Most Popular ArticlesTemplate for a Mid-Year Letter to Clients
By Dan Richards*
June 23, 2009
June 23, 2009
Reasons for caution in the near term
In my conversations with clients over the past while, the number one question relates to the outlook for the period ahead and what we should be doing in our portfolios as a result.
Having said that the worst appears to be behind us doesn’t mean we won’t see continuing challenges in the economy and stock markets in the period ahead.
As I said at the outset of this note, I am in the category of “cautiously optimistic.” Here are some of the things that make me cautious – note that some of these will be positive in the mid- and long-term, but are problematic in the short-term.
- Consumer spending, which fuels 70% of demand in our economy, is hurting as a result of increased savings rates in response to declines in stock markets and house prices. Reducing consumer debt is positive long-term but limits growth prospects in the near-term.
- Our housing market is still a mess, with 20% of mortgages in the “upside-down” category, where the mortgage exceeds the value of the house. House prices do show signs of bottoming, but it will take some time for the housing market and government policies to work through this.
- Many of you have read about “deleveraging” by businesses and financial institutions. This is a fancy word for reducing debt – and while decreasing debt levels will increase stability and reduce pain in downturns, it will also lead to lower earnings than we saw in the past few years.
- Reduced balance sheet debt will hit the profits of many banks, which are also eliminating high risk operations. While this will result in fewer crises and lower volatility in their earnings, it also means that some of the sources of windfall profits from trading and capital market activities over the past decade will disappear going forward.
- With the global economy still operating well below capacity, in the near term many companies will struggle for revenue growth and will also be facing pressure on margins; this will inevitably hurt profitability.
- The government is funding stimulus spending with record issuance of new debt and budget deficits. At some point, this will have to be repaid – and also runs the risks of fuelling inflation down the road.
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