The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
By Karl Mills, CEO and Chief Investment Officer for Jurika, Mills and Keifer
NEW YORK (
) -- This ironic motto routinely uttered by Mad Magazine's eternally optimistic mascot, Alfred E. Neuman, usually in the face of formidable adversity, could also be the motto for the U.S. stock market.
In our last commentary, we wrote that the positive forces in the economy -- specifically global economic recovery and innovation -- were strong enough to outweigh the negatives, including
inflation and geopolitical risk.
Since that time, the world away from Wall Street has taken a turn for the worse. The spreading crisis in the Middle East and the tragic disasters in Japan are the two most visible negatives. But the resurgent debt saga in Europe, the rising tide of inflationary pressures around the world, and the growing battle between loose and tight monetary and fiscal policy are also significant challenges to confidence and recovery.
So far, after a few setbacks, the U.S. stock market has managed to maintain it's "What, me worry?" attitude, shrugging off these and other challenges and moving higher; posting its best first quarter since 1998.
We still believe that for now, the force of domestic recovery, fueled in part by an ongoing dosage of fiscal and monetary stimulus, is enough to maintain forward economic momentum and generally rising stock prices. But the headwinds are greater, and the time of stimulus is coming to an end.
Given overall valuation levels, and what we perceive as general complacency about these problems and their long-term impact, the recovery and financial markets are more vulnerable to these and further shocks.
We have therefore adjusted our client asset allocation to a more cautious and defensive position than we held in January.
We continue to find the most attractive investment opportunities in large capitalization stocks, especially those with a global focus involved with technology, capital goods and consumer products. Many of these companies have large cash reserves, offer attractive dividends and represent a better store of value and source of potential return than government bonds. There are also a number of very good companies that have fallen out of favor with investors for a variety of reasons and offer particularly attractive value relative to risk.
Commodities, including gold, precious and industrial metals, food and energy continue to attract investor assets, primarily as a hedge against inflation. Although this is a consensus investment thesis, as long as global growth and/or loose monetary policy rule the day, it should be one that keeps working.
Similarly, there is a consensus opinion that interest rates of developed nations must eventually rise. Barring a new deflationary spiral, this almost certainly has to be the case, especially now that the main marginal buyers of U.S. Treasuries, including the Chinese, the Japanese, many notable bond managers and the U.S. Treasury itself, are all in the process of curtailing their investment in Treasuries, while the supply of new Treasury debt to be issued continues to climb.
The good news is that the near-term economic trends continue to improve along multiple fronts. Industrial production, durable goods orders and capital investment and spending are still growing at a healthy rate. Consumer confidence and retail sales are also strong. Corporate profits and profitability are at record levels. Employment and housing remain the two most significant problem children of the recovery.
Although we are most certainly seeing a rise in inflationary pressures in this country, the greater problem lies abroad, especially in less developed nations that have to import and pay for their resources in dollars, and for whom food and energy represent a large portion of discretionary income. Inflation is becoming one of our leading exports and is sowing the seeds of global instability. We need to be mindful that in a closed-loop system like the global economy, what goes around comes around.
The Paradox of Crisis:
In our experience, events like the Japanese earthquake/tsunami/nuclear disaster and the conflicts in the Middle East, tend to create a paradox of crisis, where things are both better and worse than they seem. By this we mean that the near-term drama tends to get blown out of perspective, while the longer-term effects are under appreciated. There are almost always unintended and unimagined consequences as the chain of cause and effect works its way through the global economy and capital markets. This process often takes weeks and sometimes months to be fully understood and properly discounted in asset prices.
Putting it All Together:
And so as we put it all together, we see a world where the recovery is likely to continue, but where the overall risks and challenges to it have increased, while general stock prices have risen as well.
Some of these challenges are almost certain to work their way into the first quarter earnings reports and guidance of companies, which will begin shortly. We will likely hear of rising input costs, shrinking profit margins, and disruptions to company supply chains.
Other challenges, such as European sovereign and U.S. municipal and federal debt remain large problems without easy solutions. European bond rates have risen sharply since the beginning of the year, even in Germany. Rising interest rates and austerity programs are not positive for global growth.
Given that current stock valuations are still above where they were at the beginning of the year, we are concerned that expectations have moved ahead of reality and are not comfortable taking a "what, me worry approach" with our clients' assets. We are much more biased towards erring on the side of caution, while still maintaining a sensible long-term allocation to the global capital markets.
Perhaps, like Alfred E. Neuman, there is nothing to worry about, in which case stocks should have smooth sailing ahead. But we think the odds favor a more cautious approach for the time being.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.