The financial markets can be easily characterized by a renewed optimism that the election will be bring an awaited change within the political landscape. However, this change may not bear much fruit due to the structural behavioral changes of the consumer and small businesses. There is no doubt the stock markets recent surge to new intermediate highs since April has been primarily on the anticipation the FOMC will initiate another round of quantitative easing (QE) as soon as next week. The problem is the Fed is signaling the economy is getting WORSE not better. The speculative nature of the stock market is troubling, and the instability of the US economy should not be taken lightly. This same complacency was present in 2007 before the real financial problems reared their ugly heads.
One of the most crucial aspects of the current downturn in the economy since last spring, is nearly 75% of GDP growth has come from inventory build-up. In the 3rd quarter, GDP was 2.0%, in which 1.45% came from inventories. The average consumer is currently dealing with foreclosures, decreasing property values, decreasing net incomes, and job uncertainty. Consumer savings rates have increased dramatically since 2009, and overall consumer spending is less than it is was prior to the economic meltdown of 2008. Consumer confidence, measured by the Conference Board, is currently at 50, which is well below the normal 105 reading during economic expansions. Moreover, consumer confidence averages 75 during the low-point of economic recessions. With an unemployment rate at nearly 10%, the consumer which traditionally makes up 75% of economic activity needs to be rejuvenated in order for future economic activity to be sustained.
Our main concern is the health of the consumer going forward. No one can deny that corporate profits have been impressive so far this year, but these percentage profit increases have come off of extremely low levels. Now that most companies have replenished their inventories, the consumer will have to come alive in order for future sales and profits to keep up with current market valuations. The market is pricing in perfection, which we see is unrealistic in the short-term.
To conclude, the election may bring some renewed hope that taxes will not increase, and consumers may become somewhat more confident. Though, with stock market valuations at five year highs and investor's confidence reading above 70%, we are cautious going into the end of the year. Our portfolio is up nearly 10% for the year, well within our target range of 8-12% annually. We still believe it is prudent to protect the portfolio from the present downside risks, and be in a position to secure positive gains for the remainder of the year. Once we see the outcome of the election, the overall performance of the economy after the holiday season, and the direction of the taxes, we will be in a much better position to take more calculated risk in 2011.
