Thursday, September 06, 2007

We are Bullish on Stocks

Each week our investment policy committee deals with the events and issues of the day, as well, as charting the course of our investments.

There are four of us: Mike Hull, our president, who has wide experience in consumer attitudes and consumer products; Vice President, Rick Roop, who has had many years of experience in energy production and organizational systems, Vice President, Randy Alsman, who has a background in finance and has been an executive in both the consumer products, as well, as the pharmaceutical industries; and Greg Donaldson, who has a long history in economic strategy, financial institutions, and valuation metrics.

This past week we had a wide-ranging discussion of the goings on under the sun, so to speak. The following in a general synopsis of our thinking: The points seem rather straight forward, however, we can tell you the getting-there was not so straight forward, but a flood of thoughts and ideas that sprang up and were either shot down or allowed to pass on. In the end, this is what WE believe, and I (GCD) am proud to say it is reasoned, reasonable, and, in my judgment, a good bet to come to reality

We saw the troubles in real estate coming. We were convinced they would be worse than what most people thought. We said as much here 15 months ago.

We are surprised that the subprime mortgage mess is as widespread as it is. Unknowns in the banking system are always unnerving, and we believe the damage is enough to warrant the Fed starting to cut the Fed Funds rate.

In the short-run, say the next six weeks, the market could be very volatile. But, if the Fed moves in a measured way, the economy and the corporations that produce most of our goods and services will perk up in the coming months and provide a very healthy stock market. Here's why:

1. The Fed has done an excellent job of gradually slowing economic growth so that inflation has not gotten out of hand. Their actions have been appropriate enough that we see a slower economy ahead but no recession -- a soft landing.

2. The Fed's second responsibility (after holding off inflation) is to stimulate economic growth to create jobs. So far, the unemployment numbers tell us the economy hasn't slowed enough. But, that is looking in the rear view mirror. Every Fed tightening in recent history has ended with a "financial accident." These accidents have become a signpost for the Fed that by raising rates, they have slowed some area of the economy enough to do some damage. This time it was housing and sub-prime lending (both of which needed some cooling off - greed had taken over the decision-making in that part of the economy).

3. Many investors, politicians, and corporate leaders are yelling about a pending recession and calling for the Fed to cut the Federal Funds Target Rate. This is the second signal that tells the Fed they can cut rates. If the CEOs of major corporations believe we are heading for a recession, what happens to their hiring practices? Right, they dry up. Their screams for rate cuts precede a rise in unemployment.

The credit crunch and the housing market could well get worse before they get better. It does appear, however, to be fairly contained. But, at this point, the Fed does not want to rescue the bad decisions made there. In fact, they see the losses and pain as healthy for the economy longer term. And, the stock market will see that, too.

We say all of this to reach these logical conclusions:

  1. The Fed has slowed the economy. Unemployment is going to rise.
  2. That will give the Fed the room it needs to revert to stimulating the economy by lowering interest rates.
  3. We think they will begin soon and continue doing so at a measured pace for several months.
  4. The stock market loves it when the Fed lowers rates -- it means the Fed does not fear inflation and is trying to stimulate economic growth.
  5. That will lead to an attitude that earnings growth will be stronger and more sustainable.
  6. As the market looks ahead to 2008, stock prices should start to rise and that could continue as long as the Fed continues lowering rates.
  7. We are bullish on prospects for stocks over the next 18 months.