July 9, 2012
To Our Valued Client-
The excitement and positive economic surprises that started the year have once again eroded into worry and uncertainty. After posting solid gains for the first 4 months of the year, the worry and uncertainty surrounding the European debt crisis weighed on the market. Throw in the coming “fiscal cliff” we face in the United States and the slowdown in emerging markets and you get a good recipe for a selloff in the stock market. Let’s look at each of these issues in more detail.
The European sovereign debt crisis has been simmering for years with occasional flare ups that remind us all that this is a very tenuous situation and the consequences for failure are severe. Greece recently held an election where many leaders who supported the terms of their bailout were defeated and fears began to rise that new leadership may be hostile toward the rest of the EU and bring about a disorderly exit from the euro by Greece. Spain, which is the fourth largest economy in Europe, recently asked for bailout money to support their financial system. A failure in Spain would be magnitudes more dangerous for the market than Greece and the hope is that the recently ended European Summit will address the debt issues in Spain, Greece, and other peripheral EU countries that threaten the existence of the monetary group.
The “fiscal cliff” that is often referred to is the end of the Bush tax cuts and the mandatory government spending cuts as set forth in the debt ceiling compromise of last summer. If nothing is changed, all the Bush tax cuts end on December 31, 2012 and the government will need to slash billions of dollars in military and discretionary spending. Some analysts estimate that this could reduce the growth in our economy by upwards of 5% over 2013 and lead us into another recession. Recessions are usually not good news for the stock market. To make matters worse, Congress seems willing to wait until after the November election to try and compromise on these problems. This leaves investors and taxpayers with another 11thhour showdown that may or may not produce a workable solution. The reduction by Standard & Poor to a AA credit rating for U.S. government debt that occurred last August, is an example of the damage that can be caused by the brinksmanship attitude of our lawmakers. Continuing to legislate in this manner may again backfire and cause more damage to our economy and our reputation as a safe haven.
The emerging markets countries, especially China and India, have been the growth leaders in the world economy pulling along the other developed countries as we try to work through our debt issues. Unfortunately, these countries are noting a marked slowdown in the growth of their economies. This has been evident not only in their official reports but also anecdotally from U.S. multinational companies reporting surprisingly negative updates from their international divisions. This could mean that the engines of growth for the world economy over the last few years may be stalling.
If you’ve made it to this part of the letter, then you probably think that our outlook for the future is all gloom and doom. The fact of the matter is that there are a lot of uncertainties to contend with through year end and beyond. We have reduced some of your stock holdings throughout the quarter or maintained stock holdings in the lower half of your asset allocation range in an attempt to cushion any downside as these uncertainties work their way through the public psyche. Our focus is on companies with good earnings from domestic sources and which might be largely insulated from decreased military or federal discretionary spending. There will surely be ups and downs to the market as countries around the world grapple with their problems. In the meantime, we are content to own quality companies with what we believe are sustainable advantages over their competitors. If the market becomes too pessimistic, we will try to buy more of these quality companies at lower prices.
It is our pleasure to serve as your money manager. We are honored by the trust you place in us.
John H. Conley, CFA
President and CEO