“Stock picking is both an art and a science, but too much of either is a dangerous thing. A person infatuated with measurement, who has his head stuck in the sand of balance sheets, is not likely to succeed. If you could tell the future from a balance sheet, then mathematicians and accountants would be the richest people in the world by now.”

 - Peter Lynch, Beating the Street

The good news for now is that the economy is showing signs of growth in sectors other than inventory rebuilding and productivity – pointing toward a more sustainable recovery. What follows is both positive and negative evidence of the current situation (late April).

 
Positive:

• Existing home sales are up 14.7% in the past nine months (annualized).
• Vehicle sales have improved 25% year-over-year.
• Retail sales continue to strengthen.
• Credit card delinquency rates continue to improve from the ’09 peak.
• Homebuilder shares have more than doubled over the past year – along with a double in lumber prices.
• Durable goods orders are up nicely since mid ’09.

 Negative:

• U.S. unemployment claims, usually an accurate economic indicator, are almost unchanged over the past three months. This suggests weaker GDP than most estimates.
• The U.S. core (intermediate) Producer Price Index has increased at a 7.3% annual pace in the past 5 months.

 
Bonds and Interest Rates

Our economy continues to show signs of continued recovery but, when combined with the massive deficits and entitlements we have set in motion, it should be natural to expect inflation and rising rates. For now, our expectations are for a slow-growth economy – a result of corporate America’s violent reaction to recession and probably over-doing it on cost cuts and layoffs. Present, somewhat robust, corporate spending is probably not sustainable and slowing will most likely not add to upward pressure on rates or cause inflationary fears to intensify.  As was our thought in the last quarter’s report, the balance sheet re-building that will be necessary in the financial sector, in households, and to a lesser extent in corporate America, has a way to run. Higher than normal unemployment, tight lending standards, and a recovering but weaker than normal housing market translate to an extended recovery. It follows that the Federal Reserve probably will not act to raise rates until late 2010 – early 2011, after we are more assured of a lasting recovery. The current steepness of the yield curve reflects this investor concern for rising inflation and an overheating economy. Again, we don’t think this will happen and eventually the curve will be less steep, particularly on the long end.

At present, yield spreads between U.S. Treasuries, Government Agencies and corporate bonds doesn’t make much sense to us. We prefer to buy Agencies – mostly step-ups with maturities less than 5 years and are seeing virtually no corporate bonds worth the added risk. Municipal Bonds also are few and far between – with low yields and scarce and unrealistic pricing.

 
Equities

Thanks to the month of March, equity markets finished positive for the first quarter. Cyclical names – probably indicative of a growing perception of economic recovery, industrials, financials, and discretionary names outperformed while commodity related stocks in energy and materials lagged. “Value” type stocks have outperformed “Growth” so far this year and smaller, high Beta stocks have outperformed larger companies.