a tool in his languishing Republican Primary effort.
The bigger picture that I see is much less foreboding. There is a shortage of storage space for natural gas in the USA. The price of Natural Gas continues to trend lower. The potential economic impact of a transition away from imported oil for gasoline refining is beginning to take root. The economic impact of this trend could be bigger that anyone imagines now. The energy revolution of the 21st century is in a very early stage.
What would the United States look like without the massive outflow of capital for the seemingly endless demand for imported energy? The dream of American energy independence is far from impossible. The opportunities for innovative natural gas and renewable energy companies in the extraction, transportation, environmental and manufacturing among many other industries are colossal.
This opportunity was noted in the Wall Street Journal on March 27,2012 page B1 in the article, “Steel Finds Shales Sweet Spot”. The article notes how steel tubing production has been escalating to satisfy demand (partly driven by the surge in natural gas production), while the decline in Natural Gas prices has been a benefit to the production cost of steel. The above mentioned article also included data on the huge differential of prices of Natural Gas in the USA versus Europe, the Middle East and many other parts of the world. This dynamic has begun attracting manufacturing companies that see a huge advantage to locate in the USA.
The twin Meta trends of rapid expansion of computing power and energy innovation along with a structural change in the energy equation in the United States is a paradigm shift for investors.
What could be the impacts of these dynamics?
Potential GDP Growth Expansion
Population Growth
Resumption of world economic leadership by USA
Change in the Equation of the US Federal Debt and perpetual budget deficits.
A longer view
The great keystone of successful investing is that we must brace against the temptation to change course based on perception of short term changes, whether they are booms or panics. 2012 has started off with one of the best first quarters in the equity markets since the early nineties. We can all be grateful for these gains.
I continue to focus on the big picture and the notion that there will be sweeping changes in tech, energy, food production and many other areas that continue to increase living standards and economic opportunity.
This optimistic view must be tempered by the reality that this country and the world face massive challenges that will cause hardship, market disruptions and create great pressure to seek an easier way. Proper long term investing will never be easy. It will always present difficult choices that will lead us to flawed conclusions.
The last ten years have been some of the most difficult for investors. Hundreds of billions have been lost. Massive amounts of money have been sold out of stocks, real estate and other equity instruments. There have been many predictions of a new world, laboring under a burden of the debts that have run up over that last few decades, that will grow very slowly or even go into a era shrinking economic opportunity and living standards.
Even in light of the big move up that has been made recently the market environment now is very pessimistic. We have many challenges coming very soon. The Presidential election will focus the public attention on debt, spending cuts and the health care crisis that is not going away any time soon.
The political reality is such that is seems almost impossible for politicians to have the courage to tell the American Citizen the truth about what changes and sacrifices must be made. I am hopeful that the sheer mathematics of our budget over-reach will force an honest process of addressing the problem as a great modern day challenge. Surely if we could change the history of the world during WWII, cure polio, and go to the moon, we can adjust our budget.
All the pessimism makes me more optimistic. There are many doom and gloomers that have yet to capitulate to the reality that the world is not ending any time soon. Get ready for a tough year…tough and long-term minded is what we always need to be to be good investors.