Economic & Market Update
By Richard Morey

May 5, 2010

THE ECONOMY

As our longer-term readers know, over time I always end up basically following what Warren Buffett recommends. At Berkshire Hathaway’s annual meeting last year, he described how the economy was going to be in “shambles” throughout 2009. A few months prior he had said the economy was likely to have difficulties until around 2012. This was the same time frame I was getting from other economists I respect.

I am glad to report that, at last weekend’s annual meeting, Mr. Buffett spoke mostly about the strong growth he is now seeing in Berkshire’s 80 companies. He indicated this shows the broader economy is growing. This makes sense, because these companies include one of the largest railroads, some of the larger insurance companies, and dozens of retail-oriented companies. And Mr. Buffett knows growth when he sees it.

At the same time, Mr. Buffett does not appear to be concerned about further waves of losses from mortgages. Of course, the bank of which he is the largest shareholder, Wells Fargo, has never owned many of the bad loans. But it is more than a little noteworthy that Mr. Buffett is not talking about any large disruptions in the banking industry. In his position, and with his background, I assure you he would see them. Instead, Mr. Buffett’s general tone is one of watching the U.S. economy experience some real growth that he says has begun to accelerate over the last two months.

The other major concern I have had involves sovereign debt defaults in Europe. When asked about this, Mr. Buffett basically said it was a fascinating play to watch. He did not express concern that this would lead to losses for a bank like Wells Fargo, so he does not seem worried about this.

On the other hand, as an investment advisor to individuals, I do have to be concerned about sovereign defaults. Should one other European country need to be bailed out, we could easily see the markets around the world plummet by 25% or more very quickly. And there is a reasonable chance this could happen.

As a result, I plan to remain fairly conservatively invested until there is more clarity on further sovereign debt defaults. But as soon as we’re relatively sure that storm has passed, we will immediately get back to our normal stock and bond allocations. This will include purchasing one or more new stock-based mutual funds.

We eventually want to again own international stocks, but at this time they are all simply too risky. Asia remains seriously overpriced, while Europe will go down much further quite quickly if another country gets into a sovereign default situation. Plus, they are looking at entire countries in their region getting ready to experience depressions. At this time, the U.S. market looks like the best place to invest.

Ideally we would obviously like to make our final stock fund purchases when the sovereign debt default risk leads the stock market to its lowest point in this general time period. Of course, that’s our goal, but the stock market is far from predictable, particularly in the short-term. We’ll do our best. Whether we hit the lowest purchase price or it goes still lower, if the underlying economy is
growing and the best companies are seeing opportunities to increase their profits, we are completely confident that over time our stock investments will give us superb returns.

Better days are ahead for our economy, once we get through this very risky situation involving possible additional sovereign defaults in Europe. Greece hasn’t officially defaulted, as they were bailed out by the International Monetary Fund. Even so, many believe they will officially default before their troubles are over. And while the best stock funds should still deliver good returns over the next few years, if another European country defaults, I’m pretty sure that will bring the entire world stock market down substantially. I therefore remain cautious until this risk has clearly passed.

Richard Morey