Portfolio Strategy Update: May 2011
Providing customized solutions for long-term financial objectives
For the past several weeks, I have been altering the composition of client portfolios, transitioning them to a more defensive posture. This piece discusses the reasons for the changes and detailsthe specific investment decisions.
Issues / Concerns
1)The broader economy and the stock markets may lose momentum with U.S. fiscaland monetary stimulus being scaled back.
In developed economies such as the United States, the economic recovery from the GreatRecession has been mediocre at best. One would expect this weaker growth following a financialcrisis. For the past year and a half, I have cited empirical data from studies performed by McKinsey Global Institute and Reinhardt/Rogoff (in their book
This Time is Different
, to whatsome have referred as “The Bible for analyzing financial crises”). The data indicate how a lengthy deleveraging (i.e., debt reduction) period nearly always follows a banking crisis, creating asignificant headwind to vibrant economic growth.Since almost every financial crisis results from an excessive build-up of debt, it is common toobserve declining credit growth after a crisis because: i) debtors are unable to borrow against less valuable assets (think home prices), and ii) banks are unwilling and/or unable to lend becausetheir balance sheets contain a higher proportion of delinquent loans.In the United States, negative private sector credit growth has constrained the strength of theeconomic recovery. As Table 1 illustrates, this post-recession credit growth is in stark contrast tothat during the typical post-World War II recovery, during which time borrowers and banks werein much better financial shape.
Table 1 The Role of Private Sector Credit Growth in Post-WW II Recoveries
GDP DECLINEGDP GROWTHPRIVATE SECTORDURINGIN RECOVERYCREDIT GROWTHRECESSION(FIRST 18 MONTHS)(FIRST 18 MONTHS)Q4 1969Q4 1970-0.2%8.8%15.4%Q1 2001Q4 2001-0.3%2.7%12.7%Q2 1960Q1 1961-0.5%9.7%13.6%Q3 1990Q1 1991-1.4%4.8%5.5%Q4 1948Q4 1949-1.6%16.7%23.4%Q1 1980Q3 1980-2.2%1.4%17.0%Q2 1953Q2 1954-2.5%9.9%19.5%Q3 1981Q4 1982-2.6%11.7%18.6%Q3 1957Q2 1958-3.1%9.8%16.7%Q4 1973Q1 1975-3.2%7.5%11.9%
Q4 2007 Q2 2009 -4.1% 4.5% -6.2%
: U.S. Bureau of Economic Analysis and U.S. Federal Reserve