October 21, 2013

Surgeons do better with checklists...

Peering through the smoke and fog surrounding the just-resolved government shutdown and debt ceiling crisis, I noticed something interesting from recent studies of casualty rates at major city hospitals: Mortality is much lower when surgeons are given written checklists.

When evaluating the US economy in the fourth quarter of 2013, perhaps investors could use a checklist too.

Amid the gruesome tabloid reports of patients being poisoned or having the wrong surgical procedures done, it isn't so surprising that surgeons — among the most highly trained professionals anywhere — would need checklists to prevent them from making as many mistakes.

The atmosphere in Washington has become so poisoned that we expect politicians to delay, defer and distance themselves from the real long-term problems. While we're waiting for the next Congress to once again face the same critical issues, let's consider our own checklist to help us evaluate the patient known as the US economy and see where we should be investing.

Investment climate checklist
  1. Are the patient's vital signs stable?
    • Leading indicators are increasing.
    • Manufacturing and service orders are rising.
    • Final demand remains steady.
  2. Does the patient take any special medications or have any allergies?
    • The economy is on a strong — possibly even addictive — dose of low interest rate medicine.
    • The economy is allergic to asset bubbles, though with no apparent overvaluations in the private sector, any excesses are likely to be avoided for now.
  3. Does the patient have any genetic advantages or particular strengths, such as regular exercise or a balanced diet?
    • Compared to other developed countries, the US has the advantage of a growing population, including an "echo generation" that is entering the home-buying years.
    • The US has an abundance of accessible natural gas, which is reducing electricity and ethylene prices, thus lowering input costs for US exports.
    • The US ranks among the top developed counties in worker productivity — that is, goods and services measured per hour worked or dollar paid.
    • These advantages have allowed the US manufacturing base to grow as a share of the whole economy.
  4. What about the patient's nervous system?
    • The corporate enterprise system is experiencing record free cash flow and some of the highest profit margins ever reported.
    • Total profit as a share of GDP remains at all-time highs.
  5. Is there any danger of infection?
    • The biggest risk is a contraction of economic activity, or recession.
    • The most toxic vector for this type of infection is the excessive use of credit, which isn't happening now.
    • A sustained decline in profits would also be lethal, but again, profits measured against the economy are still rising.
    • Higher short-term interest rates would raise the risk of an economic slowdown, though there seems little chance of short-term rates rising in the near term.
  6. Does the patient face any other risks?
    • A collapse of emerging markets would hurt the sales of US multinationals, but tentative signs of reacceleration suggest that most EM countries are emerging from the slowdown.
    • The European economy could fall apart, although the German chancellor has been reelected and it remains in her country's self-interest to avoid recession by continuing to support the indebted nations of the eurozone.
If we are surgeons about to operate on — or invest in — the patient known as the US economy, we can conclude after running the appropriate tests that the necessary vital signs are stable. Are we exaggerating the patient's state of health? I don't think so. Since the last recession, the markets have moved up almost 150%. Is this excessive? Not if we consider that the stock market has been following company fundamentals in earnings, cash flow and balance sheets. With the patient appearing to be in extraordinary health, moderate selective risk-taking is likely to be rewarded for another couple of years and perhaps longer.

No forecasts can be guaranteed.

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.


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