Q1 Review and Commentary and a Look Ahead for Markets

by: Derastone

While political instability across the Middle East and North Africa, higher oil prices, and a major natural disaster in Japan weighed on global markets, the S&P 500 is proving its resiliency and is up for the year. Amid this uncertainty, various indicators point to continued growth both in the U.S. and overseas. Though Q1 2011 GDP may come in below bullish consensus forecasts published at 2010 year-end, ISM manufacturing index readings have been rising, private payroll growth continues to improve, and the March and April employment reports suggest businesses continue to expand. Government stimulus and public sector bail outs of certain private sector balance sheets succeeded in jump-starting the economy.

One year later, following two rounds of unconventional quantitative easing and amid global geopolitical instability, inflation concerns have increased market risk.

Some market participants argue quantitative easing has only served to reduce investor confidence in the U.S. dollar, which has fueled inflation expectations and in turn speculation in commodities and stocks. While it is premature to ascertain QE’s ultimate effectiveness, many foreign central banks have already begun to implement more conventional monetary policy and interest rate hikes to curb nascent inflation trends and potentially overheating economies. Our view is that this will negatively impact emerging markets more than developing markets.

Even if a weaker U.S. dollar eases our international debt burden, individual state solvency remains an unmitigated risk to economic stability. Policymakers have yet to formulate a sustainable solution to our over-borrowing / over-spending problem that led us into the Great Recession. David Walker, former U.S. Comptroller General and head of the Government Accountability Office (GAO) in both the Clinton and the second Bush administrations, recently stated in response to the gridlock over $30 billion in spending cuts that politicians are essentially “arguing about the bar tab on the Titanic.” We think this analogy is apt given a projected $1.65 trillion deficit in 2011.

Data released by the Congressional Budget Office some time ago suggest the United States will run a primary structural deficit of 6% of GDP in 2011, a figure that did not exceed 2% of GDP from 1969 through 2009. The U.S. needs to both lower its debt/GDP ratio from the 80%-90% levels expected by 2015 and figure out ways to fulfill its Social Security, Medicare and Medicaid obligations. While details of a comprehensive plan may not emerge until the 2012 presidential election, a proposed solution will certainly impact GDP growth, interest rates, and general financial and market conditions.

While we are GARP (Growth At a Reasonable Price) stock pickers at heart, given the speed at which the global economy is changing, we constantly monitor the market’s pulse to anticipate potential impacts on the companies in which we invest and at this moment we are having trouble finding opportunities at a reasonable price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.