WHAT IS ALIVE IN 2005?
Please forgive our rhyming attempt in the first title. 2005 should have areas that are definitely alive and fit for investment. It also will have areas that are dead and should be avoided to protect the health of a portfolio.
1. Energy companies which serve the fast growing Indian and Chinese markets where demand for energy far outstrips supply.
2. Energy transportation and/or utility companies that pay high and rising dividends, and offer a combination of capital appreciation and yield.
3. Energy companies which are discovering natural gas in Canada, and pay high and growing yields. These companies are also prospects for both capital gains and income.
4. Precious metals stocks should outperform in the latter part of the year, and if the situation in the Mid-East blows up, in the early part of the year as well.
5. Foreign currencies- after a U.S. dollar rally in the early part of 2005 we expect the dollar to renew its decline later.
6. Middle sized companies in India, Taiwan and Korea who will benefit from demand from Chinese, Japanese and U.S. import markets.
7. Small, fast growing companies in the U.S. and Canada that can grow rapidly, and are currently priced below market peers. Primarily in the Internet, medical, nutrition/health food and consumer areas.
8. Our biggest concern about 2005 is the possibility of a further blow up in the Mid-East, mostly in Iran, Saudi Arabia and maybe Syria sometime this year. If this occurs, oil and natural gas stocks will skyrocket, world stock markets will fall and gold will rally strongly.
1. Big technology companies in Europe.
2. Big industrial and consumer stocks in the U.S.
3. Long maturity debt instruments.
4. Anything in Iraq.
5. Anything in Syria.
6. Anything in Saudi Arabia.
We see 2005 as a year with a great deal of global political uncertainty.
In Iraq, the cost of the war and reconstruction just keeps rising as the country moves inexorably toward civil war. I think the election polls will be poorly attended, as the chaos seems to be growing and spreading. The cost is going to be many times what had been originally advertised.
Syria and Israel are now engaged in a strong war of words. I assume that Israel is acting as the U.S. point man in the dispute. Will the U.S. invade Syria or bomb Iran in 2005? None of the above mentioned events would add P/E multiple points to the market.
Economic growth in the U.S. should be about 3%. Inflation will rise and the Federal Reserve will raise rates several times to stop inflationary psychology from taking hold.
Higher interest rates have always been anathema to the market. This is because interest rates in short-term money market instruments compete with equities for money. Higher yields on bonds, and savings instruments of all types attract money away from stocks into these alternatives. Hence, strong stock markets are not correlated with rising interest rates. In fact there is a reverse correlation.
IN SUMMARY, HIGHER INTEREST RATES ARE BAD FOR STOCKS IN GENERAL
An aside- higher interest rates are also bad for residential real estate and bonds.
THE BIG RISK
The whole world is set for modest to strong growth in 2005 (modest in the U.S. and much of the developed world, strong in the emerging world [China, India and Russia]). Recent events in the Mid-East have put this scenario in danger. There is a strong possibility of a new blow up in the Mid-East originating in Saudi Arabia or Iran. If this occurs, all bets are off for slow growth in the developed countries. Such a blow up argues for an oil price of above $60/bbl. This oil price would lead to substantially diminishing economic growth globally.
A FAIRY TALE
Once upon a time in the 1980’s there were some “geniuses” [so called] working at a gold mining company. One day they noticed that the price of gold was declining. They decided to hedge forward their production [sell, at current prices, ounces of gold not yet produced] of the gold mining company. Over the years they managed to hedge [sell ounces not yet produced] many years worth of future production.
This worked well for some years, and while other gold mining companies were reporting lower earnings per ounce mined, the “geniuses” were getting good profits from the gold, which had been sold at higher prices. They were applauded, promoted and given big bonuses.
Then one day, the price of gold began to rise. The “geniuses”, who had sold at higher prices and enjoyed the ride down, ignored the price rise and circulated all kinds of rumors that the rise would not last and prices would again fall. They were aided in this propaganda campaign by the brokerage houses and banks, which had made so much money writing the hedges and derivatives and selling them to the gold company. After two or three years of rising prices, the price went from slightly above $260/oz to over $400/oz, the “geniuses” who had engineered the great hedging coup were no longer with the company. They were fired. The “geniuses” were replaced. They were replaced by people who believed that hedging is unwise in a period of rising prices.
The moral of the story is bulls make money, bears make money and hogs get slaughtered. The second moral is trends change. After a few years, any trend reverses. One must be alert to reversals of trend. Do not believe the disinformation promulgated by those who have money to make from the trend remaining in place. No trend can fight logic for long, no matter how high the PR budget of the trend beneficiaries.
A similar series of events is being played out in the oil markets.
FAIRY TALE #2: OIL PRICES ARE GOING TO FALL INTO THE $20 RANGE AND STAY THERE
Like everyone else, I would love to see oil prices fall. It would help the economy, remove inflationary pressures, increase optimism and help stocks rise. Unfortunately, one only needs to read the international press on a regular basis to see how much of a tinderbox the Mid-East is today. After the warmest U.S. November and December in a number of years, oil is $48/barrel. Where would it be if we had a cold November and December?
Traditionally, at the end of the home heating season in North America, Europe and Japan energy prices decline and stay down until the next heating season approaches. I sincerely hope that this pattern plays out this year, however I have grave doubts that such an outcome is likely. Mid-East tension in Iraq, Syria, and Saudi Arabia all could unhinge this prediction.
Increased demand from India and China is not seriously factored into the equation by many observers. They do not yet see how the world supply and demand outlook for oil has changed. I congratulate those observers who have pointed out the changes.
The fairy tale today is about the fantasy that oil prices will fall back into the $20 range and stay there in 2005. Is it just the brokerage houses that wrote the derivatives to the oil companies who are still putting out the propaganda that oil prices will fall to $29/barrel and stay there? I guess they would rather not lose money on their derivates, for themselves and their clients, than be correct on their prediction about the oil price. One answer would be that they are stupid, but that is far from the case. They are very intelligent, and much too wise to admit anything that could damage their derivative positions. Look for some derivatives executives at major firms to lose their jobs in 2005.
Oil will be a big factor in 2005. If the Mid-East continues to have problems, and especially if Saudi Arabia has problems, oil will exceed $60/barrel in 2005. Not average $60/barrel, but exceed. If oil exceeds $60/barrel, we will have an unattractive year in most stock markets outside of the fast growing core of South and Southeast Asia.