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Investment Update from Hutchens Investment Management
The recent run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a short-term technical correction.
“IF YOU SEE A FORK IN THE ROAD…TAKE IT”
-- Yogi Berra, Philosopher
Nothing states the actions of our government any clearer than the Yog’s statement, according to David Minor of Hutchens Investment Management. The path chosen by the Obama Administration is clearly income redistribution and increasing government involvement in the US macro-economy and individual lives. Promoting this agenda during the financial crisis enabled the government to increase regulation, punish financial institutions, reward unions, and protect public employees.
We also witnessed an intrusion into the housing sector that slowed recovery and failed stimuli that will burden future generations. Meanwhile, there has been no serious attempt to curtail runaway spending. To date, only government discretionary spending, not entitlements, has been marginally cut by Congress (only growth rates not in absolute terms.) As we approach “crunch time” in late February, the President and the Congress, like our European Socialist cohorts, will most likely kick the can down the road until the next financial crisis.
With an electorate comprised of less than 50% paying income taxes and a Congress only concerned about reelection, there is justification to be less ebullient on the outlook for stocks. The economy is barely moving forward, unemployment is high with an increasing secular structure, and many believe the consumer is about to retrench as he is once again overextended. In light of these perceived negatives, the stock market has moved up dramatically since March 2009. Bond market participants, thanks to a number of QE’s, have enjoyed unfathomable principal appreciation. Given the current picture of “muddle through” growth, why should anyone be aggressive on equities over the next few years?
Firstly, the private sector has not been overwhelmed by the public sector. In fact, since the financial crisis, the private sector, with its free market tools, has deleveraged, bottomed, and may be about to renew its historic growth levels. Secondly, as hard as the Administration pushed for the public sector; state and local and federal government’s artificially induced unproductive growth has stopped or declined. More interestingly, unions, Obama’s most favored special interest group, are rapidly losing members and political influence. Thirdly, in an economy where close to 70% of GDP is determined by consumers, self-interest continues to gain momentum. We have been watching for the past three years a revived consumer sector that most economists and market strategists claimed could not continue their spending patterns, much less increase them.
So the other fork in the road is led by the consumer, whose spending remains unimpeded by government intervention. This is the path that leads to the end of the financial crisis overhang and a start of a new cycle for equities as the economy without the Fed, grows in nominal terms (real plus inflation) closer to historic cyclical norms. Consumers have repaired their balance sheet, stock portfolios gained, equity returned to their homes, and most importantly came to realize that individual self-determination outweighs government intervention. Corporate financial strength, a better global economy, and rising house prices will be the catalyst to spur private investment. Taking the other path with a President whose agenda prioritizes immigration reform, gun control, gay rights, and climate change there is not much to be hopeful for the economy from this Administration. One fork leads to political stagnation and the other to economic growth.
As usual, analysts have once again misjudged quarterly earnings. This is particularly true for revenues, which by most accounts were forecast to decline absolutely from year ago levels. Earnings were estimated to be flat or slightly down. According to the Bespoke Investment Group, as of early February 63% of companies have beaten estimated revenues and 64% earnings. Arguing that the estimates reflect sharply lowered corporate earnings, our data show that dollar earnings are 6% over a year ago. Breaking out the major sectors Bespoke finds Technology has the highest beat rate at 72%, followed by Consumer Staples (69%), Healthcare (68%), Industrials (65%) and Consumer Discretionary (64%). Technology handily beats on revenues (68%), second only to Healthcare (71%).
Our investment strategy is a full position in equities. The recent run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a short-term technical correction. But in the longer-term this is inconsequential as growth with a dose of inflation will be the ultimate catalyst for a sustainable bull market.