March 20, 2013
Washington failed to produce an alternative budget plan so today marks the first day of sequestration—automatic spending cuts of $85 billion over the next seven months (the government’s fiscal year ends September 30th). Just as Nero fiddled while Rome burned, the market continues to rally while Washington becomes ever more dysfunctional. Speaking of Rome burning, the Italian elections last weekend failed to produce a single political party winning a clear path to a majority. In fact, there’s a dead heat between a comedian, a Communist and the former playboy prime minister who presided while Italy fell into its current deep financial crisis. Surprisingly, the failure of the Italian elections got the market’s attention—for one day—and then the rally continued. Regardless of the crisis du jour, investors are singing O Sole Mio (my sunshine) and buying up shares.
The rationale for stocks going higher, according to the talking heads on the financial networks, is that they look cheap compared to bonds. The flaw in that argument is that most everything looks cheap compared to bonds. Every central bank on the planet, with the possible exception of Brazil, is stimulating its respective economy. That said, we believe stocks will likely go higher as retail investors continue their search for yield. This search for yield is the primary reason the current market rally has confused many market watchers. Stock market rallies aren’t typically led by the more defensive, high dividend paying stocks. Some market watchers have even cited this phenomenon as the reason this rally has run out of steam. We disagree. When retail investors rotate from one asset class to another it usually lasts for years, not weeks or months—we believe that rotation has begun and that these are the early days of what could be a long process.
Sadly, the one thing that could disrupt this powerful retail asset class rotation from bonds to stocks are the very politicians investors seem to be ignoring today. The current sequestration debates in Washington could easily lead to another debt ceiling showdown in May. The Italian elections could throw the whole Euro-Zone into another craze; and, Japan’s current quantitative easing stimulus plan (about 15 years past due) is prompting other nations to accuse them of starting a currency war—last I checked it was our own Federal Reserve Bank that “invented” quantitative easing in response to perceived deflationary risks (Japan has experienced real price declines for the last 15 years).
All of this leads us to the conclusion that we need to remain tactically bullish toward stocks. Elvis Presley was so enamored with the melody to O Sole Mio that he commissioned new lyrics to be written. The song, It’s Now Or Never, was a number one record in the US, UK and numerous other countries in 1960. It was Elvis Presley’s best selling single ever. It strikes us the title is a little more appropriate for the current investment environment than “my sunshine”. The markets are poised to go higher if the politicians would just get out of the way; but, history has taught us that should they not get out of the way investors will. It’s now or never or until the politicians try to “fix” things again.