Corporate America’s lack of confidence appears to be manifesting itself again as the economy seems to be losing a bit of steam.  However, notwithstanding the fact of the recovery environment, it is still normal for our economy to “ebb and flow”.  We do however, think that our economy will reinvigorate during the second half of the year.

While the U.S. economy is on stronger footing than a year ago, we’re not getting a lot of vigor, or acceleration.  On the positive:

1. Two million more American are employed.
2. Commodity prices appear to be rolling over which could result in the lowering of food and oil prices in the months ahead.
3. Housing permits are up which is, of course, a positive leading indicator for homebuilders.

With this deceleration, the equity markets have flattened.  We have been expecting a corrective phase, but that correction may come in the form of a sideways movement in the coming months as the summertime approaches.  In looking beyond summer, we feel the markets will eventually extend to higher levels than where we are trading today.

We continue to like financial service companies and it looks like the homebuilders are gaining some momentum.  Both of these sectors have provided leadership in moving the markets higher, which is encouraging as these are the two main groups that led us into the 2008 “Great Recession”.

The first quarter of 2012 is almost in the history books and the markets have posted one of their best quarters in almost ten years.  It’s almost as if the calendar flipped and everyone’s mood took a turn for the better.  In reality, our economy has continued to improve and the market is simply reacting to the stronger data.

From here, the biggest question we have: “Is all the good news already priced in?” From a long-term perspective we believe there is room for continued growth.  In the short-to intermediate-term, we believe the markets are beginning to lose momentum and may be ready to take a breather.  The catalyst for this corrective phase could come from a couple of primary areas:

Global fundamentals are not strong.  While they appear to be improving, the question becomes: “How much of this economic momentum is already ‘baked into the cake’?” The world economy is at a barely-growing-2%-level.  Additionally, as we previously forecasted, Europe has fallen back into recession.  Lastly, peaking profit margins and a decade of fiscal austerity have held back the private sector.

China is weakening dramatically.  This is probably the biggest threat to our recent growth push.  With the Communist Chinese Government, of course, there is little trust in the country’s economic reports.  There does, however, seem to be consensus that the economy has cooled from many years of an 8%-plus-growth rate to something in the 7-7.5% range.  That’s a dramatic dip for an economy with a 5% plus inflation rate.

Overall, we are seeing some very encouraging things out of our economy and this market rally is strong confirmation.  However, we have also seen how quickly things can change and how quickly money can be lost when the markets reverse.  Our firm’s philosophy has always been to buy corrections and not chase markets, which is why we are holding back some cash right now.  We will look to do some buying if the market corrects “nicely” in the coming months.  But, for now, there are several reasons the market could enter a corrective phase.  Rest assured, we will not simply throw caution to the wind because of market momentum.

We have seen payroll increases of roughly 300,000 per month for two straight months and as we have been saying, job creation is the single biggest catalyst for our current economy.  Jobs, of course, produce consumer spending.  On the same note, perhaps the best insight into the strength of the US consumer can be seen by the expansion/contraction of consumer credit.  For the three month period ending December 2011, this component surged nearly 8% on an annualized basis.  This is a very good sign for consumer strength.  The question then becomes:

1) Is this simply an unstable path based on some type of pent-up emotional demand or,

2) Is it confirmation of the underlying strength seen in the latest payroll report?

…of course, only time will tell.

Notwithstanding these potential favorable indicators, several risks remain.

1) In spite of the Greek bailout, the European debt crisis is still unresolved.  As such, Europe will most likely fall back into at least a mild recession at some time during 2012.

2) With oil now trading north of $100 per barrel, this will quickly become the biggest threat to our recovery.  Economies are driven by energy and energy is overwhelmingly supplied by oil. No matter the political rhetoric, this will not change for many generations to come.

We saw a 13,000 DOW this week, which is encouraging.  From an investment perspective, we have identified several sectors of potential opportunity in which we are looking to start building.  We are anticipating a mild pull-back to help us nitiate positions in some of our favored areas.

The markets finished 2011 with some momentum and, for the first several weeks of January that momentum fed into 2012.  The markets seem to have begun the year with a sense of relief, almost as if to say, “It simply feels better now that we’re not in 2011”. While it is not based on empirical data, market participants are almost giddy to start the New Year.

