Tuesday, January 13, 2009

What if…

…the Keynesian stimulus efforts of President-elect Franklin Delano Obama don’t work?
…credit spreads remain elevated throughout 2009?
…depression/deflation valuation levels come to pass?*

What you see listed above are the three areas I chose to focus on at last Thursday’s 12th Annual "Market Forecast" luncheon. They were selected by me to help frame the discussion among my six expert panelists (Bernstein, Janjigian, Reynolds, Steindel, Trennert, and Wyss)**. Based on the dialogue that ensued, it achieved its goal. Of the three items listed, it was the first, the most macro of the bunch, that generated the most conversation between the panelists and attendees and one that I wish to share in this blog posting.

It must be assumed that some form of fiscal stimulus package will be passed by the US Congress in the coming weeks. By all accounts, the package will have all the qualities of a camel – a horse designed by committee. This is to say tax cuts (for the Republicans) and liberal causes (for the liberal Democrats) will reside along side stimuli that Keynesian oriented economists prefer.

Whatever the blend, there are two larger issues that must not be ignored by investors. The first is embodied in the opening “what if” question – what if the Keynesian stimulus efforts fail to produce a sustainable recovery? At last Thursday’s NYSSA event, panelist David Wyss (Chief Economist, Standard and Poors) articulated what sounded to me like the best answer – the hope that the stimulus package helps unfreeze the private sector (banking, corporate, and personal) and, thereby, a multiplier effect begins to emerge in which a sustainable recovery gets underway. The scary part in this answer is not just the prospect that the unfreezing process does not occur as prescribed but also that the answers David and all five other panelists provided seem to always include the word “hope” – as in “who knows if any of this will have the desired lasting effect?” The second issue is what will be the economic philosophy going forward?***

Investment Strategy Implications

Relative to where things have been recently, the financial markets appear to have entered a somewhat quiescent period. The multi-faceted stimulus and stabilization programs should have their desired effect in the coming months. This is evident in the steady decline in key market metrics, such as the TED spread and the VIX. While still elevated, the direction for the next several months seems almost certainly to be headed in a constructive direction.

The big “however” in this view is what comes after the fiscal and monetary stimulus punchbowl begins to run dry. Then what? For investors, keeping a keen eye on the above and other market and economic metrics will be key to determining if the audacity of our economic hope comes to pass.

*As a point of reference, the valuation parameters noted have been posted on this blog twice in the past weeks (see Dec. 30 and Jan. 7). They provide a framework within which investors can draw their own conclusions re operating earnings for the year ahead and the appropriate P/E ratio.

**Without doubt, given these incredibly challenging times there are numerous areas to explore, many of which could be argued as being vitally important to the investment decision-making process. However, only the most dedicated bottom-up only investor would deny that the global macro climate is the overriding factor is front and center to the future of the markets and economies.

***This is a larger, related issue to the Keynesian stimulus question, one that contains an evolutionary aspect of the current economic crisis: Now that American-style capitalism, in place since the Reagan revolution, has imploded, what will take its place? For interesting and insightful perspective on this subject, see
“Where Do We Go From Here”

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