Reaching Equilibrium for Stocks

05/24/2013 9:00 am EST

Focus: MARKETS

Ronald Muhlenkamp

Founder, President, and Portfolio Manager, Muhlenkamp & Company, Inc.

Europe is still in trouble, and China has potential, but stocks in the US are fairly priced these days, or getting there, writes Ron Muhlenkamp of Muhlenkamp & Company.

We've been saying for a couple years that we're monitoring Europe, we're monitoring China, and of course the United States.

In the middle of last year, when Europe announced that they would do whatever it took to keep their banks from imploding, that seemed to be enough to help their bond markets. But it hasn't been enough to help the economies. France is now in recession, and Germany is growing very slowly.

When the European Central Bank said it would backstop European banks, we thought that took some of the pressure off the American-based international banks. We used that as a bit of timing to "up" our investments in financial institutions like Citigroup (C) and JPMorgan (JPM). That has worked out fairly well for us.

We're still not interested in owning most European stocks or making the bet on the European economy-and we aren't willing to go far enough out on a limb to bet on European bonds. What has been interesting is that interest rates, particularly in places like Spain and Italy, have come down very nicely. Europe's jawboning has helped their bond markets, but it's not helped their economy or their stock markets.

In the case of China, we do think its economy is expanding. Their new goal is about 7.5% GDP. It seems to be working a little slower than people expected. They are making a push toward more consumer spending and less infrastructure spending.

With Europe slowing down and the relative strength of the US dollar, commodity prices have come down-from steel to copper, basically the hard commodities, and lately gold. We do not own any material stocks or basic material stocks.

In the US, there has been no snapback from the recession of 2008-09. We are, however, growing at 2%, so on the nominal numbers, the US economy is above where it was in 2007.

On a real basis, that is inflation-adjusted, growth is just barely above what it was. If you look at per capita/real, we're still below where we were in 2007, which explains why a whole lot of people think we're still in recession.

With the November elections, we elected more of the same. We think that says that the pressure remains to raise taxes. In the meantime, the Federal Reserve is continuing to print money. It's buying Treasuries and mortgage-backed securities-about $85 billion a month. And it's buying about two-thirds of the debt that it's printing to cover our deficits. This has:

  • achieved the intended purpose of keeping interest rates low
  • added some support to the stock market

All that money has to go someplace. With low interest rates, it's been tempting for people to borrow money and buy stocks.

We own stocks where we think the company's balance sheet, earnings, and cash flows are quite good. The trend in the market has become a little bit more mixed, so we have raised some cash. This market will probably swing too far in both directions. But, on average, we think stocks are fairly priced.

We don't own any bonds. We think interest rates are below where they should be. We think interest rates are purposefully being manipulated by the Fed.

It's going to be more expensive to hire people, so we expect that employment remains disappointing. In general, the background/economy looks like about 2% growth in GDP.

We're trying to be more nimble. We're a little quicker to sell; we're a little quicker to raise cash. And we want to be sure that the companies that we do own make sense.

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