Sunday, April 04, 2010

FGI Commentary

The following commentary appeared in the April issue of the Forbes Growth Investor.

It seems that no amount of bad news will keep this market down. Stocks soared in March, a month that saw a horrific terrorist attack in Moscow, rising trade tensions with China, and the passage of a major government healthcare bill that will no doubt add to the national debt and deficit no matter how loudly Democrats insist that it won’t.

That’s not to say there was nothing to cheer. Housing prices appear to be firming and even rising in some parts of the country, state governments are projecting better-than expected tax revenues, consumer sentiment and confidence numbers appear to be trending higher, the IPO market is coming alive, M&A activity is picking up, economists are forecasting real GDP growth, and some corporations are finally seeing a pickup in demand and sales.

Yet there is still plenty to worry about. Most notably, employment is still a concern. Initial jobless claims are still too high even though the latest nonfarm payroll figures were encouraging. However, even if the economy creates 100,000 net new jobs per month, it would take seven years just to get back all the jobs we’ve lost since the recession began in Dec. 2007. And that doesn’t take population growth into account. As a result, the unemployment rate could remain elevated even as job creation strengthens.

In addition, the government is playing too large a role in the economy. The recent announcement that it plans to reduce its stake in Citigroup is welcome news, but what government gives with one hand, it usually takes away with the other. For example, chances are investors are underestimating the true cost of healthcare reform. Already, several major corporations have announced plans to take huge writeoffs as a direct consequence of the new healthcare law. Instead of applauding their executives for honest accounting, Democrats are accusing them of playing politics.

Investors are also underestimating the real possibility of a trade war with China. Last month, China tried and convicted an Australian national employed by Rio Tinto for accepting bribes. Because the trial was held behind closed doors, there is no way to know the extent of the evidence. The accused man may indeed be guilty, yet the lack of transparency during the trial makes global businesses wary.

Rio Tinto was not the only company to raise China’s ire. Google, one of the world’s largest companies, decided to pull out of China. Now it is trying to serve Chinese users from Hong Kong. Google was particularly upset about censorship issues and hacker attacks that appear to be government orchestrated. Google clearly decided that the possible rewards of doing business in China are no longer worth the risks. It remains to be seen how many other companies, if any, follow Google’s lead.

Another worry is the rising level of interest rates. The Fed insists that it won’t be raising the fed funds rate any time soon. However, it is planning an "exit strategy" that involves selling assets. Higher interest rates may be needed to entice investors to purchase those assets. Furthermore, recent government bond auctions raised worries as the yield on the 10-year note moved closer to 4%. China, a big buyer of U.S. debt, has reduced purchases in recent months. There is speculation it may cut back further; and not just to send the U.S. a message. As hard as it may be to believe, China is expected to report a trade deficit for March—its first monthly deficit in six years.