NOTEWORTHY

Chevy Chase Trust - Investment Update, Fourth Quarter 2018

Investment Update: Second Quarter, 2009

This is a quarterly update of economic conditions and investment strategy.

Economic Conditions

First quarter, 2009 U.S. GDP decreased at an annual rate of 5.5%, the third consecutive quarter of economic contraction and only slightly better than the previous quarter of minus 6.3%. While economies throughout the world continue to contract, for the past six months U.S. economic performance is among the worst of the major economies in the world—both developed and developing.

Given the magnitude of the fiscal and monetary stimulus we expect positive GDP growth by the end of this year. Inventory rebuilding will be an important element in this uptick.

The growth spurt very likely will be limited. The reversal of the housing bubble has more to go and the housing sector is crucial to a sustained recovery. In the next round of weakness, high-end residential real estate may be particularly affected. Also, commercial real estate loans almost certainly will be a problem over an extended period. Many of these are interest-only notes that will be coming due for refunding that may not be forthcoming. Moreover, considering the magnitude of the Federal budget deficit, relief in the form of a larger stimulus is unlikely.

Key economic data tell the whole story: employment, personal income, output, and capacity utilization are at deep recessionary levels. The unemployment and underemployment figures are particularly disconcerting. Unemployment is pushing 10%, and adding underemployment — part-time employees unable to find full-time work (the BLS U-6 measure) — the figure is approximately 16%. Also, there has been no let up in initial and continuous unemployment claims.

The news is not much better at the State and local level, which comprise more than ten percent of the U.S. workforce. California is issuing IOUs to pay its bills—an extreme case given its uniquely volatile revenue. Municipalities will find it difficult to find new revenue sources to offset lower income and property tax revenues.

Consequently, we see modest growth at best through 2010, generated by Government stimulus spending.

There are possible game changers. On the positive side, a bipartisan plan that addresses the structural deficits in Social Security and Medicare would greatly improve confidence. Individuals and businesses would be in a better position to plan expenditures, savings and investments with better information on future entitlements. A plausible plan would also restore confidence in other Government financial programs. On the down side, the growth in China that so many are counting on to provide global stimulus may not be there. The banks in China have not disclosed their non-performing assets; real estate may become a big problem; and there are reports of serious underemployment and unemployment.

Investment Strategy

Despite the aforementioned slow growth forecast, there are a number of attractive investment sectors. These sectors have strong underlying secular trends that are likely to bridge a slow growth period. Examples include:

  1. Energy – Depletion rates of producing oil fields strongly suggest an imbalance of supply and demand that will put upward pressure on prices, even if full throttle is given to alternative energies. This will happen over an extending time period, becoming more visible when world-wide economic growth resumes. The value of politically safe oil reserves will be greatly appreciated then, and this is where we will be invested.
  2. Water – This is a crisis in formation that may become more serious than the energy problem. More areas world-wide are losing valuable land resources due to drought conditions. In addition to specific companies involved in the water industry, a few countries are very well situated, e.g., Canada and Brazil.
  3. Food – Tied in with the water problem, a growing deficit exists between food production and demand. This will almost certainly get worse as the wealth of the developing countries grows and the composition of their food consumption changes. A revolution is under way in agricultural technologies, especially in seeds and crop use.
  4. Healthcare – As noted, it’s a big problem that will become more so as the demographics take hold and not just in the U.S. and Europe. Japan and China also face rising medical costs and workforce changes associated with aging populations.
  5. Electrical Transmission – A full national update of the transmission grid is needed, here, and in many other countries. Use of the grid for transportation and the internet will drive demand for decades. A few U.S. and foreign companies are well situated.

Finally, it will be more important to consider the international dimensions of investing. There are many reasons for this: growth may be higher in other countries than in the U.S.; unlike the past, some countries will be much less dependent on export growth to prosper and will become consumer markets; there are world-class foreign companies uniquely situated to deal with the new secular demands; and it may be necessary to hedge the U.S. dollar value of our investments to sidestep their depreciation in the event of a weakened U.S. currency.