"So I decided to take time out to reflect on the possible meaning of all the churning that I see in the securities markets, in the halls of Congress and statehouses, in the meetings of international bigwigs. One thing I have concluded is that the whole world economy is groping for some kind of equilibrium, some sense of stability. I have listened to your interesting conversations this afternoon, and I can tell that you also sense this extraordinary measure of uncertainty in the financial environment.
"I want to suggest that in such a time, the key to successful investing is to outline for ourselves a finite number of high-confidence beliefs about the economic and market environment, to invest boldly based on these convictions and to continually measure the validity of our convictions against the stream of data from the real world. I would like to share some convictions that I have about the investment environment, and I hope you might weigh in on these issues the rest of the day.
I am convinced that large-cap U.S. stocks on average remain very overvalued relative to current and prospective earnings.
Earnings estimates are too rosy. Profits in the late 1990s represented a larger share of GDP than the historic norm, so a recovery to those levels is a risky assumption. Furthermore, corporate profits going forward will be pressured by global competition, excess capacity, imbedded pension obligations and more rigorous reporting standards.
Domestic demand for goods and services will be sluggish. Companies generally have more incentive to reduce debt than to expand capacity, so it may be a very long time before we see robust capital spending. On the consumer side, aging boomers will be increasing savings at the expense of consumption. Our auto and housing stocks are as new as they have ever been, so when interest rates stop falling, demand in these two large industries seems likely to fall; unless we erect deadly trade barriers, imports will keep gaining share against domestic vendors, with a predictable impact on U.S. jobs and consumer spending.
Business competition will be unusually stiff and only the best operators will survive. Financial flexibility and competitive advantage are critical. Perhaps not a good time to buy the equity index.
This is not a promising environment for riskier credits. A lot of debt will probably have to be written off before the threat of deflation is put to rest.
The spread of democratic capitalism is the most critical variable in emerging market prospects; optimism seems warranted, but it's early.
An increasing role for government will be a drag on U.S. economic energy, regardless of whether it is funded by taxation or borrowing.
In a sluggish economy, longer-term interest rates have room to decline, and P/E ratios have a lot of room to decline. It will not be an environment that can sustain long periods of investor enthusiasm, so rallies in stock prices will be suspect until a sense of stability prevails.