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Portfolio strategy update A schizophrenic market.
Editor’s Note: The following portfolio update is from David Gottstein’s monthly Dynamic Research Group’s newsletter. It was compiled in early January. Everything is good, then everything is bad, then everything is good again with the market at new highs.
Every new market poses new challenges. There are no two time periods that are just alike, as the world is never the same.
Laws of nature govern both physical and socio-economic behavior; thus, ultimately stock prices chase earnings.
The market is at new highs, despite the fact that earnings are off almost 10 percent from last year.
The “average” larger cap company’s earnings are flat, but when taken in aggregate, this universe of stocks is off a full year’s worth of growth. This means that the smaller companies in the group are outpacing the larger ones. Why is the market so high? Primarily because of three things: 1) interest rates have been trending downward; 2) the Federal Reserve and Treasury have growth strategies leading them to print huge sums of money and lower interest rates in order to liquefy the economy and; 3) market expectations have embraced the idea that earnings have hit their bottom because of the Fed’s actions and policies.
For years, governments and leaders abroad have borrowed against the future and built up excesses against current economic supply and demand realities. The bursting of those bubbles has affected the rest of the world.
Asia and Latin America are looking to the West to help solve their hangovers. We will help because it is in our collective self-interest to do so.
In order to maintain power bases, governments, and particularly democratic societies; find it difficult to avoid finding political cover in deficit spending policies that lead to material financial excesses. Because the United States has the will as well as the capacity for excess due to our relatively sound financial position, we believe the domestic economy will grow over the next 12 months, despite potential harm to inflation-fighting money supply and interest rate targets.
If it takes several years to turn the world economy around, we are likely to create our own domestic growth bubble, ultimately leading to either a recession or a relatively long period of economic stagnation.
Therefore, even though the market has reached very high value and PE levels again very quickly, we are maintaining an 87.5 percent invested posture. We are cautious but unwilling to fight the Fed.
We could experience another 10 percent correction. However, as other countries have been able to do, and as we have done during times of war, the United States can create a feeling of prosperity for a year or two before severe financial consequences creep into the market in the forms of higher inflation and slower or negative growth. Keeping a larger cap perspective In keeping with our discipline of focusing on larger companies with substantial histories of success and growth in their markets and avoiding others where liquidity and market value capitalization are dubious, we are paring some smaller companies from our universe.
Ten years ago, we would only make new investments in companies with a total market value in excess of $500 million. We have decided to double that number to $1 billion. We are dropping those that fall below $500 million from our research universe and our portfolios. Therefore, we have decided to liquidate positions in Novacare, Stride Rite and Yellow Freight.
Always expect volatility from the markets, and keep your eye on the unfolding economic and political realities. Price will chase those ultimate realities, whether they are flat, up or down.
Good luck this month.
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