In BSW Blog, Economic Outlook, Emerging Markets, Portfolio Commentary

Economic & Market Outlook:

Question: What is the fastest growing disease in the United States?

Here are some hints: it currently afflicts more then 25 million people; another 6 million people have it and don’t yet know; and one in three children born today will likely be afflicted during their lifetimes.  Here’s one more hint: generally this disease is completely preventable.

Answer: The fastest growing disease in the United States is Type-2 Diabetes.

Also called Adult-Onset Diabetes, Type-2 Diabetes is closely linked to obesity and the disease’s rise is paralleled by the growing obesity epidemic in the United States.  Nearly two out of every three Americans are now considered obese; and one out of every eight deaths in America is caused by an illness directly related to obesity.  More than $200 billion is already spent annually in the United States to treat Type 2 Diabetes, more than the annual spending on the Iraq and Afghanistan wars.  We are literally drowning in our own excess.

While the soaring costs and incidence of Type-2 Diabetes is alarming, it is also an eerie analog to the challenges facing the US economy – and their problematic solutions.  The primary causes of Type-2 Diabetes and obesity are poor diet and lack of exercise.  It results from bad choices, made over the course of years and decades.  Walk or drive?  Fast food or slow food?  Play sports or watch sports? Fries or fruit?  Likewise, the American economic crisis was long in the making and also a result of bad choices over the course of years and decades.  30-year fixed mortgage or an interest-only, optional payment, adjustable rate mortgage?  Cash or credit?  Save or spend?  Pay now or pay later?  In both situations, there are no “bad people” just simply choices, some better than others, but all with consequences.

Hooray for Colorado! Fittest state in the US!

There is no cure for Type-2 Diabetes.  No magic pill or pixie dust.  Instead, the key components of treatment and successful management of the disease are exercise, dietary changes, and weight loss.  It is not an easy road.  It is a slow, deliberate process that requires time, discipline, and behavioral modifications.  A more radical and unproven therapy involves gastric bypass, whereby the stomach is partitioned and the intestines rearranged.  It often results in rapid weight loss, but also poses significant dangers.

Similarly, there is no magic-bullet or quick fix for the US economic crisis caused by overconsumption, excessive leverage, and speculation.  Correcting these excesses will also require time, discipline, and behavioral modifications.  These include paying down debt, saving more and spending less, and retraining workers.  Neither is this an easy road.  Unfortunately, rather than own up to its condition, the US is opting instead for a radical and unproven therapy termed “quantitative easing.” Essentially the gastric-bypass of monetary policy, quantitative easing is just a fancy way to describe printing more and more money, which also poses significant dangers.

There are three key economic groups within the US: companies, consumers, and governments.  Two of the three, companies and consumers, have already begun the arduous process of retrenching.  Consumers are saving more and slowly paying down their debts, but they still have a long way to go.  Total consumer debt outstanding is still more than twice the level of a decade earlier.

Meanwhile companies, perhaps the most nimble of the three groups, have aggressively cleaned up their balance sheets and improved operating efficiencies.  As a result, corporate profits have rebounded strongly, while top-line revenues are also beginning to grow again.  Of the companies that have thus far reported their third quarter results, 142 companies in the S&P 500 have beaten estimates for both earnings AND revenues.

Although economic conditions are improving, discipline, patience, and fortitude are scarce virtues in Washington DC or on Wall Street.  Unemployment naggingly hovers at roughly 10 percent.  When underemployed or discouraged job seekers are included, that figure rises to 17 percent.  The general sense of alarm about current unemployment levels has also obscured the fact that a significant component of unemployment is structurally driven – both at the microeconomic/worker-level AND at the macroeconomic level.  There are more than 2 million unemployed construction workers and more than 750,000 unemployed former auto-industry workers; both industries which are very unlikely to return to their previous employment levels soon, if ever.  At the micro level, structural unemployment results from a mismatch of labor skills and employer needs.  In other words, there are too many workers used to pounding nails rather than pounding out lines of code.  At the macro level, our economy was (and is) too heavily weighted toward consumption rather than production.  Once again, the current predicament is a result of poor choices over time to “buy it (on credit), rather than build it.”

Unfortunately, no amount of quantitative easing, interest rate cuts, or dropping money out of helicopters can obviate the difficult and arduous process required to atone for our collective folly.  Instead, it is likely that the extraordinary measures of the Federal Reserve may simply soften the initial blow, but prolong the cost and duration of economic “dis-ease.”  As such, we believe credit and leverage will continue to contract as consumers continue to make more rational financial choices, leading to lower aggregate demand and a slower pace of domestic growth.  Consequently, we continue to favor the faster-growing emerging markets and multinationals with reach into those markets, companies with strong balance sheets and dependable earnings (such as consumer staples), and countries with commodities-based economies and strong currency fundamentals or significant competitive advantages (such as Australia, Canada, and Germany).

 

Summary:

We hope this Portfolio Commentary provides you with better insight into the components of your growth equity portfolios and our current 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.

-David Wolf, Chief Investment Officer

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