SPENCE Asset Management

Is time on our side? April 2013

As the first quarter of 2013 fades into the record books many investors, economists, and politicians are having difficulty reconciling U.S. stock market behavior with U.S. economic performance. It isn’t the first time there has been disconnect between stock price performance and the economy. While the long range correlation between aggregate U.S. stock prices and the U.S. economy is pretty direct, investors should not be concerned with over-analyzing U.S. aggregate stock prices for the first three months of 2013.

However, for intermediate and even fairly long stretches of time, what is more important for investors are to analyze and compare the investment options that are available. Money is always on the run and it always has to go SOMEWHERE. A quick review of the choices available to investors:

We have said many times that the bulk of investment capital tends to flow into one of three primary areas: 1) interest bearing instruments, 2) income producing real estate, 3) ownership interests in businesses.

Interest bearing instruments: For the past five years interest bearing instruments have been subject to what amounts to incredible government price controls. During this time frame the U.S. government has been borrowing more than a trillion dollars a year while elected officials overseeing the Treasury Department and Federal Reserve refuse to pay market rates for these funds. Instead, they have used Fed policies to crush interest rates down to unprecedented levels and hold them there. This has made it relatively easy (for the time being) for the U.S. government to borrow and spend.

There is no doubt that an interest rate market that is absolutely dominated by government policy has wide reaching effects on the market pricing mechanism for bonds. Simply put, bonds have never been more expensive.

Income producing real estate: Well-located income producing real estate, serving tenants with stable long range economic prospects has usually been a solid investment choice. Inherent to the property investment decision are answers to two tricky questions: 1) Is the property going to always be well-located, and 2) Is the prospective tenant pool likely to continue to enjoy stable long range economic prospects?

The outlook for most income producing real estate properties is and always has been murky for many reasons- some specific to geographic region and some specific to the type of real estate. But even the most fantastic real estate properties must be managed. And perhaps most important of all, real estate is relatively illiquid. But there are two key global factors affecting traditional commercial real estate investing that cannot be ignored: 1) The demand for commercial real estate has been jostled thanks to the incredible phenomenon of online retailing. And 2) Technological developments that make virtual office environments possible for many workers which is reducing demand for office space.

Ownership interests in businesses: The reason why stock prices have been rising nicely lately has as much to do with the factors associated with the discussions above of interest bearing instruments and income producing real estate as anything else. Given the factors above, shares of businesses are really currently the only investment option offering the investor growth.

This begs the question: When will the government stop interfering in the market pricing mechanisms that determine the terms agreed upon by lenders and borrowers? Nobody knows. The best bet seems to be 2017 at the earliest. However, it is also worth noting that the longer there is interference and displacement, the more imbalances in the systems will be created. The longer we pile on U.S. government debt, the lower interest rates will have to be to service that debt in order to avoid a disaster.

What can an intelligent investor do while this unprecedented era of government control over the primary factor affecting all pricing mechanisms plays itself out? This is a question we ask ourselves nearly every day.

And our conclusion? Ultimately, we feel that it is important we do our best to make sure time is on our side, instead of having time work against us. This means owning instruments that have a very strong chance to deliver growth in cash flows over time which means owning shares of businesses with excellent growth prospects.

With a slow growth environment in the U.S., a recession in Europe, and distinct uncertainties in Japan, China, and the rest of Asia, there is simply no variable we know of other than growth that can put time on our side. We can only assume that the Rolling Stones had the ultimate confidence in their investment approach decades ago:

Time is on my side, yes it is Time is on my side, yes it is Now you always say That you want to be free But you'll come running back (said you would baby) You’ll come running back (I said so many times before) You’ll come running back to me If those now aging rockers were actually singing about their investments back then, the “running back to me” they were referring to must have been GROWTH.

Again, money is always on the run. While we are stock investors by trade, it is crucial we keep our eye on the other available options for money. And given the alternatives, we believe that the only way we can protect ourselves and make sure time is on our side, is to correctly identify reliable growth situations. While this may not be particularly easy to do during an unprecedented era in U.S. economic history, it is not impossible; there are still pockets of growth out there. We are hopeful that we own shares of major players in growth industries, and, no matter the time frame, we are always keeping our eye on where eventually, investment capital is likely to “run back to.”

Jim Spence, Eric Walton

The information contained herein is for informational purposes only without regard to any particular user’s investment objectives, risk tolerances or financial situation and does not constitute investment advice, nor should it be considered a solicitation or offering to investors. To determine if investment in a Separately Managed Account with Spence Asset Management is an appropriate investment for you please call 1.800.230.1840.

Investment Advisory Services are offered through Spence Asset Management, a federally registered Investment Advisor. Investment Advisory Services offered through IAR’s of Spence Asset Management, a Registered Investment Advisor to all residents of the United States.

The views expressed here are those of Spence Asset Management and are subject to change with market conditions. The information contained in this newsletter is derived from sources believed to be accurate. You should discuss any legal, tax, or financial matters with the appropriate professional. Neither the information presented nor any opinion expressed constitutes investment advice or a solicitation for the purchase or sale of any security. Market forecasts cannot be guaranteed. Past performance does not guarantee future results.