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Outlook:

One month into 2009 – a new president installed in office – yet no more clarity. In fact more questions than answers.

After criticizing Hoover in the 1932 election for running deficits (sound familiar?), President Franklin Roosevelt tried diligently for six years to balance the budget and resuscitate the economy at the same time. It did not work. Then, willing to try anything after more than five years of failure, FDR said in one of his fireside chats in 1938, “We suffer primarily from a failure of consumer demand because of a lack of buying power. Therefore it is up to [the government] to create an economic upturn” by making “additions to the purchasing power of the nation.” This reluctant realization alone was not enough to pull the U.S. economy from the depths of the Great Depression. It took entry into World War II to drive deficit spending high enough such that GDP more than doubled in five years as unemployment declined from an estimated 18% to roughly 1%.

Today we find ourselves in a similar situation. The surpluses of the late 1990’s withdrew financial assets from the U.S. economy that were temporarily replaced from 2001-2007 by loose lending standards, house price appreciation, and mortgage equity withdrawal. When house prices began to roll over near the end of 2006, the U.S. economy needed a budget deficit that was large enough to offset the cumulative deleterious effects of the late 1990’s surpluses. This of course did not happen, and the situation has deteriorated as the diminution in aggregate demand has cycled in a vicious feedback loop with weaker economic data, a weaker banking system, and rising unemployment.
We had very high hopes for the Obama stimulus plan, and we still very much hope that it will work; but we are concerned that it is neither large enough nor swift enough to offset the contractionary forces we are facing.

From an economic perspective, it is not important if the stimulus occurs through additional spending or cutting taxes, it just needs to happen quickly. The recently-passed version of the stimulus seems short on rapid infrastructure spending and tax cuts, and long on pet projects and politically-driven initiatives. We recognize that many interested parties who view themselves as “conservative” are frustrated by what they view as fiscal incontinence by Washington. We agree that pet projects and deferred earmarking add viscosity to the stimulus effort, but nonetheless the spending and/or tax breaks need(s) to occur. Only the U.S. government has the balance sheet to offset the contractionary forces we are facing. We are fortunate that automatic stabilizers, such as lower tax revenues and expanding transfer payments, are more difficult for Washington to manipulate. It will be quite interesting to see the final shape and efficacy of the stimulus package. Our fingers are crossed that the stimulus in its final form plus the automatic stabilizers will foster aggregate demand large enough to break the back of this contraction. Equity markets will be watching closely.

Thank you for your continued support. I am always available to discuss our performance and portfolio.

Best regards,
Josh Davis

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