2013 was a year to remember, as wary market participants watched stock prices hit new highs. The U.S. stock market continued to astonish bystanders as it marched forward in the face of a U.S. government financial disturbance, ongoing European financial and political turmoil, conflict in Syria, and a shaky economic and financial foundation in China.

The Standard & Poor’s 500 (S&P 500) closed the year with a healthy gain of 32.4%, delivering a home-run year for giddy investors. Impressively, the S&P 500 has risen more than 177% from the March 2009 low—an exceptional climb in a relatively short investment period.

Despite the market run-up, various questions linger:

  • Will we be able to get our economic growth back on a “normal footing” and get back to historically lower unemployment rates?
  • What will happen if the U.S. government is unable to reach consensus on how to manage longterm budget and debt issues?
  • What will be the market reaction once the Federal Reserve further reduces support for quantitative easing (the ongoing monthly purchase of U.S. Treasuries and mortgage-backed securities)?
  • Can Europe re-invigorate economic growth as more affluent regions are required to subsidize the less affluent?
  • How fast can China develop a self-sufficient economy, and what impact will this have on global trade?

We do not know the answers to these questions. When we step back to evaluate the global economic landscape, however, we remain concerned about circumstances that could lengthen the ongoing worldwide political and economic stalemate. We see common global problems that will become more unmanageable over time unless they are addressed. These include:
1) The inability of the world’s major economic powers to collaboratively deal with growing deficits and debts
2) An unwillingness of U.S. elected officials to contend with large government entitlement programs that are unsustainable in their current form

Due to the harsh financial penalties to citizens that would result, countries continue to delay developing solutions to these shared global challenges. Of course, this inaction only worsens our economic woes as debts continue to mount. In the meantime, in an effort to create market and social stability, governments and central banks are implementing short-term “band-aid” measures to address our common financial and social challenges. Near-zero short-term interest rates, ongoing quantitative easing (purchasing government and government-backed bonds), along with rising government debt all seem to accommodate global citizens in the near term, but over the long term these solutions are not sustainable. We will eventually have to stop “kicking the can down the road” and deal with our financial and social challenges if we are to set ourselves on the path of creating long-term value for all global inhabitants. In our opinion, the longer we procrastinate developing solutions to address these concerns, the greater the probability that the type of market fluctuations that have characterized the past 10 years will continue.

For the time being, financial markets have recovered due to government financial stimulation. Despite the positive market results over the past five years, however, our experience tells us that caution and prudence should prevail going forward. Why?

We recently read a book, Antifragile, by Nassim Taleb. The author presents a basic premise: In a desire to create a stable environment in any endeavor, we often create fragility, ultimately leading to unintended instability. In other words, an attempt to over-control the environment in any area, such as education, healthcare, economies, etc., often leads to a situation that gets out of control. For example, we can compare the government’s desire to control the current economy to an overprotective parent intervening in the life of an out-of-control high school teenager. When the high school teenager is facing many restrictions, along with the threat of severe grounding for each small infraction, we all know what usually happens when this teenager experiences the complete freedom of being away at college. Similarly, over-control and interference today can lead to a destabilized situation in the future.

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2013 Annual by ValueWalk.com