We believe the economy is recovering, albeit at a pace that is below trend relative to prior recoveries.
This is due principally to slow private-sector lending and recent tax-raising initiatives that will temper capital spending and employment growth.
The slack in the economy will remain, inflation will not be an issue despite the massive fiscal deficits, remaining housing excesses will be slow to be removed and the Federal Reserve’s accommodating policy stance will remain in place. When pundits cry about the lack of economic recovery, our response is: “Be careful what you wish for”. Rising interest rates in response to a vigorous recovery will mark the end of the market rally as higher interest rates and the real economy attract capital away from equities.
Despite the Fed creating vast amounts of liquidity, banks are impeding the flow of money to consumers and businesses by holding onto their funds to rebuild their balance sheets and increase capital. Without an increase in lending, firms are unable to hire new workers and expand production. With consumers, the same holds true with spending.
This trend continues as the reported loans, mortgages and related investments for many of the major banks declined during Q4. The Fed can print all the money it wants, but if liquidity is not finding its way into businesses and consumers, the recovery will lack vigour while allowing inflation to stay low. Banks are happy to accept a world where they can ‘borrow short and invest long’, but while there is a lot of ‘borrowing short’ going on, there is a dearth of lending as banks buy treasury and agency bonds as they focus on rebuilding balance sheets.
Our focus remains on companies ‘wisely contracting’, remaining disciplined in their capital expenditures and headcount growth and staying ahead of their peers doing so. Continued profit-margin expansion and more rapid asset turns will allow these companies to maintain the positive momentum in their returns on capital and related stock returns.
In addition, we are focused on those ‘wealth creators’ with business models that can power through the macro environment by expanding market share and their global sales presence, many of which can be classified as ‘Nifty-Fifty’ type stocks. We believe this will provide the right formula for delivering strong risk-adjusted returns during 2010.
James Abate is manager of the PSigma American Growth fund
