Maybe the Wind Isn't Blowing..
Willingdon Wealth Management
By Michael Kayes
October 8, 2012
I begin this edition of Willingdon Views with a tribute to a great American, Neil Armstrong, who passed away last month at the age of 82. The first man to walk on the moon was from Wapakoneta, a small town in west-central Ohio. Despite his fame and extraordinary accomplishments, Armstrong maintained his small-town values throughout his life. In a statement released shortly after his death his family referred to him as "a reluctant hero who always believed he was just doing his job." Makes one wonder what they'll say about us after we're gone...
The stock market has been on a roll, up more than 10% over the past four months. Record low interest rates, strong corporate earnings and cash flow, and the fact that many investors have been under weighted in stocks has fuelled this impressive rally. With the election only a month away, it seems a reasonable bet that the rally might continue.
Prudent investors are always trying to figure out what could happen to reverse the current trend... Based on the recent polls, it looks like President Obama will be re-elected.
While there are certainly many other questions, I think these are the most important ones from an economic and market perspective.
I have long said that the market would prefer a Republican sweep, but I think that is highly unlikely. So, we enter the final quarter of 2012 a bit cautious despite the impressive performance for stocks in the first nine months. All this begs the question - How can the market be rallying at the same time that Obama's lead in the polls seems to be growing? Is it perhaps possible that an Obama win could turn out to be positive for the economy as well as the market? Is that what this rally is forecasting? I guess that is possible since the stock market is in fact a discounting mechanism and valuations are largely driven by what investors expect will happen in the future. But for the life of me I can't see how an ever expanding government and unprecedented deficits will end up being good for our economy or country. I suspect we will find out in the not too distant future.
In the meantime, The Fed has launched another stimulative program, QE3, to the tune of $40 billion per month for as long as they feel it is necessary. In addition, it has reiterated its promise to keep interest rates low for years. The result of this, in the short run, is positive for stock prices as investors may shift some money out of bonds and into stocks.
However, in the long run, the problem in our economy is not that interest rates are too high. The low growth and stubbornly high unemployment are due to political uncertainty, out of control government spending, and increasing costs imposed on the private sector related to taxes, compliance, regulation, and entitlements. These are gale force headwinds, which the Fed can't fix.
Corporate earnings season begins in the next couple weeks, which will give us insight into the strength of the economy as year-end approaches. From a big picture perspective, companies with innovative products, effective cost control, and shareholder-friendly deployment of cash flow will likely deliver the best earnings performance. Moreover, these three key success factors should continue to drive relative performance into next year.
As such, our research efforts will continue to focus on identifying companies that have sustainable competitive advantages over their peer group in these important areas. In a slow growth, increasingly competitive global economy, introducing innovative new products, having a cost advantage, and utilizing cash flow to enhance shareholder value through increasing dividends and repurchasing shares, are all critical. It just so happens that many of these industry leaders are US multinationals. Our economy, despite its recent struggles, still leads the world. And if we do manage to get our financial house in order, America may continue to lead far into the future. America is forever hopeful, and I am thankful for that.
But if you are struggling to be hopeful, perhaps you might recall that incredible night back in July of 1969. It was a cloudless sky, the moon bright and bold, as my family watched the Apollo 11 crew's historic landing on the moon. As the Astronauts planted the American flag, I rushed outside and glanced skyward, prideful of being an American.
I yelled to my dad, "I can't see the flag."
To which he replied, "Maybe the wind isn't blowing."
Michael Kayes, CFA
(c) Willingdon Wealth Management
