Investment Thesis

Two key events transpired this past week that set the framework for what we feel will be further pressure on the market. The first was the weaker than expected employment numbers on Friday that set the tone for reduced growth in the U.S. economy and the second was an escalation in problems as it relates to the European debt crisis.

Economic Recovery?

“The defining characteristic of the current economic recovery is that it keeps disappointing just when you think it might finally have some durable momentum. So it is with Friday's March employment report, which turned up a weaker-than-expected increase of 120,000 net new jobs. That's half the pace of the three previous months and is a long way from what it should be some 33 months after the economy started growing again.

The jobless rate fell a tick to 8.2%, but that was mainly because the labor force shrank by 164,000 workers in the month. The labor force participation rate—or the share of the civilian population that is working—also dropped again to 63.8%. In March 2009, a month after the $800 billion stimulus passed Congress, the labor participation rate was nearly two percentage points higher, at 65.6%.” April 6, 2012 - A Jobs Slowdown – Wall Street Journal Opinion.

A large consensus of economists, those largely from the right have been aggressively going on the record to show the overall dismal performance of our economy despite moderate improvements of late. There seems to be an ongoing debate between supply side and Keynesian economists as to the reasons for this. Keynesian economists on the left point to the severity of the 2008 crisis and claim not enough stimulus spending on behalf of the Federal government was implemented to spur a robust recovery.

Supply-siders on the right argue too much money was drained from the private sector and that, along with a sharp increase in regulation has caused this recovery to continually stall.

When compared to previous “severe” recessions, it is true that this recovery ranks as one of the weakest on record.

“The Great Depression started with major economic contractions in 1930, '31, '32 and '33. In the three following years, the economy rebounded strongly with growth rates of 11%, 9% and 13%, respectively…. In the early 1980s, the economy experienced a double-dip recession, with contractions in both 1980 and '82. But growth rates in the subsequent two years averaged almost 6%.” - April 2, 2012 - The Worst Economic Recovery in History - by Edward P. Lazear – Wall Street Journal Opinion.

Our view holds that Chairman Bernanke has been forced to go above and beyond traditional monetary policy stimulus measures because Washington is in such a funk. Both parties have engaged in ideological sparring and have completely rendered traditional fiscal policy measures inept. The last decade of abusive spending in Washington has drained our resources at a time when we could use them.

Instead of following a true fiscal stimulus plan which should include cutting taxes and increasing spending, each party has dug their heels in the ground on measures that are counter-intuitive to growth.

Democrats need to stop the "eat the rich" mentality and consider lower taxes and less regulation. We also need to balance the budget over time without abandoning the growth initiatives that has made this country an economic superpower. Republicans should understand that fiscal responsibility is a hugely important issue but one that shouldn't be taken in the face of a prolonged slowdown.

It appears our leaders in Washington need a pending crisis to get something accomplished. Well...we hit $15 trillion in debt last year and are expected to see that figure grow by $1 trillion per year going forward. If we choose to kick the can down the road and leave our decisions until the last minute, the bond vigilantes will not be so patient. Higher rates will force change...and painfully so if we let it get to that point.

Bottom Line: Economic growth will be the central talking point this election year and the nascent recovery of late is certainly subject to headwinds. This continues to play into our near-term bearish stance. That said, we are growing continually bullish in our longer-term outlook for equities as valuations and corporate earnings still look decent.

Europe…Again!

There have seen several articles written over the past few weeks claiming that a break-up of the single currency may be all but inevitable. No one really knows what this will mean for stock markets around the world, but one need to assume it won’t be pretty.

We are not clairvoyant in the ways of the euro, but we do track how the bond markets react. Over the past year, rates on the ten year bonds for most southern European economies have gone through a staggering run as investors increasing view investments in these nations at risk of potential default.

In figure 2, we have started to see yields on the ten year for France, Spain and Italy start to increase again. Yields for Germany and the U.S. have started to decline. This is a sure sign of the flight to safety that plagued the equity markets all of last year.

While trying not to sound too ominous, we will continue to monitor the situation across the pond.

Bottom Line: The crisis in Europe has moved to the backburner, but is far from over and may once again creep to the forefront. This is a potential negative for the market.

Investment Thesis

We have positioned ourselves in preparation for near-term market weakness. Our stock account has a short bias, our bond account has increased beta-neutral exposure and our separately managed accounts (SMA) are sitting in cash awaiting deployment at the appropriate time.

Joseph S. Kalinowski, CFA