September 2012 Investor Letter
The beginning of September marks an unofficial end to the summer, and for Wall Street that means it’s time to get back to work. The period that begins with going away in May ends with Labor Day, and the news flow, which slows to a crawl in late August, picks back up in September.
Prices set after Labor Day carry a little more weight than they do in July or August because there’s a sense that everyone is back in the office and the judgment of the market represents the opinions of all investors, not just a sampling of those not on vacation. Therefore, what happens in early September can often set the tone for the rest of the year. If the market gets off with a bang, it can lead to more prolonged rallies. However, a less than exuberant embrace of the markets to start September can lead to extreme late month volatility as investors dash for the exits before year end. This year, there are plenty of reasons that I can see the market tipping either way.
On the one hand, there are still plenty of storm clouds. Europe continues to be a source of discomfort, while China is even more troubling. Official statistics and anecdotal evidence are confirming Chinese weakness, and some are starting to whisper that Chinese GDP growth could be as low as 5% going forward. For many US companies, China had been a centerpiece of future growth plans, and so a slowing Chinese economy poses a greater threat to US stock prices than Europe does. On the bright side the Chinese have already cut rates once and monetary policy does tend to be effective with some lag, so worries about China may be slightly premature.
While international markets show weakness, the US continues to be a relatively brighter spot on the world stage. Economic activity remains sluggish, but so far the consumer isn’t slowing further. Retail sales for the back to school season were extremely encouraging, and best of all housing is showing signs of genuine strength. Over the longer term, I remain skeptical of what housing prices will do in a rising interest rate environment, but in the near term, inventories have finally normalized and pricing is beginning to rise. Psychologically, individual investors still seem much more comfortable investing in real estate than in stocks. At these relative prices, I think that’s misguided, but increased that positive sentiment may produce some near term price appreciation. From an economic standpoint, housing has been the missing piece for the US recovery and so if the housing market returns, we may see a stronger economy yet to come. This includes an employment recovery, which would be a huge surprise to the stock market and could provide a boost to new all time highs.
Between here and there, we still have to contend with plenty of politics, including the presidential election and most importantly the fiscal cliff. How congress handles that problem could make or break the next few months. The most likely scenario is that congress will kick the can down the road again, but with the US congress anything is possible.
Our positioning is mostly unchanged from August: highly conservative cash position, with the expectation that our stock picks will carry our portfolios. A pullback would be more than welcome to give us the opportunity to make purchases at lower prices.
Scott Krisiloff, CFA