BE PATIENT AND WAIT
This is easier said than done, but to us, this seems like the prescription for 2007. We need to be patient and wait for the events which seem to be unfolding in world economies.
CORPORATE PROFITS WILL GROW RAPIDLY IN THE FAST GROWING COUNTRIES AND THE FAST GROWING INDUSTRIES
The primary determinate of stock price appreciation is corporate profit growth.
Stocks in fast growing countries and industries will be volatile, but they will respond to corporate profit growth. They always have in the past. This response will take the form of sending the stocks of the companies which grow upward. Assuming that this chain of events happens, companies in our favorite countries and industries (those with powerful tailwinds) will rise in price. We are being patient and waiting for the inevitable market correction that these countries frequently have about once a year. At that time we will add to our positions.
In our opinion, Gold will act as an alternative to poorly managed currencies, and although we expect inflation to moderate this year, gold could rally as people begin to seek the security of real money instead of the badly managed paper that most countries put out and call currency.
NON U.S. CURRENCIES
The better managed foreign currencies have every reason to rally against the U.S. dollar. This will happen over the intermediate term. Over the short term, it is possible that the U.S. dollar can rally, especially because it fell from August through November. Some traders argue that it is due for a rally. The modest rally of the last five weeks may suffice; we certainly believe fundamentally that the dollar should fall. A continued rally in the U.S. dollar would ignore the short, intermediate and long term fundamentals. It is not however, uncommon for traders to ignore the fundamentals for a period of time. In fact, they have been doing that a lot lately.
SCORING THE FUNDAMENTALS OF THE U.S. DOLLAR
For this exercise, we will use the following scoring system:
a score greater than +1 = bullish
a score of -1 to +1 = neutral
a score below -1 = bearish
Short-term currency valuation indicator: Real interest rates (current short term interest rates less the current inflation rate).
U.S. interest rates are flat, British Pound rates are rising, Japanese Yen rates are close to rising, and Euro rates are steady.
Impact: neutral to bearish for the U.S. currency. Score: -1 for the U.S. Dollar.
Intermediate term currency valuation factor: Relative economic growth (relative to the economic growth rate in competing countries).
The U.S. economic growth outlook is improving slightly due to lower oil prices and the impact of global demand for U.S. goods and services. Europe, Asia and Latin America all import energy. The U.S. will have higher demand for its food commodities. Corn demand will increase as more is consumed to make ethanol, and increased prices of soybeans and other feed grains as substitutes for corn in animal feed. Europe, Asia and Latin America also sell food commodities which will be benefited by increased demand. This will stimulate the economic growth of Europe, Latin America and Asia by at least as much as it stimulates the U.S. economy, and their economies are already growing faster.
Impact: neutral to bearish for the dollar. Score: -1 for the dollar.
Long term currency valuation factor: Deficit versus surplus (Budget, Balance of Trade, and Balance of Payments)
The U.S. is running triple deficits, and they are getting bigger and bigger with each passing day. Nothing is being done to deal with them, except in the case of the Budget deficit the plan appears to be to make it larger by spending more on Afghanistan, more on Iraq, and to bring in a bunch of new pork barrel projects.
Impact: bearish for the dollar. Score: -2 for the dollar.
Adding up the Score
If the total score were to total +2 or higher, the dollar should rise. If the total were +1 to -1, then we would expect a neutral dollar. If the total were -2 or lower, then declining dollar would be the expected outcome.
Based on our assessment of the short, intermediate and longer term factors that determine a currencies value versus other currencies, the evidence favors a declining U.S. dollar as it scored a -4.
SOME GLOBAL INDUSTRIES WITH TAILWINDS
Consumer Goods (in countries with fast economic growth)
Financing Capital Spending (in fast growing economies)
Financial Services and Advice (for restructuring industries and companies)
Feed Grains (and companies that serve the feed grain industries)
There is a shortage of narrow bodied passenger planes for Asian regional usage. Local airlines in Asia want to have more routes from one side of India, China or other countries to the other. People are starting to travel on business and tourism much more in these countries and there is a shortage of planes. There is a huge demand for used narrow body and regional jets.
There is also a huge demand for railroad equipment as China and others plan massive increases in their spending on railroad construction (more on this below).
China has announced that it will spend over $15 billion a year for the next fourteen years upgrading and expanding their railroad facilities. This creates huge demand for equipment and raw materials such as steel, copper, zinc, nickel and coal, among others. Many other developing counties have immense plans for infrastructure development and they only grow larger with each passing year.
Consumers in the developing world are just starting to get their feet wet consuming. India has a lot of domestic consumption because the country does not encourage foreign capital and the consumer markets were developed by British and Indian firms in the mid 1800’s. In China, such is not the case. Consumer goods are just making a rapid and effective entrance in China, and we expect a lot more consumer spending in Asia in coming years.
Solar, nuclear and wind power much more developed in areas outside of North America and this will continue. We are looking at companies that supply parts to the wind power industry.
Global Financial Services-
Recently, we have spoken with managements of many of the world’s largest financial institutions, and they are all aggressively expanding in Asia and in Latin America. The world is their new profit center and they are shopping for customers and investments in the developing regions like never before. This bodes well for higher valuations in the Indian, Chinese, Thai, Taiwanese, Hong Kong and many other developing stock markets in the months and years to come.
Agriculture Feed Grains-
Increasing wealth in the developing world and more demand for biofuels both argue for higher costs of food stuffs. As people get wealthier, they eat more meat. More meat means more feed grains and this means higher prices for soft commodities.
Well, so much for our latest memo. Please contact with your questions and comments.