Author: Gabriel Grego, Zanshin Capital
Covestor model: Buffettian Value
Since its 2/28/11 inception on Covestor and through end of day 7/23/11 the Buffettian Value model has been up 3.87%, while the benchmark S&P 500 has been up 1.34%.
We are operating in a environment filled with uncertainties of all kinds, but overall I feel optimistic about the medium-to-long term prospects for the equity market.
As a first hurdle – and potential danger – there is the threatened U.S. default on sovereign debt. Unimaginable only a few months ago, the possibility of a short term default on at least some forms of US government obligation is now real. While the short term consequences of such an event would clearly be unpleasant, I disagree with the catastrophic scenarios which routinely appear on the media these days. Caused by political, rather than economic constraints, a U.S. default is bound to be easily reversible and temporary in nature. Of course, the stock market will likely swing downward violently, but as usual, at Zanshin we are waiting for just such occurrences to load up on good shares at lower prices.
There seems to be encouraging news on the European front regarding the Greek crisis, though in this case the proposed solution is a short term fix rather than a long term settlement. Indeed, I am much less enthusiastic about the long term prospects for the EU economy, plagued by adverse structural problems such as an aging population, inflexible labor markets, and decreasing corporate competitiveness. Save for Germany, most other long term bets on European economies are speculative in my view.
A different story is unfolding in the United States. Yes, the economy keeps growing at a disappointing 2%ish pace. However, the recently begun earnings season is showing corporate profits growing at an strong pace. This is not surprising, as companies generally have been cutting costs during the financial crisis, expecting to face another Great Depression. When only a Great Recession showed up, U.S. corporations are now in the enviable position of facing a mildly growing economy with a truly low cost base. Productivity has increased tremendously, and technological advancements allow companies to operate effectively even on a sharply reduced workforce.
Two interrelated pieces of the puzzle are still missing for the U.S. economy to finally return to a sustained growth: housing and employment. The housing sector is still depressed because of the existing stock of unsold homes that is keeping prices stubbornly low. That stock is shrinking at a predictable pace and will likely bottom at some point during the next 8-10 months. When that happens, new construction activity will resume, employing more people and injecting new liquidity into the system. New salaries increase disposable income and the wealth effect resulting from increasing house prices should provide a considerable boost to spending. Today’s anemic 2% GDP growth might well increase to 3% or even 4% once the housing tailwind starts again to blow.
If the above scenario proves even partially correct, it follows in my assessment that equities today are still significantly undervalued.