There remain a myriad of positives and negatives in this economy, which is why we saw no real headway made last year.  The European debt crisis continues to be the most negative headwind we are presently facing.  As of this writing, it appears they may have hammered out a deal to write down/swap much of the troubled Greek debt, which would have some positive ramifications for the Eurozone.  The problem is, we have seen this story before and the markets are very cautious to anticipate this.  On a positive note, the economy technically remains on reasonably solid footing.  Our channel checks point to an economy that grew 3+% in the fourth quarter and that, in perspective, is a good number.  Keep in
mind that we continue to believe what we’re seeing in our economy is more a “crisis of confidence” than a wealth problem.  Earnings remain strong and corporations are hoarding cash.  With the Eurozone issues and the political gridlock we’re experiencing, companies simply don’t have the confidence to go out and expand their businesses.  However, a change in confidence with markets can develop quickly and we believe that at some point in 2012 that could very well happen.

In looking at historical tea leaves, let me mention that we actually have a couple interesting tidbits working in our favor coming into 2012.  First, the fourth year of a presidential term typically has a positive bias in the markets.  Conventional thinking is that it is because investors feel the “ship will be righted” in the next four years.  Also, for whatever it is worth, but true nonetheless, years that end in “2” have historically shown outperformance.  Obviously, these types of  outperformance precedence aren’t set in stone.  But, it’s nice to know we may have a slight edge coming into this election year.

Frankly, many of the fundamentals of our economy are improving:

1. GDP growth appears to be accelerating with our  current channel checks coming in around 3.5% annualized.  If sustained at this level, it would be strong enough to create new jobs.  Obviously job growth is the primary driver to consistent economic growth.
2. Christmas sales have been remarkably strong, with online retail leading the way with a 7% increase year over year.  While consumers have continued to spend, the high numbers of unemployed consumers has kept a cap on the economy.

However, the other 2 negative factors which we must ultimately solve for sustained economic health are:

1. The European sovereign debt issue… a long-term solution must be forged out.  So far the crisis has been dealt with by applying various short-term band aids.
2. The U.S. debt issue… Our aggregate national debt has now reached 100% of our annual GDP this is a level we have not experienced since WWII.  Obviously, until there is a long-term political solution to this it will continue to plague our economy and thus our markets.

We would hope that the 2012 elections will provide some clarity for our economy and markets.  In the meantime, we will continue with vigilance to find niches of opportunity while exercising a cautions perspective.

On behalf of our entire team, I leave you this month with my most sincere best wishes for the 2012 New Year.

Notwithstanding…

The European Debt Crisis.

The failure of Congressional Super Committee.

No relief in sight for the US Housing Crisis.

Record high unemployment levels.

I am writing this letter today watching:

A stock market close for the day with an almost 500  point gain (Dow Industrial).

An economy still growing at a 2.0 – 2.25% GDP growth  rate.

Black Friday sales numbers which set new records.

The market continues to trade at the mercy of changing news out of Europe and in a US economy with no real accelerated growth.  However, at the “end of the day” as we approach the end of the year, it appears that the market will end with positive growth for 2011.

As we have discussed in the past, money always is “chasing” security and yield.  In spite of all the issues, there still is nowhere else in the world that better provides security and potential yields than the US.  Hence money continues to flow into the stock market driving it higher.

Except for unforeseen geo political circumstances, we cautiously expect this rally to continue through the end of the year and into early 2012.

As we enter into the Holiday Season, on behalf of our entire Delta team, Please accept our very best for a most joyous Christmas and prosperous New Year!

As I write this month’s letter, I am watching the market rise above the 12,000 (Dow Jones) mark.  This rally is a result of a European debt bailout by the European Union, the international monetary fund, and of all people, China.  In fact, the market is on course for the largest monthly point gain in the history of the Dow Jones Industrial Average.

That said, what does all this mean to us as asset managers?  That question is perhaps best answered in an assessment of both short and long term perspectives:

On the short term:

The need for a European bailout was the result of major sovereign debt issues across the continent.  The default issues started with Greece, but the bigger fear was that a Greek default would spread to countries like Italy, Spain and Portugal.  None of these countries individually is a major driver, but the ripple effect could be devastating.

This current market rally, while well received, may also be an oversold bounce before we go lower, so we’re being patient in this area.  It’s not that we don’t appreciate the rally; we simply need more evidence it’s sustainable.

We are still not seeing consistent job creation.  Of course, this continues to be the primary catalyst for full recovery.  As discussed in last month’s letter the primary reason for lack of job creation is lack of confidence in the political direction of our country.

On the long term:

Corporate earnings are good and corporations are flush with high amounts of cash.

