As we had indicated a few weeks ago, investors should turn off the political news related to the debt ceiling debate, and we now encourage investors to stay the course with their investment strategy, despite the media’s attempt to amplify yet another containable crisis.
When we first published
our report suggesting that there was no cause for worry about the debt-ceiling deadline, we received quite a number of questions about how we could be so confident. Well, first of all, there is a degree of common sense: 1) the President could take it upon himself to invoke the use of the fourteenth amendment, which indicates that the US must make good on all of its debts and 2) politicians had already lived through the mistakes of Lehman and the failure to pass TARP on the first try. The likelihood of the US defaulting was practically zero on this basic information, despite the media’s over-attention paid to this topic. Anyway, articles suggesting that the US could default do make good headlines.Now that we’ve passed the debt-ceiling deadline unscathed (not exactly, we’ll get back to this in a bit), the media has latched on to the situation in the Eurozone yet again. Granted, Europe seems to be in worse shape than the US, and certainly Italy and Spain could use some shoring up in credit quality (perhaps an understatement), but we’re not talking about the potential for a global catastrophe here. But even if we felt some pain, this is NOT 2008! The US banking system, while intertwined with that of Europe, has largely cleansed itself and their capital ratios are on much better footing. And even if the US banks start to feel sympathy pain from an inconceivable global calamity, stay away from them. Nobody is forcing you to own financials. In fact, our financials exposure in our Best Ideas portfolio is a goose egg. If the markets come to reflect the fear of the unknown and start to fall, sit tight; we will recover.
Now to get back to what the politicians did do by taking the debt ceiling debate down to the wire. First, it’s without a doubt that corporate expansion hit the pause button for those two weeks in late July as Congress tried to discover reason – comments from CEOs from Emerson Electric (EMR), “Washington is arranging the chairs on the Titanic,” and Caterpillar (CAT), “lack of clarity on US deficit reduction,” only support this view. So, when July data starts coming in, don’t be surprised to see some weakness – in fact, look at the ISM New Order Index (under 50%–indicating contraction–for the first time since June of 2009). However, order growth at General Electric (GE), United Tech (UTX), and a variety of other industrials was phenomenal in the second quarter. We suspect orders were still on a breakneck pace before the media got a hold of the debt-ceiling story, and we suspect they will resume once the media gets its attention off of Europe. And how can it possibly be 2008 all over again when we’re seeing such strong reports out of General Motors (GM) and AIG (AIG) – two firms that the government had to bailout during the crisis?
Could the market just be looking for something to worry about? It’s certainly possible. But we do have one long-term concern. With the cuts Congress must make in the years ahead, the domestic equity markets now finally are left to fare for themselves, in our opinion. Will the US ever see another bailout? Probably not, even if it needs one. It seems like keeping the US debt down now is the only thing that matters, even if it may mean we must forgo another stimulus package. We can only hope that budget surpluses and deficits continue, and we view a manageable national debt as critical to a prosperous domestic economy and, for all intents and purposes, harmless. And what should investors think of S&P’s downgrade of the US’ credit rating. Not much. If the US encounters any problems with its debt, it can print money. Granted, this would cause inflation, but the US can’t conceivably default – it can very easily inflate away any debt. Good for equity holders, bad for bondholders.
All told, we were impressed with second-quarter corporate earnings and look to an equally strong, if not stronger, back half of the year and 2012. We think the markets continue to search for fear, which over a three to five year timeframe, will have an irrelevant impact on equity performance. The markets had almost fully recovered from the Lehman debacle prior to this correction, and we are confident we will once again set new highs with the S&P 500 again. Stay the course.