Market ReviewSubmitted by Karstens Investments on May 3rd, 2016
By Michael D. Karstens, CFP®, AIFA®
The first quarter of the year was a volatile one for stocks. After posting sharp losses the first several weeks of the year, the market bottomed on February 11th and rallied sharply for the rest of the quarter. Large U.S. stocks actually posted gains for the quarter led by the Dow Jones Industrial Average, up 2.20 percent, and the S&P 500, up 1.35 percent. Small cap stocks and technology stocks also rallied sharply, but still posted modest losses for the quarter with the NASDAQ off 2.75 percent, and the small cap Russell 2000 down 1.52 percent.
Over the past several years, many financial people – including ourselves – have warned of massive government debt, money printing, runaway entitlements and the potential consequences of such policies. Recently, social media has been abuzz with a video by economist James Dale Davidson. I had not heard of Mr. Davidson before, but did take the time to watch the video. Aside from promoting his book and “how to prosper from the economic collapse” paper, the video raised some very interesting points. One thesis was that the stock and real estate markets were very extended and poised for 40 percent plus declines. His main point, however, was that the enormous government debt would end in economic ruin. I found his supporting charts in regards to margin debt, government debt, unfunded liabilities, etc. to be in line and accurate with similar charts that I have seen from various other sources. All in all, he made a very compelling argument regarding some of the issues we face. You can find the video in its entirety by googling “James Dale Davidson video.” I share this with you because it is a familiar theme that we hear from a majority of our clients. Hardly a day goes by that we don’t have a client share their fears about the current state of politics, the massive government debt, government money printing, massive entitlements, etc. These are legitimate worries and we share most of them. In this month’s Words of Wisdom, I share quotes of some of the greatest financial minds of our time that echo these concerns. So with that, I would pose a question – what if these problems don’t have dire consequences as many predict, but somewhat more manageable consequences?
I remember coming across an article in the early 80’s that was written by Warren Buffett’s father, Howard Buffett, in the 40’s. In the article, he warned of excessive government spending, mostly due to war, and the inflation it would likely cause. Since then, the dollar has lost over 90 percent of its value and prices have skyrocketed. Despite this, the standard of living for most Americans is much higher today and we have not only survived, but thrived. In another example, many of you will remember the name David Stockman. Mr. Stockman was President Reagan’s budget director. After President Reagan left office, Stockman wrote a book on the coming government debt collapse. Obviously, Mr. Stockman was a very smart man, yet the mountain of debt that concerned him at the time has grown many times over since he wrote his book 25 years ago. And once again, most would argue that the standard of living today is higher than it was 25 years ago.
Lastly, I recently came across a piece by James Montier titled, “Market Macro Myths: Debts, Deficits and Delusions.” The entire article can be found at www.gmo.com. In the article, Mr. Montier makes the argument that many of the fears that I mentioned earlier are not as concerning as most people think, and in many ways are myths.
He cites five specific myths:
Myth 1: Governments are like households.
Myth 2: Printing money to finance budget deficits is inflationary.
Myth 3: Budget deficits and high debt lead to high interest rates.
Myth 4: Budget deficits are unsustainable.
Myth 5: Debt is a burden on future generations.
I must admit that most of the thinking in his paper ran contrary to many of our long held beliefs. With that said, GMO is a very highly regarded firm that I have followed for many years. I have found their research and predictions to be as accurate as anyone, and the arguments made in this piece are supported by very detailed research. At the very least, it’s a contrary take on an area that many people have placed great fears. If Montier is correct, maybe our greatest concerns are somewhat overblown.
Investment conclusion: one cannot rule out massive potential problems from current government deficits, money printing, government intervention, etc. We believe it makes sense to have some cash and high quality bonds, should massive debts (and high stock and real estate values) lead to some type of severe economic downturn. On the flip side, real estate, gold, oil and natural resources may give us protection, should money printing turn into inflation as many believe it will. Lastly, quality stocks, both domestic and international, have proven to be great ways to build and maintain wealth over long periods of time. In short, it seems dangerous to bet everything on a pending collapse or a theory that all debts need not cause worry. •