I believe we’ll see recovery, not recession

Author: Gehman Capital

Covestor model: Undervalued Growth Companies

Gehman Capital’s Undervalued Growth Companies model is a small cap portfolio that is designed to maximize rates of return over an extended period of time. I do not market time to avoid losses, or take profits in the short term. I choose to invest in companies that I think have a product, or products, that will generate long term profits and have the financial resources to withstand the stresses of start-up companies. For all of 2011, the account was down 41.4%. In 2012, the account is up 17.8% as of early February.

I believe that certain US equities are underpriced and, more broadly, there is a lot of money currently available for investment in the global economy and markets.

Most every central bank in the world in trying to force money into the world economy. The money has allowed the US to avoid an extreme disaster, and will continue to stimulate a recovery – it may be slow – but I believe it will be a recovery – not a recession.

Now that the US is starting to recover, it is the European debt crisis that is pressuring stock prices. I believe that Europe will also avoid a serious meltdown and will eventually rebuild their economies.

We know it is political and social differences that is causing Europe so much trouble in defining a solution. There is a strong consensus building now, however, that if there is a large enough fund to “ring-fence” the problem countries that the extreme pressure and discussion of defaults will be eliminated. When this happens, each country can go about repairing their structural problems and will eventually be provided with stimulus money to help them grow out of their financial stress.

The solution resides with Germany, which has the capital and the will to create a fund to “ring-fence” the problem countries. But – they are not going to do that until they are convinced that controls are in place to be sure that the weak countries will not – again – throw money at the “dark hole” of a welfare state that cannot sustain itself.

Once Germany makes the money available – their ability to determine how the money is spent must be pre-defined. If they just make the money available – it will be wasted. Germany is waiting for a European structure that can sustain itself.

Germany, however, has almost no choice – it must stabilize the European Community and the Euro for their international trade. Germany’s economy is strong because of their exports. Their exports are strong because the Euro is cheap – the Euro is cheap because the weaker countries cause it to be cheap. If Germany had to trade on the Deutschmark – or some other German currency – their exports would be expensive and they would be suffering like the rest of Europe.

Therefore, I believe that Germany will use their resources to stabilize the European Community – but only when they are convinced their money will not be going down the “black hole.”

What does this mean for stock prices? Investing is a process of analyzing risk and reward. I think the US stock market is assuming that there is a 50% chance that Europe will drag the US economy down. I think there is only a 20% chance of this. Even if it takes a long time for the European Community to recover, the US economy is much more dependent on China and other emerging countries. Therefore, I think it could be extremely expensive to be entirely in cash – as many investors are.

In the worst European case, I think US stocks could drop in the area of 20%. Therefore, I suggest that investors invest the percent of their portfolio that can withstand a 20% drop. Note, now, that I think the odds are very high that the stock market will move on to greater heights. If Europe has a problem, the market could easily have a significant drop, but over a reasonable time period, I think the market will recover.

That is because the US economy is not dependent on Europe – it is dependent on the domestic economy – which is being flooded with cash from the Federal Reserve Board – and the emerging markets – which are being driven by the growth of the new middle class.

Obviously there are risks in the economy, but I think the risk-reward favors putting some money in the market.

Extreme amounts of capital are available around the world Germany needs the Euro to maintain their strong economy Germany has the capital to seed a fund that will “ring-fence” the problem European Countries.

The European Community will recover over time, and I believe there is a high probability that stocks will trade much higher over time.