According to the Bureau of Labor Statistics, US economic data was delivered in line with market expectations during the past month. The present readings show moderate, sustained growth for the American economy. Data from around the globe, particularly from the market moving regions of the EU and China, has also been moderately positive and in line with market expectations.
We are witnessing rising interest rates for government securities in the US and the EU. As such, there is developing concern that higher interest rates could negatively impact 2013 global GDP growth estimates.
US economists expect a strong spring housing market with a positive multiplier effect on US GDP. The present sanguine outlook, in conjunction with the Federal Reserve's $85 billion per month in asset purchases has continued to provide a strong bid for US equities.
To reiterate my concern about inflation, unit labor costs rose an eye popping 4.5% in the fourth quarter of 2012. See bls.gov. With the Dow Jones Industrial Average at roughly 14,000 and the S&P 500 at roughly 1500, the Federal Reserve now has a window to normalize interest rates, I hope we do not miss this opportunity.
I suspect that the Federal Reserve Board is beginning to gradually move toward a more hawkish posture.
We have reviewed earnings from the December 2012 quarter for about 80% of the companies that we follow. Most of the companies had single digit revenue growth for 2012 with EPS growth for the S&P 500 averaging roughly 5%. A relatively normal year by historical standards.
We believe the businesses that we own are still reasonably priced relative to historical valuations, but valuations for public companies have risen significantly over the last four 4 years, now more than 100% off the March 2009 lows.
It is becoming more difficult to find bargains, and therefore we have positioned the portfolio slightly more defensively. In doing so, we reduced speculative exposure and added diversification.
I would like to address the news surrounding sequestration, as US Federal government policy poses the most significant known headline risk to the portfolio over the next several months. It now looks like the congressional negotiations will be pushed into May.
During the 2011 debt ceiling debacle, Congress passed the Budget Control Act of 2011. According to the US House of Representatives Committee on the Budget, the Act requires the Federal government to reduce the deficit (through revenue, spending or any combination of the two) by $1.2 trillion over the next ten years. If no congressional agreement can be reached during the present negotiation period, automatic cuts (approximately 50/50 between military and domestic programs) will take effect as mandated by the Budget Control Act of 2011 through the sequestration process.
After discounting the interest expense savings and accounting for the new tax revenues which were implemented in the final moments of 2012, if sequestration is allowed the take effect, the US Federal government would have to cut spending by approximately $85 billion per YEAR.
As you are likely aware, the Federal Reserve is presently purchasing $85 billion per MONTH in assets.
If sequestration cuts $100 billion or less from annual US Federal spending, the action amounts to only slightly more than half-of-one percent of total annual US GDP output.
In my estimation, sequestration would do more good for the US economy than harm, and the markets would be relieved to see US deficits moving in a positive direction.
The implication for investors, so long as any brinkmanship in Washington, D.C. does not have a sharply negative and lasting impact on US consumer and business confidence, the sequester could be an opportunity, giving equity buyers who have remained on the sidelines an entry point.
Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.