"Kee" Points with Jim Kee, Ph.D.

I’m in New York doing some media interviews. The following are questions I have received, so I thought I would share the dialogue for this week’sKee Points. For most of you this will be redundant, so I apologize in advance!

Question 1: What are the three most important things every investor should have on their radar today?

 

I feel like I’m supposed to say “European debt crisis,” “Slowing China growth,” and/or “US debt/deficit problems.” Those are all important, but I think they are more accurately described as“things that take your eye off the ball.”Nobody knows how Europe is going to turn out but, frankly, I’m more encouraged than discouraged by what I see coming out of Europe. Its two steps forward and one step back for sure (with concomitant headline risk), but the tangible actions taken by independent governments and union members overall seem to be in the same direction: (1) working towards keeping the union intact, (2) matching the monetary union with the member fiscal union (at least better than what currently exists), and (3) avoiding a global financial/credit freeze. As for China, just know one thing: China fears high unemployment and the social unrest that follows, and it will do everything in its power to avoid a hard landing. That includes monetary and fiscal policy, like lowering reserve requirements (monetary) and accelerating 5-year infrastructure spending plans (fiscal). As for the U.S., the big issue is the future “entitlement tsunami,” particularly Medicare, which will be felt in earnest after 2020. The thing to keep in mind here is that this problem will be handled not with debt default or hyperinflation, but rather through “means testing” benefits, that is, the more you have (income/net worth) the less you get (benefits). There are 1001 ways to do this. Means testing is in addition to small tweaks that make big differences, like changing inflation adjustment procedures for benefits, and/or changing eligibility (like age) requirements.

 

Rather, I think investors should keep the following in mind:

 

Avoid short-term forecasts and focus on the longer-term relationships among asset classes.Usethe markets through disciplined diversification rather than trying to outsmart them.Think “process over guru.”Be cognizant of history. Bull markets with above average returns began in periods like the depths (1932) of the Great Depression, or going into and through the largest global war in history (WWII), or during the highest escalations of the Cold War. It is just not true that the world today is more treacherous for investors than it has been in the past (though recent daily volatility has been high!).The things that are going to drive investment returns going forward aren’t what people are talking about now; that’s known and priced in. It’s the balance of unforeseen shocks – positive and negative – that will determine the future performance of various asset classes.

Question 2: What is the most important thing you are watching right now?

Oil prices and U.S.policy uncertainty, both tax and regulatory policy. Higher oil prices – particularly if they are supply-driven or driven by speculative activity – can act like a tax on producers and consumers and slur growth. But the U.S. is less energy intensive (energy use per unit of output) than it used to be, so I don’t see this as a recession threat. Policy uncertainty is another concern, because too much policy “churning” or uncertainty about taxes and regulations will put business decision-making regarding capital spending and hiring (both of which are forward-looking) on hold. This promises to be a particularly raucous elections cycle, and policy uncertainty is pretty high right now. It could come down in the coming months, which is what I’d like to see. But there’s no way to know in advance. We just have to watch it all play out.

It should be helpful to focus on four things: Autos, housing, exports, and business investment. Normal expansions are driven or led by autos and housing, but these two sectors have been largely on their backs for the past few years. Fortunately, exports and investment spending have been a bit above average, which has filled the gap. But that also means the U.S. economy is more sensitive than normal to global GDP growth (exports) and the overall policy environment (investment spending). And these could slow, because of both policy uncertainty (bonus depreciation, etc) and because of a Euro area recession and slower emerging markets growth (exports). So it is important that autos and housing start to turn up, and it looks like they are. That’s why oil prices and policy uncertainty are so important, in my opinion. I don’t want them derailing what looks to be a nascent recovery in housing and autos here in the U.S.

So it’s not one thing I’m watching, but a lot of things!