ECONOMIC AND MARKET REVIEW SEPTEMBER 2014

“Indeed, this latest correction may be the steepest in the last three years. We believe that this is only another short term pullback in a secular (longer term) bull market.”

U.S. financial markets generally rose in the third quarter. Equities were led upward by large cap stocks, while smaller cap indices actually fell during the period. Longer maturity Treasuries went higher, while shorter maturities fell in anticipation of eventual Fed tightening. The preoccupation with the Fed gradually gave way to the realization that overall global economic growth remains sluggish and is stuck in the “New Mediocre,” – as characterized by International Monetary Fund Managing Director Christine Lagarde.

Economic growth has bounced back nicely after the bitter winter, and U. S. real GDP may grow at 2.2 -2.5% for 2014. The job market also continues to improve, though wage growth remains anemic at best,-which has restrained consumer spending. Other economic indicators are mixed as well, with manufacturing continuing to advance while housing related construction has stumbled.

The economy in the Eurozone has slowed, hurt in part to the sanctions imposed on Russia due to the ongoing conflict in Ukraine. Japanese economic reforms are proceeding slowly, while China is trying to cope with overinvestment in infrastructure and housing. Among other emerging nations, elections are playing a big role in market returns, with India still favored due to the policies of Hindu nationalist Narendra Modi, its new prime minister, and his Bharatiya Janata party. Meanwhile, Brazil’s economy, facing a presidential runoff between incumbent and first woman president Dilma Rousseff and opposition party challenger Aecio Neves, has been very volatile in 2014.

cartoon bank 9-30-14In Hawaii, a pickup in construction jobs has not yet happened, and local economists are starting to look at it as a 2015 event. Tourism is doing better, and 2014 may be a record year for both arrivals and visitor spending. However, foreign arrivals may be impacted next year if the current strength in the U. S. dollar persists or accelerates. The recent Ebola virus scare may also affect both local and mainland travel. Present indications are that although the virus is quite lethal, it does not spread easily (such as SARS). Also, the advanced countries have much better medical technology and hygienic standards than the developing nations where the virus was first discovered, so the extent of any contagion may be limited.

With the continuing sluggishness in many foreign economies, and now with the concerns about Ebola, stocks are undergoing another period of volatility similar to what occurred early in the year. Indeed, this latest correction may be the steepest in the last three years. We believe that this is only another short term pullback in a secular (longer term) bull market. Conditions for a major bear market similar to 2000 or 2007 are not present. Additionally, few economies globally are either in or about to enter into recession and country monetary authorities are generally pursuing stimulative policies. Central banks remain very sensitive to the issue of slow growth and the chances of a policy mistake by any of the major economies remains low.

North America, led by the United States, is the world’s economic engine again, similar to the decades of the 1980’s and 1990’s, when we last experienced a secular bull market. Careful security selection remains crucial in generating good investment returns. Many studies have shown that attempts at short term market timing do not work, a view shared by the great investor Warren Buffett, who has said, “With a wonderful business, you can figure out what will happen; you can’t figure out when it will happen. You don’t want to focus on when, you want to focus on what. If you’re right about what, you don’t have to worry about when.” We recommend staying the course and maintain our constructive outlook for the next few years.