Do not be concerned by the recent market pullback

US stocks peaked at a record high on May 21st, 2013, gaining 18% YTD.  Our forecast for the whole year was 8%, so either we were grossly wrong or the markets got ahead of themselves.  We told our clients that a 5-7% correction was totally to be expected.  For the last few months, we've mostly left cash in cash, waiting for a buying opportunity, which in fact may be upon us.

Since the record high, US stocks have fallen nearly 5%, and bonds have sold off as well.  The reason is very simple: the era of near zero interest rates is coming to an end.  There's not an investor in the world who doesn't know this, so there's a hair trigger tendency to sell on the slightest news.  It's as if 50,000 fans at Yankee stadium were half out of their seats, ready to rush to the exits at a moment's notice (someone will get trampled.)  According to the CNN Fear & Greed Index, investor confidence swung from "extreme greed" to "extreme fear" in just one month.

We are not planning on rushing anywhere.  It was only last April-June 2012 that stocks fell 9.8%, erasing the gains for the year (but still closed up 16% by year end.)  Anyone who jumped out of stocks June 1st, 2012 would have missed gains of 31.6% over the next 12 months.

We note that housing prices are on the mend - not soaring as during the bubble but rising enough to shift many homeowners into positive equity and stimulating housing starts.  Housing starts means housing construction, one of a few remaining high paying blue collar jobs that can't be exported.  Housing jobs means higher personal income, which increases spending and employment in service jobs.  The United States has many problems to resolve, but these problems are manageable.  Meanwhile stocks prices are driven by earnings growth, which is also on the upswing.

Questions from our clients:

Do we expect China to surpass the US in GDP?

On a straight line basis, China's economic potential will exceed the US by 2030.  Problem is, economic growth is NEVER a straight line.  Japan was on the same trajectory in the mid 1980's, but failed to transition from an export driven economy to a consumer driven economy and has been stuck in recession for 20 years.  We wonder if China will have that same experience, compounded by inadequate governance, terrible environmental problems, class conflict between the cities and the countryside and the demographic effects of the "one child" policy.

Is Obama a socialist or a fascist?

Neither!  Hitler was a fascist; Stalin was a Socialist.  To place Obama in either category is to show utter ignorance of history (displayed nightly on Fox News.)  Obama is a politician who historians will probably grade above Carter and below Clinton for effectiveness.  He'd have much smoother sailing if it wasn't for the catastrophic administration of George W. Bush, which managed to blow up the financial system and the retirement savings of millions of Americans while spending $5 trillion on two wars.

Will the United States survive?

There are two periods in United States history during which the fate of the nation hung in the balance.  The first was 1861-5 during the American Civil war.  The second was 1929-1940 during the Great Depression.  During the Civil War, about 620,000 Americans died in combat, along with about 150,000 civilians.  That was about 2.5% of the population, equivalent to 7.5 million casualties compared to the current US population of.  During the Great Depression, the banking system fell, unemployment reached 25%, GDP and wealth shrank drastically.

At present, US GDP is at a record level; American wealth is recovering, moving back towards the high set in 2000.  We will survive this period.