On Investing in the US

At the February 29th “Deal Makers” Boston conference sponsored by the Association for Corporate Growth (“ACG”), the spotlight was pretty much stolen by Dr. David Kelly of JP Morgan Funds, who gave a sweeping assessment of the American economy and (from his standpoint) how one ought to invest into it.

Introducing his summary by noting that too much attention is paid to forecasting (no one can know what is going to happen in a given year), the key to success is to find imbalances and invest in ways that will be profitable when balance is achieved.  His theory of investing is reliant on the proposition that there are no paradigm shifts; everything reverts to baseline, a proposition  that historically seems true,  and which also speaks to an investment strategy that neither times the market nor is upset by short term volatility.

Generally, Kelly expects 2012 to be better than 2011, which was net flat for equity markets.  He sees increases in consumer confidence, improvement in consumer balance sheets (measured by percentage of income used to service debt), slow but steady job growth, a rebound in housing and a vigorous year for automobile sales.

While keynote speakers always revel in statistics, some of the statistics are pretty startling:

  • The ratio of the price of a home to average income is historically very low, with the affordability index (impact of lowered price and low interest rates) showing that we are at the most propitious time to purchase housing since World War II (notwithstanding the foreclosure overhang).


  • New housing starts are magnitudes below standard, so notwithstanding the foreclosure overhang the available housing inventory will inevitability fall.


  • For the first time in forever, it costs more to rent living space than to buy it.


  • As the housing market improves, the value of homes will increase, bank reserves for loan losses will decrease, and banks will then be more willing to lend across the board.

In a tirade, Kelly challenged the proposition that there are no jobs.  In 2011, 48,400,000 hires took place in the United States, a rate of almost 1,000,000 jobs a week.  The job market is selective and competitive, however, and he noted that unemployment for any person who attended any amount of college was 4.1%, increasing to 8.7% for high school graduates, and upwards from there.

He predicts an increase in U.S. manufacturing, although since 1948 the percentage of work force jobs in manufacturing has fallen from 25% to 8.4%.  The fall seems to have stopped.  The United States still remains the major manufacturer in the world, through increases in productivity.  Our hourly labor costs are flat at least compared to other developing countries, in large measure because of weakness of unions.

There is great concern for the political stalemate concerning taxes.  Kelly predicts that the automatic spending cuts scheduled for 2013, if the President and Congress fail to enact new tax legislation before the end of 2012, will cause a recession because the cuts will take too much demand out of the economy.  He sees, however, that either a Republican or a Democratic win for the presidency will lead to a tax deal which will include tax increases in various areas.

Kelly was particularly critical of the Federal Reserve, believing that they are making things worse.  If the main problem with the U.S. economy is, as he believes, a lack of confidence and not a lack of liquidity, announcing in advance that several years of fixed interest rates are necessary because things look lousy is exactly the wrong message to send, and feeds into the “wait and see” attitude which in turn prevents companies from moving forward and banks from lending.  And indeed low interest rates make the business of lending so unattractive to banks that there is little incentive to lend.

He is bearish on bonds at this point, noting that the ten year Federal bond is now upside down, yielding 2% against core inflation rate of 2.3%.  Conversely he believes that stocks are still relatively inexpensive, with price to earnings ratios, even after the current rally, still a little bit below history.  He thinks we are all too deep into bonds and that bonds are not, at this time, a conservative move.

How to invest?  As he believes corporate profits will grow this year, stocks will remain cheap.  Large cap growth stocks are the cheapest.  Dividend yielding stocks look good to him, with dividends (a rarity) exceeding government bond yields.  He is not much scared of inflation, but notes that investments in commodities, even at a modest level, will counter-act any hit a portfolio may take from the inflation side.

If Israel decides to take out the Iranian nuclear capacity?  This may cause temporary volatility and some inflation, but he goes back to principles: time and diversity solve volatility issues, and inflation in the long run will stabilize and can be hedged.

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