Download STRATEGIC INSIGHT WHISTLING PAST THE TOMBSTONES

STRATEGIC INSIGHT
WHISTLING PAST THE TOMBSTONES
March 31, 2015
It has been nearly two years since we focused our investment strategy on the concept that U.S. stocks
would be the only game in town. In follow-up commentaries we put forth a renewed optimism that this
thesis was correct and the continual flow of money would be into the U.S. rather than out of the U.S. A
logical extension of this thesis was the expectation for a strong dollar and our avoidance of sectors that
would be hurt by a strong currency move. Commodity prices, all denominated in dollars, predictably
fell, taking along most investments in that arena. Currencies of countries predominately dependent on
the business of exporting commodities also fell. The recognized wealth of Brazil, Russia, Australia and
Canada (to name a few) all fell, while the comparative wealth of the U.S.A. increased proportionately.
Fortunately, our “call” was right and we avoided much of the pain experienced by investors in
commodity-related positions. As we always work to preserve capital while providing a good “risk
adjusted” rate of return, our exposure to these “macro calls” will necessarily be moderate. We will
never “bet the farm,” and as such, our process is perhaps best described as one that leans rather than one
that jumps. So we’ve leaned in the right direction…now what?
Looking at the world today, it’s nearly impossible to rationalize a positive outlook for the global
economy. Furthermore, it’s equally difficult to envision a world at peace. Headline grabbers such as
ISIS, Greece, Iran, Israel, Putin, Islam, North Korea, Taliban, Ukraine, Terrorism, Yemen and Syria
should be enough to frighten most foreign investors. Domestically, headlines about our internal political
strife, government, budgets, taxes, new regulations, deficits and a sputtering economy are equally
disturbing.
Aside from the intangible geopolitical risk, one must look at the cold, hard, financial facts related to our
world’s economy today. Since the financial crisis six years ago, the world has not de-leveraged. In fact,
the global economy has borrowed an additional $57 trillion (in 2013 dollar values). This increased debt
has been mostly borrowed by governments, making the debt to GDP ratios worse than they have ever
been for these countries. To make matters worse, the dollar has since appreciated 20% against the
global currency index, bringing the nominal sum of this incremental debt to over $64 trillion!
At the top of the heap is China, whose debt to GDP ratio has deteriorated by 80% over the last seven
years. Currently Chinese corporate earnings are clearly in decline, as are real estate home prices. Their
stock market is up sharply, but not as much as their margin debt which is up 250% over that last year.
Could this be another 1929 in the making?
Across the globe in Europe, we see little chance that Greece can solve its own problems. They will
either be forced to leave the Euro or the other European nations will be forced to absorb Greece’s debt.
Scared yet?... I vividly remember having this same feeling in the pit of my stomach as a young boy
growing up in Lahaina, Maui in the 1940s. The rules of the road, set by my parents, was to be home by
-over-
5:30 p.m., “no matter what!” On days when the “fun level” was high, I would play as long as possible,
making the only route to being home on time a shortcut…Yes, through an old, dusty Lahaina graveyard.
At that time of day, the shadows were elongated and the surety of some ghostly intervention by some
old whaler, Hawaiian priest, or Chinese medicine man was virtually 100%. My whistling would get
louder, then stop, as I broke into a run. I always made it home, winded perhaps, but happy to be home.
Our present market journey is seemingly no different, except that this graveyard is distinctly larger.
Our U.S. debt picture, while somewhat deteriorated, is not yet catastrophic as are most. Our political
differences are no longer subtle, but this is probably part of the healing process. Voter conclusions are
firming along with the candor, and demagogues are finding smaller audiences to fool. (It feels like
we’re finally headed toward a rational election.)
Thanks to a dock worker’s strike and some extreme winter weather, the first quarter economic numbers
are a bit soft, and have been scaring the market, but we expect the next three quarters to be strong. We
expect the stronger dollar to keep inflation suppressed and consumers more inclined to spend. All in all,
a pretty good picture.
The story up to now has been our economic decoupling from the rest of the world. Going forward, the
story is likely to be a decoupling within our own stock market. This decoupling will feature strong
dollar beneficiaries with strong earnings and weak dollar beneficiaries with weak earnings. We are busy
“culling” our list and looking for more good companies from the “strong dollar list.” Selectivity will be
the key…so one shouldn’t simply “buy the market.”
In answer to the same old question about when we should run from this frightening environment, the
answer is once again, “not yet.” There is still some money to be made.
***
Harlan J. Cadinha
Chairman and Chief Strategist