January 2015

It's a Big, Wide World, Economically Speaking

The English poet John Donne famously said, "No man is an island." The same is true of countries and their economies. And that accounts for much of the volatility in U.S. markets over the last several months.

Looking at the United States alone, we should be in an exceptional investing climate, for five main reasons:

1. Corporate profits are at record levels.
2. There is virtually no inflation.
3. Corporate cash balances are at historic highs.
4. Interest rates are at historic lows.
5. Oil prices are low.

And for the most part, markets have been performing well. In 2013, for example, the Standard & Poor's 500 Index was up about 30 percent. But markets did not repeat that extraordinary performance last year, and some people are concerned about the slowness of the recovery.

It is important to remember, though, that the recession from which we are recovering was the second-worst in history. It is my hope and expectation that this relatively slow recovery will prove to be longer-lasting than some previous, quicker recoveries.

But perhaps even more important is that the U.S. recovery, like the recession that preceded it, is not occurring in a vacuum. We are part of a global economy. For example, we depend on countries like China and the nations of Europe as markets for our exports. And many of those economies are in significant trouble.

Japan remains stagnant. Europe is still struggling -- with limited success -- to preserve the European Union even as some of its members are sinking. The Chinese government is trying -- with mixed success -- to move its economy to a more western model. And of course, there is continued unrest in the Mideast and Africa that, as we saw in the events earlier this month in Paris, occasionally spills over into the west and puts companies and consumers on edge.

Finally, while the dropping price of oil is a mixed bag for Americans -- bad for those companies and regions that produce oil, but good for consumers, who create 70 percent of the GDP -- many countries that import most of their oil are really struggling. That exacerbates the negative impact of falling oil prices on the markets.

These kinds of issues are likely to keep the markets fairly volatile for a while. But now more than ever, it is important to think long term. And long term, the outlook is positive for several reasons, starting with the five factors cited above.

That positive investment climate is likely to continue. It is true that currently stocks are a little expensive, selling at a P/E ratio of about 17, compared with the historic level of 15 to 16. But analysts believe that corporate profits will be record-breaking again in 2015 and 2016: FactSet’s S&P earnings estimates are $116.96 for 2014, $125.55 for 2015 and $140.92 for 2016. This means that P/E ratios should start returning to a normal range.

In addition, the United States has a much more effective regulatory environment than most other countries have. We have SEC oversight of our markets and FASB accounting, both of which can help identify potential problems before they become major.

In addition, our Federal Reserve board is more effective and more powerful than the European Central Bank, for example. First, the Fed has two major missions: to stimulate the economy while controlling inflation, and to promote employment. The ECB is not empowered to promote employment. And in the financial crisis that began in 2008, the ECB was reluctant to take steps like quantitative easing to try to right the European Union’s financial ship. That reluctance has relaxed some, but it might be too little too late.

In addition, the ECB answers to all its member countries, which form a loose and relatively new union whose members sometimes have very different economic agendas. The Fed, on the other hand, is the only -- and the final -- word in the United States.

At Peachtree Investment Partners, we continue to look for strong companies with a competitive advantage, experienced management and strong cash flow. We also prefer companies that pay a dividend, in part because dividends can help smooth out volatility.

No one has a crystal ball, and the last several years have taught us that events anywhere in the world can be felt everywhere. But we still believe that our best protection is to continue to look at these kinds of long-term fundamentals and, as much as possible, to avoid the noise.

Garry K. Schaefer
Atlanta, Georgia
January 13, 2015

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