To begin, gratitude and thanks from everyone at BSW to our clients and colleagues; we thank you for 2011’s success and we wish you health, happiness, and good tidings in 2012. It is our privilege to work with such outstanding people.
This portfolio commentary and outlook is being posted from Furano, Japan, a small town in center of Japan’s northernmost island of Hokkaido. As many BSW clients know, my wife is from Japan and we visit her family during each New Year’s holiday. Residing here yields a very in unique perspective on the global economy and investment markets for several reasons. First, Japan is still mired in an economic malaise that began in 1990 following a massive real estate bubble. These so-called “lost decades” offer keen parallels to post-real estate bubble dynamics in the United States. Second, Hokkaido is becoming a global skiing destination and now attracts visitors from around the world. My wife spends the winter here working as a backcountry skiing guide for Hokkaido Powder Guides and, in that context, I have the opportunity to meet and speak with her clients, who are generally business owners and corporate executives from Australia, Canada, China, Europe, Japan, New Zealand, and Russia.
Finally, as clearly evidenced by 2011 dynamics, investment markets are increasingly driven by global, macro-economic themes (for example, the European debt drama) that are, unfortunately, given short shrift by the US media in favor of inane, paparazzi-like coverage of the Iowa caucuses or, even worse, the Penn State football program.
Looking back on 2011, it would be very easy to assume that is was a grim year for investors. The year was beset by challenges, both in terms of number and magnitude, including:
- The massive earthquake/tsunami/nuclear disaster in the world’s third largest economy (Japan) that killed more than 19,000 people and wiped entire towns out of existence.
- The ongoing sovereign debt crisis that not only plagues Europe but also now threatens the United States, as evidenced by the US debt ceiling debacle and the US credit downgrade.
- Growing civic unrest around the world, from the Arab Spring in Tunisia, Egypt, Yemen, and Libya; to the Occupy movement in the United States; riots in the UK in August; violent austerity protests in Greece and southern Europe; massive demonstrations in Russia; and more than 100,000 different demonstrations in . . . China (yes, communist China).
- Persistent volatility in investment markets leading to an astonishing 69 days in which 90% of S&P 500 stocks moved in the same direction, more than the total of such days in 2008 and 2009 combined.
- Widespread failures of political leadership and process in the US and Europe leading to, for instance, the lowest US Congressional approval ratings and the second lowest consumer sentiment readings ever recorded. The US deficit is now $13 trillion with no meaningful reduction in sight. (Aside: For an amusing summary of Federal spending folly, please visit the 2011 Waste Book – true gallows humor reading!).
Despite all this, the global economy seemingly muddled through – and obscured some persistently good data from the US, that I will discuss below. While the European debt crisis and the tragedy in Japan combined to sink international markets (EAFE down 12 percent), and uncertainty about Obamacare and taxes hurt US small companies (Russell 2000 down 4 percent), large cap US companies managed to eke out a small gain (S&P 500 up 2%) and continued to benefit, via strong earnings, from their “right-sizing” following the 2008 correction.
Although the global economy is far from out of the woods, as I have discussed in prior blog posts, I am a dedicated rational-optimist. Bad news sells, so it seems that is all we get from the media. But the negatives of 2011 drowned out some compelling data for astute investors, especially regarding the US. First, the fourth quarter of 2011 was the ninth consecutive quarter of US economic growth. In fact, US economic growth actually accelerated during each subsequent quarter of 2011.
Second, the US has now had 21 consecutive months of private sector job gains. As context, the US lost 8.8 million jobs during following the great recession of 2008. We have now recovered 3.3 million of those jobs. Although US unemployment will likely remain higher than its historical level, these job gains point to underlying growth and demand rather than continued demise. Finally, US consumer sentiment has now recovered from its lows following the Congressional Debt Ceiling drama and consumer spending is making relatively small but directionally important gains.
Looking abroad, European leaders will, ultimately, act to save the Euro via more fiscal integration – though Greece will probably get kicked out eventually. In the long run, the forced austerity measures will be beneficial to Europe by reducing bureaucracy and forcing a disgorgement of subsidized industries. In the emerging world, softening raw materials prices are reducing the risk of a hard landing of the Chinese economy, but China’s real estate bubble remains a true sword of Damocles for the global economy. Nearly 25 percent of all investment in China is linked to real estate – their own version of a real estate bubble that was largely created by tying the Yuan’s exchange rate to the US dollar.
The skidding of the Chinese economy has been evident here in Hokkaido, as the number of Chinese visitors has decreased dramatically. The ripple effects of this are also seen via Hokkaido’s Australian presence, as Australia is the primary supplier of China’s raw material binge. In the ski village of Niseko, where the Japanese joke that they now need an Australian visa to enter, property prices have stalled or collapsed, and there is a palpable, yet unspoken sense of tension. As the “Saudi Arabia of Rocks” (my new expression), Australia is essentially just a mining boom-bust town with a national anthem.
In a nutshell, I am rationally-optimistic for investment markets in 2012. Indeed, a few factors may conspire to bolster a Goldilocks scenario for US investors over the coming years. Shale gas and fracking have the potential to meet US energy demands, reinvigorate the auto industry, and wean the US off it foreign oil dependency – but it must be done responsibly. US industry and manufacturing is strong and poised for a renaissance. Here, the media confuses US industrial employment with industrial output. Consider that US factories now produce double what they did in the 1970s – but with far fewer (highly skilled) employees. And, as the Chinese Yuan appreciates, the Chinese labor arbitrage in manufacturing becomes less and less competitive versus their American peers.
Finally, 2012 is an election year in the US, which generally means nothing gets accomplished politically. Again, being in Japan offers up an interesting perspective. In September 2011, Yoshihko Noda became Japan’s prime minister, the 7th prime minister in the past 5 years. The country ‘s one-party dominance and squabbling, do-nothing politicians have starved initiative and squandered countless opportunities to revive the moribund economy and eliminate wasteful bureaucracy. Japanese people are incredibly, remarkably, and awe-inspiringly polite and nice – perhaps too nice. They should be marching on the Japanese Diet to tar and feather the whole lot. Alternatively, Americans pride themselves on a rugged individualism and a distrust of government. Hopefully those factors manifest themselves in strong election year demands of real change and decisive bi-partisan action to address our collective challenges – the remaining roadblock to renewed and sustained US economic growth and prosperity.
We hope this Portfolio Commentary provides you with better insight into the components of your growth equity portfolios and our 2012 economic and investment outlook. If you would like to discuss these positions or your portfolio in greater detail, please don’t hesitate to contact BSW. As always, we are happy to help.