We have the pleasure of spending quite a bit of time among the "1 percenters" - American families whose annual income exceeds $500K. Our favorite cocktail party question this summer is: "Given everything you've heard recently, do you think the stock market is up or down this year?" About a third of people estimate "down", the remainder estimate "up." We reply, "The answer is "Up. By what percentage do you thing the stock market has gained this year?" Most respondents, including Wall Street professionals, guess "low single digits?" The answer is: through August 7th, the S&P 500 is up 11.3% on the year and is within 0.8% of the 52 week high set April 3rd.
This exercise demonstrates once again that when it comes to investing decisions, "perception is more important than reality." At present, US investors perceive that investing in stocks is a sucker's game, but if they keep all their cash in money markets at 0.01%, they'll never be able to retire. More important to most Americans is that the value of privately owned businesses and real estate is still well below the records levels set prior to the financial crisis. So consumer confidence remains in the toilet. Business confidence, which includes the desire to hire more employees, isn't much better.
As a result, the US economy has entered yet another soft patch - still growing at 1.5%, but well below potential of around 3%. One bit of good news - housing construction and home prices clearly bottomed in the last year and are moving modestly higher.
Wall Street faceplants again!
In the last year, we've seen the Facebook Faceplant (down 37% from the IPO), MF Global's loss of $1.2 billion on EuroBond trades gone wrong, the LIBOR price fixing scandal, and the harpooning of the "London Whale," which cost JP Morgan Chase around $6 billion. In the latest debacle, Knight Capital, one of the largest market making US stock dealers, lost $440 million dollars as a rogue trading program aggressively bought shares for 30 minutes, which were sold at a loss later in the day.
This disaster had no impact on investors unless they happened to trade between 9:30 and 10:15 on August 1st. But the error reinforces the opinion of average Americans that the markets are out of control, and that the regulators have left the room. This is a totally reasonable conclusion. And the situation will only be turned around when average Americans call up their Senators and Congressmen and shout, 'I'M AS MAD AS HELL, AND I'M NOT GOING TO TAKE THIS ANYMORE!' Forget fines - Wall Street managers need to know that casually destroying other people's capital leads to jail time. Why do we send a teen to jail for 5 years for robbing a convenience store of $500 dollars, but are totally blasé when some Wall Street idiot blows $500 million or even $5 billion?
So we wait...
With three months to go to the US presidential election, governmental policy to boost the US economy is paralyzed. Obama gained about 1% over the last month in the polls relative to Romney in 12 "swing states." Obama would probably win if the election was held today. It is probable that the House of Representatives remains Republican in November, and the probability that the Senate remains Democratic increased in recent weeks, thought the odds still favor Republican control. The next critical moment for the US economy is when the current tax regime "sunsets" December 31st, 2012. There is no one in Washington prepared to negotiate a satisfactory compromise. Americans would trade a tax increase at this point for certainty about what rates will apply in 2013.
The US Federal Reserve is "out of bullets" at this point to boost economic output through monetary policy. The Europeans have made enough compromises in the last month to take their crisis off the headlines, but the situation is years from being resolved.
Overall, we rank the investment climate as "Yellow -Caution." Our investments in banks and commodity producers took a pounding April-June, but now are on the upswing. On a valuation basis, we feel comfortable remaining fully invested. Problem is, in the current environment, macro investing trumps value investing. As cash comes in, we are investing slowly, trying to take advantage of pull-backs