Taking Stock

There are many positive signs in the US. Gross Domestic Product (GDP) for the 3rd quarter was up 5% on an annualized basis compared to the 2nd quarter (adjusted for inflation). The Unemployment rate fell to 5.8%, and there are now, finally, more people working in the US than at the previous economic peak in 2007 (although the US population has grown by some 15 million over that time). Manufacturing activity has been picking up, housing prices have rebounded, credit is becoming more available, and confidence is improving. What's not to like?

The growth rates of the 2Q and 3Q are not terribly surprising given the 2.1% weather-affected drop in the 1Q. We expect that when all the numbers are in, GDP growth for full-year 2014 will come in only modestly better than the 2.0%-2.5% trend since the end of the recession. In 2015 we expect more of the same. While the labor market appears to be making a full recovery, a closer look reveals that labor participation rates remain very low, part-time jobs are replacing full-time jobs, and incomes remain stagnant. At the same time, the costs of necessities like health care, housing, education, food, and saving for retirement have gone up, and credit remains relatively tight. In short, the middle class continues to get squeezed.

We believe strongly that the process of deleveraging has yet to run its course. We also believe that the answer to the problem of too much debt is not the encouragement of more debt. While some will point to the modest decrease in consumer debt as real progress, it must be recognized that the decrease has been more than offset by large increases in federal government debt. Taxpayers will eventually have to pay the bill.

While the recent economic trends in the US have been modestly better, growth is slowing around the world. China's growth rate is slowing to rates not seen since 1999, Japan is in recession, and Europe has stalled. The United States has gone from the least bad house on a bad block to a pretty decent house on a bad block. Twelve years ago the US accounted for about a third of global GDP, and that percentage has fallen to about 22%. This is important because our ability to carry the world (or take it asunder) has lessened. The old idea of economic decoupling - that what happened around the world wouldn't affect the US or vice versa - is no longer valid. The global economic fabric is intertwined and interdependent.

In our view, the notion that there is some point of "escape velocity" for the US economy is a fallacious idea. The 2.0%-2.5% GDP growth we have achieved since the recession ended has been heavily dependent on ultra-low interest rates, high levels of government spending, and inadequate levels of consumer saving. While low gas prices will certainly help in the near term, any increase in interest rates will likely put a ceiling on the growth we can expect. This needs to happen, but it won't be pleasant. Financial assets as well as the economy at large have been supported by the Federal Reserve. When the Fed eventually removes accommodation, rates will rise, markets will fall, economic growth will suffer, and the world will not end.

Shouldn't we sell? Yes and no. Yes, sell those things that have become too expensive, risky, or violate your sell discipline. Don't think for a minute that you will successfully sell at the top or have any idea when you should buy back. How eager were you to buy in March of 2009 when the Dow was at 6,700?

Investing is for patient optimists: they believe things will be bigger and better at some point hence and are willing to wait. Over the years they have been well rewarded. On the set at CNBC last week a friend quipped, "Buy, hold, and be rich when you're old." I loved it! In short, times have been great, but we believe tougher times are ahead. They will pass painfully, and better days lie beyond. Be disciplined, dispassionate, and optimistic. This is a great country and a great business. Be of strong heart.