Consumers have much stronger balance sheets than in recent times.

While consumers have retrenched and become more fiscally responsible, their spending continues to keep our economy afloat.  They have, however, curtailed spending on luxury goods, autos and housing.

Even at the panic lows of 1998, stocks were about twice as expensive as they are now.  The markets are at very reasonable long term valuations, which should eventually be a strong catalyst for growth.

On a personal note…  We as Americans have the great privilege and freedom of celebrating in a few weeks, The Feast of Thanksgiving Day.  On behalf of our entire Delta Team, please accept my very best wishes for a day filled with thankfulness.

In the past hour while writing this letter, the Fed announced the implementation of another monetary strategy in an attempt to inject more cash into the economy.

Of course, the stated objective is to “spur economic growth”.  But, the operative question is: “Do we have a ‘money’ problem or something else?”  It is our belief that it is not a “money” problem plaguing us, but rather a “confidence” problem.

There are, of course, many factors which lead us to such a conclusion…to look at a few:

The markets continue to essentially churn sideways with no real confidence.

Over the past several months, the economic data has been very mixed giving us no real foundation for growth.

Large amounts of money flowing into treasuries, thus driving down yields.  In fact, the 10-year bond closed today at its lowest level ever.

The markets are trading at very low equity valuations and dividend yields are very high compared to historic levels.  Thus, we are seeing substantial long-term value but not real catalyst to attract buyers and thus drive the markets to higher levels.

Now…interestingly, corporate insiders have continued to buy up their own stock.  But… these insiders are typically early and are looking long-term.  We continue to agree with these insiders that the long-term economy capital markets have substantial potential.  But, the short-term is a bit cloudier.

As always, we continue to look for emerging trends and sectors which have potential upside growth.  At the end of the day we still have a 14 plus trillion dollar economy.  And… that’s a lot of commerce and potential opportunity for investors.

We think there are a lot of comparisons between the summer of 2010 and 2011.  First, we see the same array of indicators lining up now as we saw a year ago.  Does that mean we will experience the same 4^th quarter results as 2010?  Obviously, we will not know that answer until early 2012, but there are a lot of “under the surface” positives that people are simply choosing not to see.

As we have often said, ultimately at the end of the day, markets are driven by one thing and that is corporate earnings.  At closer glance, we see many positives on the earnings front:

1. Second quarter earnings reports were very strong but, maybe more importantly, most companies have continued to hold their guidance.  That translates into the fact that these companies believe they can hit their 3^rd quarter projected earnings.

2. Corporate insiders have been buying a “ton” of their company’s stock.  The reason is obvious; they believe they can make money buying their own stock at these levels.

3. Additionally, most leading economic indicators are still pointing to positive growth for the remainder of 2011.

History tells us that, when markets suffer a shock and the technical picture is broken, time is needed for them to heal.  So while we fully expect to see more choppy waters in the short-term, we believe that a strong run by year end is
forthcoming.

In a worst case scenario, we “could” see ratings agencies such as Moody’s, S&P and Fitch downgrade U.S. debt.  Such downgrades would possibly be more damaging than the default itself as it would likely force increased selling pressure on all forms of U.S. debt, leading to higher interest rates and lower bond prices.  Additionally, because we’re in a slow economic recovery rising interest rates would slow our recovery further, as borrowing costs would go up for companies and individuals.

History does not give us many comparisons for our current dilemma.  But, it is worth remembering that we experienced government shutdowns in late 1995 and early 1996.  In those instances, the stock market performed quite will.   In fact, the Dow Jones was trading around 3800 in November 1994 and around 4900 at the time of shutdowns.

What we need to focus on is that the markets are a “discounting mechanism”.  In other words, much of the fear of a shutdown was already “baked into the cake” in 1995 as the markets had anticipated a shutdown and adjusted/discounted  accordingly.  Of course, the prior results do not guarantee a positive outcome, but it does serve as a helpful antidote.  What the markets cannot discount are occurrences and events which are truly unexpected and unanticipated.  The markets know this issue is looming and arguably, investors have already discounted accordingly.  Case in point, the S&P 500 is currently off about 5% from its highs and the markets have essentially gone sideways since January.  This is against a backdrop of improving corporate earnings, with much of this scenario is already built into the markets.

At the end of the day, the capital markets are signaling that America will not default on its obligations.  While our current situation itself is disconcerting, it should not have a very long lasting effect because corporate earnings, not politics, drive the capital markets.