Capital Ideas Newsletters



November/December 2010

“On the one hand… and on the other hand…” Well, as applied to “one hand” the housing market and economic crisis has caused deflation. And “on the other hand” the U.S. continues to print money to inflate the economy. We say BOTH deflation and inflation are happening at the same time. Let us explain.

If you buy a home today, odds are that it will cost less than it would have three years ago. If you go to Wal-Mart or Target, the values are incredible and you will pay less for much of their merchandise. If, on the other hand, you want luxury items from abroad, you very well may pay considerably more.

This trend may continue for awhile. Capital has flowed through the American consumer to the government’s intended target — i.e. housing for one (mortgage deduction!). In the last 50 years, the average American home has grown from approximately 1,500 sq. ft. to 2,500 sq. ft. — much larger than the homes in China and most of the world.

Also, for the better part of 50 years in this nation, we have stressed consumption. Rather than consumption, we should be incentivizing education, good health habits and investment in infrastructure.

Bonds have been very kind to investors and QE2 (quantitative easing the second time around) is an attempt by the Federal Reserve to keep interest rates low and boost stock prices. So far, it is working. We must recognize, however, that buying bonds ultimately raises their prices while lowering their real value — the definition of a bubble. Thus, it is crucial that investors be vigilant in monitoring their bonds to decide the exit point. Simply put, we do not want QE2 to equal the Titanic!

Stocks rallied exuberantly on the heels of the Fed’s announcing its continued willingness to buy treasuries. We especially like the juicy dividend stocks and the stocks with a strong prospect of dividend increases. Why? With bonds, one’s income is set — no increases. With stocks, increasing dividends provides inflation protection because of the extra income derived. Retirees are consistently concerned about “increasing income.”

President Obama got a wakeup call on Election Day and came out like a contrite puppy. Policy needs to drive this administration now — not apologies.

The G-20 meeting brought about a major change in international expression of discontent with America for inflating (QE2) its way to stability. For the first time that I can remember, foreign governments are meddling forcefully in U.S. economic policy. There was sentiment at the G-20 meeting that the U.S. should stop the stimuli and work out its problems the old fashioned way — cut back its spending, reduce debt and live within its means. How successful this pressure is on the Obama administration could possibly determine the direction of U.S. monetary and economic policy over the next year or two.

The Deficit Commission came out with a package that we thought was reasonable. If only the Politicians would take it seriously!!

On November 9, China’s Dugong Global Credit Rating Company reduced its credit rating for the U.S. to A+ from AA citing “a deteriorating intent and ability to repay debt obligations after the Federal Reserve announced more monetary easing.”

As Bill Gross from PIMCO said, “Nobody knows whether QE2 will work; we are certainly in unchartered waters.” This is why we must continue to diversify our clients, among other investments, into foreign-oriented fixed income, more inflation resistant assets and acknowledge that creativity in investing will be a critical component to success.

We believe that we are indeed close the end of a thirty year bull market in bonds, so we must look increasingly to asset classes that provide, among other things, an inflation hedge. We feel that good stock selection and active management of all positions will be critical to achieving our individual client’s investment goals.

We want to take this opportunity to thank you, our friends and clients, for your support over the past year.

Managing money is an imperfect art — at FMC we strive to do what is right for each of you individually.

We are dedicated to being the best at all times and still believe, as we did over twenty years ago when we started, that the best is yet to be!

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