Portfolio strategy update

Editor’s Note: The following portfolio update is from David Gottstein’s monthly Dynamic Research Group’s newsletter. It was compiled Aug. 30.

CURRENT MARKET NEWS

The bull rages on

Never in history has a free market benefited from such a prolonged period of solid economic growth and wealth generation.

Year after year, the stock market continues to perform significantly better than the yields available in the bond market. In the olden days, you could count on having to suffer through one year of losses for every two years of gains.

However, stock and bond markets have greatly benefited from low inflation for almost two decades now. There’s been no real bear market in all that time. We agree with others who argue that October of 1987 was a bubble-bursting correction in a continuing bull market.

The forces at play in 1987 still exist today, and are exerting even greater positive influence. Moderate economic growth with low inflation was a new concept back then. However, the stability that low inflation and low interest rates bring became a platform from which the technology and information revolution took off. The efficiencies and productivity that were unleashed then, and which continue today, parallel the economic impact of the first steam power and the ensuing Industrial Revolution.

What does it mean for the stock market?

The economy continues to perform superbly, adding mid-teen levels of earnings gains once again, and with inflation still in check. In a defensive move, the Federal Reserve just raised the Fed Funds and discount rates by 25 percent. Things are so good, the idea is to slow the economy down, even before we’ve really have seen the whites of inflation’s eyes. The era of historic wealth generation continues unabated. Of course, along the way there will be excesses of greed in the stock market that will give way to rationality and then fear. We call these selling and buying opportunities.

What if......?

That’s not all bad. The Federal Reserve will use interest rates to govern economic strength when it reaches aberrant levels. At this point, 3 percent annual economic growth allows for 10 -to-15 percent annual earnings growth — enough at these price levels to give large cap investors a total annual return of 10 -to-12 percent.

The current valuation of the equity market is attractive to us, relative to bond yields. We are therefore lowering our cash position to 10 percent and investing 90 pecent in equities — until prices get excessive — or the low inflation strong/growth economic equation changes. Perhaps that might happen sometime next century.

It used to be that we took things from the ground to the factory, to the distribution center, to the store and then into mother’s car. Now we take it from the ground, to the factory, and then UPS or Federal Express delivers them.

Or at least it seems that way. Brick and mortar shopping still dwarfs e-commerce, but that may change. Can the old-line department stores still grow? The tough nut for home shopping has always been the delivery costs. Stores can’t afford to deliver just one hammer. On the other hand, if you joined a shipper’s club sponsored by Federal Express or UPS, they could bundle your purchases from various stores or websites and make logistically rational deliveries. The only things you would need to go out for are things you need within the next few days.

Perhaps this isn’t right around the corner. However, it is something to consider when you think either about how far our efficiency revolution can go, or when you want to purchase stock in a brick and mortar non-grocery retailer that doesn’t have a web strategy. Good luck this month.