Courage That Counts

“Success is never final, failure is never fatal. It's courage that counts.”

-John Wooden

 

John Wooden has been widely celebrated as a great leader both on and off the courts, and rightfully so.  He was a champion that was dedicated to teaching others to be the best they could be.  In one of the most interesting articles I read about him over the past couple of days, it noted that one of his greatest character traits was listening. 

 

In the world of investing, listening is comparable to reading and thinking.  While we can all pontificate and get on our soap boxes to express our opinions, what we do in the quiet hours of the morning when our competitors are still sleeping is what will give us the “courage that counts”.

 

We recently had the opportunity to listen to Professor Charles Hill, a political science professor from Yale University who came by our office to lead a discussion with our clients on the emerging risks in the Korean peninsula.

 

Charlie’s ultimate conclusion was that despite saber rattling, the North Koreans would continue to be rational actors.  While the recent sinking of a South Korean warship was an act of war, it was a well thought out action, with expected responses.  North Korea pushed the envelope, and while the response has been negative, the likely expected outcome will be some sort of appeasement of the North Koreans by the world community. 

 

After walking us through the history of the Korean conflict and probabilities of increased conflict between the two Koreas (which according to Charlie is less than 10% and would only occur in a scenario where an action was grossly misunderstood), Professor Hill began describing an emerging Geopolitical Risk Zone in the waters of Asia.  He described a scenario in which the U.S. would have to reassert itself and its domination of the global shipping lanes to protect its allies against rogue attacks such as the North Korean submarine attack, but also reassert its strength vis-à-vis China in the Asian waters.

 

Obviously this type of new strategy would not come without a cost for the United States, and could require a massive build up and redeployment of the Navy.  As George Friedman from Stratfor noted in his recent book, “The Next 100 Years”:

 

“The U.S. only emerged as the decisive global power after World War II and is still immature. The U.S.'s power is based on its Navy and ability to control both

oceans, the Atlantic and the Pacific, which no other power has been able to do."

 

Over the coming year, we will be contemplating more of these Geopolitical Risk Zones as war, historically, has been a great way to outgrow sovereign debt burdens.

 

Changing gears slightly, and in the Golf Clap of the Day Award, according to a Bloomberg article this morning investors prefer the United States as the market with the best opportunities versus the BRICs.  According to the survey, 4 out of 10 investors surveyed prefer the opportunities in the United States versus only 2 out of 10 when the survey was last taken in October 2009.  In that time period, the equity markets in the U.S. are down ~-0.6%, while the BRICs on average are down ~-3.0%. So much for Professional Prognostication . . .

 

Larry Summers noted in an official response to this survey: “This attests to Obama’s efforts at restoring the United States to strong economic fundamentals.  While there remains much to do, the U.S. economy is growing.” 

 

While our Macro Team isn’t paid to be permanent bears, even if that is how we sound as of late, we all need to be realistic about these supposed “strong fundamentals”.   When I look at the U.S. economy, there are three issues that concern me most directly.

 

1. Domestic Debt – We have discussed this ad nauseam, but with the United States entering into the danger zones of 90%+ debt-to-GDP and 10% deficit-to-GDP, we need to keep this risk front and center. (As such, we have noted this long term trend in the chart of the day attached below.)  We are in unprecedented territory in terms of sovereign debt in this country.  On the State level, the cracks are already starting to show as evidenced by Fitch downgrading Connecticut bonds yesterday despite it being “one of the wealthiest states per capita.” 

 

2. Housing Inventory – Josh Steiner discussed this on the Morning Call yesterday, but with the tax credit in the rear view mirror and no talk of an additional credit, mortgage applications have dropped off meaningfully.  Even Bob Toll had to admit such when he revealed on a recent conference call that year-over-year growth in buyer traffic - traffic is among the best leading indicators for housing - actually declined by two-thirds in May vs April.  If these data points continue, housing inventory is set to ramp back up quickly, which will be very bearish for home prices.

 

3. Unemployment – While Friday’s employment report is in the rear view mirror, its forward looking implications need to remain in the foreground.  The report was abysmal, and if we normalize for census hiring private payrolls added for the month of May was reported at an anemic 41,000 – the first marginal deceleration since December of 2009.  Scarily, the massive stimulus had a very limited impact on employment, although the debt associated with it lives on.

 

Collectively, these issues make us bearish of U.S. equities, but as John Wooden also said, “A coach is someone who can give correction without causing resentment.” In our case, we hope that a Risk Manager is someone that can call corrections without causing resentment. 

 

After all, we have no dog in this Global Market Fight, other than to help our subscribers punch, counter punch, and ensure that their “failures are never fatal.”

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Managing Director

 

Courage That Counts - US Debt to GDP


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