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Our Investment Flash written the morning after the January 1 fiscal cliff deal has proven to be the right call, as the after-tax attractiveness of dividends has now drawn investors to the stock market for four long months. In re-reading this missive, I am now confronted by my own choice of words suggesting that this strength could “last for a while.” In Wall Street parlance this could mean anything longer than an hour; so, after four consecutive months that descriptive phrase is clearly becoming “long in the tooth.”

Determining the direction of things is difficult enough, but answering the “when?” question is tougher…but I’ll give it a go.

The market strength has surprised many as it comes out of a very lackluster economic environment. Especially surprised are the stewards of pension plans and endowments who have prescribed all-time low allocations to equities and high allocations to bonds and alternative investments. As bonds have done virtually nothing this year, endowments and pension returns for the first quarter are typically substandard. And as economic growth has been anything but robust, many private equity and venture firms are also having a tough time delivering on promises.

Accordingly, since the first quarter results were disseminated, we expect that many institutional funds are reallocating more monies to the stock market. This money should be finding its way into the market during the present quarter, creating a demand disequilibrium that should continue for another month or two. Likewise, the many individual investors who were advised to invest overseas during recent years are learning that a strong dollar is eroding the value of their savings resting in foreign markets and foreign currencies. We can also expect an exodus from foreign markets as our dollar appreciates and our markets advance. We find ourselves enjoying this “virtuous cycle,” but it certainly can’t go on forever.

In order to understand America, we must now keep an eye on international monetary and economic policies. Initially, our own policies were our primary concern as our Central Bank quickly began printing money to ward off the effects of the negative credit and business cycles of 2009 and 2010. As these problems eventually encompassed Europe and the Far East, other Central Bankers quickly followed with their own versions of QEI, QEII, etc.

Today, we have a unified, and apparently coordinated international banking effort to print money to avoid a cyclical, debt-driven, economic downturn. In effect, we now have a “race to the bottom” by all countries. In this kind of a race, the United States with its relative stability will probably come in last…meaning we win! As capital becomes threatened in less stable environments, it will flow into the U.S., further strengthening an already strong currency.

Additionally, economic signs within the U.S. are picking up. Unemployment claims are down, while tax revenues are up. Political advocates of the current policies are already “crowing,” hoping that these tax revenue numbers will convince Republicans to abandon spending restraints and debt ceiling arguments. These added tax revenues are no surprise to those who took income/capital gains last year in order to avoid today’s higher tax rate. The tax payments for last year’s gains have just been paid. (How quickly we forget!) Nevertheless, it all sounds good and helps buoy the positive stock market mood.

Real Estate numbers have turned for the better, as demand for homes is diminishing inventory overhang. This all, of course, is being fueled by artificially low interest rates, the byproduct of all the “newly printed” money. After all, those that couldn’t afford to buy a home with an 8% mortgage can now do so with a 3% mortgage. Sound Familiar?

Insofar as this market bounce is riding a wave created by Central Bank liquidity and positive comparative dividend tax rates, we can effectively gauge the turning point by carefully watching the Federal Reserve for signs of change.

This wave, however, promises to be bigger as it also includes potential international money, created by the new “race to the bottom.” Lastly, we cannot overlook the positive secular economic effects of our growing domestic energy production. As the U.S. becomes more energy self-sufficient, our vulnerability to Geo-Political forces is diminished, making us more of a safe haven for liquid global capital.

It all adds up to a potentially large wave, capable of surprising everyone as to the strength and duration of the upside move. Should the rise become more parabolic, the risk of a fall from higher levels will become apparent, frightening many and bringing increased volatility to markets, but let’s deal with that when and if the time comes. In the meantime, try to enjoy the ride.

In answer to the question about “when?”…not yet.

About the Author

Harlan J. Cadinha
Founder, Chairman and Chief Strategist




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