First, we would like to take a moment to wish you and your family a Merry Christmas, Happy Hanukkah, and a very happy New Year! Please enjoy the time with family and friends as we begin a new decade come January 1, 2010.
In recent weeks economic data continues to show improvement for the U.S. economy. Economic data, like most things in life, are usually measured on a relative basis. The economy looks fantastic relative to where it was a year ago and today it would be difficult to find someone who would argue that point.
But the past is the past and is now forever part of history. We must focus on the future and what lies ahead. In the financial world there is always an abundance of opinions and ideas. However, the smartest minds in the investment business and economic arena are theorizing totally different outcomes in 2010 and the years ahead. Some are expecting low inflation and slow growth for a number of years, while others expect a fairly robust worldwide recovery along with higher levels of inflation. We suspect the various economic outcomes will be debated heavily in future months. So what's possible for the economy and the markets in the years ahead?
First, we have to expect that interest rates will move higher in 2010 and beyond. A number of determinants have held down interest rates over the past year - a near-zero interest rate policy by the Fed, a surplus of savings around the world, government interest rate intervention and stimulus, a banking industry reluctant to loan, low current inflation readings and future inflation expectations, and quantitative easing by the Fed to jump start growth.
However, the higher probability of a reviving world economy, the structural imbalances and worsening financial conditions of our state and local governments, the liabilities associated with an aging population and the need to finance our federal deficit will likely weigh on the bond markets and interest rates in the year ahead. While it is always easy seeing the world from a rear view mirror, the difficulty, of course, is in figuring out when the turn will come. If economic growth is robust, the turn may come sooner. If growth is not as robust as expected, interest rates could remain at lower levels.
Second, we should expect higher inflation in the future. Again, it will be difficult to predict when it will start to accelerate, but we can be fairly certain it will arrive. The Fed is determined to bring inflation back and current policies will likely bring about their desired result. With so much liquidity being pumped into the global financial system through extremely low interest rates, massive government stimulus programs, along with Federal Reserve and other world government's monetary policies, we should expect a pickup in inflation, especially if we have no clear and definitive program in place to withdraw the excess liquidity from the system.
Third, just as the 1% interest rate policy and massive liquidity injections under the Greenspan administration caused the housing bubble and relatively lack luster economic growth coming out of the last recession; we can expect the 0% interest rate policy along with an obscene amount of liquidity injections under Bernanke will have unknown implications and unintended consequences. Unfortunately, it is extremely difficult to predict what will happen and where it will manifest. The unexpected could surface in a year from now, 2 years from now, or 5 years from now, but we can be almost 100% certain something will result from current policies.
Finally, there seems to be a societal and political shift towards more populist ideals in this country. Since the crisis began, more people are questioning the structure and perceived inequalities of capitalism and are beginning to think about alternative ideas on how to structure society. Citizens are collectively moving toward the belief that they are entitled to have access to what they need in order to live a full life. Of course, in our society, human needs have always come before private profits. These include access to food, housing, education, and medical care. However, "human needs" is a very broad term and is expanding to include other wants to which citizens believe they are entitled.
While this populist shift may not have an immediate impact on capital markets, if the movement gains traction there could be an impact on economic growth and corporate profitability in the future. If the economy recovers and the unemployment rate declines significantly, we should expect the movement to lose traction. However, if the unemployment rate remains high, the populist movement could really begin to impact policy coming out of Washington.
While we can attach a higher probability of certain outcomes in the coming years based on current economic conditions and market expectations, we can't predict the timing or possibility of another crisis, which would dramatically impact the probabilities of the various outcomes discussed. The next several years could prove to be very interesting and we look forward to navigating through whatever environment unfolds.
