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Mid-Year Commentary

I recently visited a long-time client at his office. We discussed his portfolio, specific investments, the market and economy in general. After I explained my optimistic outlook for the financial markets and the economy, he gave me a quizzical look and asked “But aren’t you worried about what is going on in Washington?” Great question. My answer was “Indeed I am!”

As we come to the mid-point of 2010 and just enjoyed our country’s July 4th celebration, I can’t help but wonder what our Founding Fathers would think about our government’s attempted involvement in seemingly every aspect of our lives. I couldn’t escape the irony of celebrating Independence Day while there is a growing grassroots movement to gain independence from our own government and its intrusion into our lives.

Let me be clear at the outset that this is no partisan rant. There is plenty of blame to go around on both sides of the aisle and in all of the corridors of power in Washington for the current state of affairs. I am simply opposed to “Big Government.” If my memory serves, so too were our Founding Fathers. I believe in free markets and Adam Smith’s “Invisible Hand.” In short, I believe in a laissez faire system of government, where economies function most efficiently when they are not encumbered by government regulation. Unfortunately, I fear we have veered strongly and swiftly in the opposite direction. My hope and belief is that Middle America is ready to take our country back. While you won’t hear much about this in the mainstream media, you will hear it in conversations at the barber shop and in the grocery store. What began as gentle rumblings are now growing louder and will likely be heard in voting booths later this year. The predominant theme seems to be “throw the bums out!”—and this is no partisan cheer. I think they mean ALL the bums.

In a recent interview on Bloomberg Television, Mike Holland, a well-known money manager and founder of the investment firm Holland & Company, noted that there was “a shortage of adults in power in Washington.” While one could easily dismiss such a comment as flippant and “good TV,” upon reflection one might be forced to take it seriously. As if on cue and to prove his point, shortly after Holland made the statement, one of the most recognizable elected officials in our nation’s capitol stated that “one of the most powerful tools we have to create jobs is to send out unemployment checks.” Seriously. I’m not joking.

That nonsensical comment led Scott Grannis, former Chief Economist at Western Asset Management, to post the following on his blog:

“…most of the great economic tragedies can be traced back directly to misguided policies and an utter lack of understanding on the part of politicians of how businesses and economies actually work.” Grannis goes on to say “The amount of pain, suffering and economic losses incurred by hundreds of millions, if not billions, of people around the world, due solely to the policy prescriptions of ignorant and arrogant politicians, is almost incalculable.”

Granted, those are strong words, but it would be wise for us to listen. While we have enjoyed a significant rebound in markets since March 2009, a heavy malaise seems to have retaken our country over the past couple of months. Economic news has turned a bit weaker and sentiment has turned very negative. Confidence is not running high in the minds of most Americans at the moment. We have lost confidence that our economy is improving and that, I believe, emanates from having lost confidence in our leaders.

A sense of optimism will return when our political leaders start acting like adults. A sense of optimism will return when corporations begin reporting strong earnings this quarter. A sense of optimism will return because, in America, it always does! We are a resourceful, resilient and productive nation that will soon resume our position of leadership in the world despite current difficulties. We have survived much worse and come out stronger than before. I have little doubt that we can and will do it again.

Call me Pollyanna, call me a flag-waver, call me what you will…but I am optimistic about the future of our economy and the market. This current bout of negative market sentiment has pushed equities to levels I define as undervalued. Current earnings estimates for the S&P 500 range from $90-$95. Consequently, the index is trading at 10.9-11.5 times earnings. Modest valuations combined with a recovering domestic economy and continued strength in emerging market economies around the world should lead to positive returns for the stock market during the second half of this year.

This nascent economic recovery will continue in fits and starts. High unemployment will likely remain a fly in the ointment, but the unemployment rate is a lagging economic indicator. The trend is improving and I believe it will continue to move in a positive, albeit slow, direction. China’s economy will continue to grow at a rapid pace, which bodes well for the global economy. Markets recently slid on news that some were forecasting China’s GDP growth would cool—from 11.5% to 9% or 10%! That is phenomenal growth by any definition. As standards of living rise around the developing world, consumption increases and economies blossom. The United States, its economy and markets will be direct beneficiaries.

So, despite our problems and our differences, let’s continue to celebrate our great country and our freedom. Let’s regain our place among the leaders of the free world. Let’s tell our elected officials how we feel—let’s not let them dictate how we feel. And finally, as the glow of the fireworks of this past July 4th weekend slowly fade, let’s not forget the sacrifice of all the veterans who made this country what it is and can be.

I will close with another quote that I think speaks to us during times of pessimism and doubt:

“There is in the worst of fortune the best of chances for a happy change.” —Euripides