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THREE INVESTMENT PHASES FOR 2010

THREE INVESTMENT PHASES FOR 2010

THE DOLLAR FELL IN 2009
In 2010, we expect the U.S. Dollar to fall against the Australian Dollar and other commodity-related currencies, but rise against the Euro and the Japanese Yen.
We see the world markets in 2010 as having three overlapping phases.

PHASE 1: A CORRECTION IN THE U.S. MARKET HAS BEGUN
The U.S. market falls due to attacks on U.S. business and Federal Reserve Chairman Bernanke.  Details on this were sent to readers in our last Friday commentary dated Jan 22, 2010.  The effect of the U.S. correction on foreign markets is yet to be seen.  We prefer foreign markets to the U.S.
Globally, interest rates have not been raised substantially.  However, they are inching up slowly and will begin to rise in Asia and the Pacific Rim, especially in Australia and China.
Until the onset of phase 2 , described below, the world will follow the lead of China, which now is considered the world’s healthiest economy.  However, if Chinese interest rates rise too much, it will speed up the commencement of phase 2 as follows:  Global Investors will discount future events.  People buy stocks today, discounting events that they believe will happen in the future.
Chinese GDP was up 10.7% in the fourth quarter of 2009. If investors believe that strong Chinese GDP growth will cause the Chinese policymakers to raise interest rates, they may sell global stocks well in advance of feared interest rate increases.  The logic is that higher Chinese interest rates will slow economic growth in China, thus slowing Chinese demand for electronics from the U.S., Taiwan, Korea, and Japan; machinery from Germany, Japan, and the U.S.; and raw materials from Brazil, Canada, Australia, and others.
PHASE 2 : CORRECTIONS IN THE WORLD’S FASTER-GROWING MARKETS

Once investors perceive that interest rates are beginning to rise in the better managed countries, stock and commodity markets will move down.  We plan to reduce our exposure and perhaps even be out of all stock markets (including the fast growing Asian and Latin American markets) and base metals during this time, as we believe they could be vulnerable to high volatility and declining prices.
During this period, the Euro and Yen should continue to fall in U.S. Dollar terms.  Gold should hold up better than commodities as a weak Euro and Yen will attract investors from Europe and Japan into gold.  Oil will be in a seasonal weak period as oil demand customarily begins to taper off in March.  We will repurchase oil shares after a decline.  The exception will be oil companies who are making new discoveries and adding to their oil reserves; we will continue to hold these companies.


PHASE 3: RALLY PHASE FOR THE WORLD MARKETS

During this phase, the fast-growing markets that we have written so much about over the last few years will rise substantially in our opinion.  After the initial reaction to higher interest rates dissipates, we expect a rally for stocks, oil, and gold.  The stocks that will do best are the Asian growth countries such as Singapore, Taiwan, Indonesia, and Hong Kong, along with India and Brazil. 
The U.S. rally phase will not begin in earnest until it is clear that the Obama Administration will lose some support and some seats in the Congressional elections.  Wall Street has lost confidence in the Obama administration, in large part because of its attacks on big business.
Within North America and Europe, we will focus on export-driven stocks.
In our opinion, those who buy during the decline in phase 2 will enjoy good investment performance for 2010 as a whole.  The markets will be volatile, and those who succumb to the pressure and buy high, or sell low, will be penalized.
SUMMARY

We expect world markets to be volatile but trade sideways or rise slightly through early spring.  After that time, we expect a correction in world markets. We believe that the stock market correction has already begun in the U.S.  Later in 2010, the stock market will resume a strong uptrend.  We believe that the key to global market success in 2010 is to buy quality export driven companies when the stock market dips.  Those who buy on dips during the correction period should enjoy the fruits of the market rally later in the year.
When holding cash balances, we would avoid the Euro and Japanese Yen, and favor the Australian Dollar and other commodity-oriented currencies.  This is a year to hold cash during declines and look for bargains.  After the declines, we expect the bull markets in stocks, oil, and gold to resurge.
The world banking system has been liquidating excess leverage and consolidating its operations for the last two years.  This deflationary process is continuing in the U.S. and Europe, and was set off by the credit mortgage and real estate pricing collapse which began in 2007.
U.S. Politicians, as is their tradition, have made a hash of the financial recovery.  They have voted for an ineffective TARP bill, while larding it with handouts to ensure their re-elections.  Politicians were also widely responsible for the credit meltdown in the first place.  They pressured banks to make bad loans to people who had no chance of repaying, but who had an excellent chance of voting.
To be fair, we must point out that the politicians were ably assisted by greedy investment bankers, overleveraged bond speculators,  mortgage bankers, real estate brokers, appraisers, a compliant accounting profession, and a shockingly incompetent and conflict-of-interest-ridden group of ratings companies who rated as AAA many mortgage bonds that were worse than junk bonds.
An article on this subject that we believe is helpful to understanding this problem and its current evolution was in the Jan 23-24 Financial Times.  The article is by John Authers, and it is titled “Politicians look to enter another Faustian pact.”  Please see below for article from Financial Times.

Financial Times
Politicians look to enter another Faustian pact
By John Authers

Published: January 23 2010 02:00 | Last updated: January 23 2010 02:00

Politics, the art of the possible, always defines what is possible for markets. But this only becomes evident in times of stress.

Since credit markets lapsed into crisis in 2007, the key moves have all been made by the world’s governments, led by the US. This is still the case.

It was a perceived political failure to make an adequate response to the problems created by the bankruptcy of Lehman Brothers – the US Congress’s initial refusal to vote through the Tarp bail-out plan, and the European Union’s failed attempt to agree on co-ordinated deposit insurance – that triggered the global equity collapse in early October 2008.

In a more limited and less dramatic fashion, politicians again triggered sharp falls for stocks this week. After the rally in the US S&P 500 from its nadir in March had reached 70 per cent on Tuesday, stocks endured a 5 per cent sell-off.

There are several levels at which the politics matter. First, governments’ borrowing, through issuing bonds, provides a baseline for financial markets. Any fear that they cannot be trusted to repay their debt is potentially lethal.

To read article full article please visit http://www.ft.com/cms/s/0/b1379f2a-07bf-11df-915f-00144feabdc0.html

POSTSCRIPT
Last Friday, in a surprise announcement, President Obama unveiled a proposal, unofficially termed “The Volcker Rule,” to separate banking and brokerage operations within the nation’s financial industry.  This plan, which was initially introduced by financial elder statesman and former Fed Chairman Paul Volcker, would in effect introduce restrictions on the behavior of big banks that also trade for their own account.
This action is partially in response to information such as a recent article in the January 13, 2010 New York Times.  An excerpt from the article by Andrew Ross Sorkin says:
“In an e-mail message to select clients, Thomas C. Mazarakis, the head of Goldman’s fundamental strategies group, acknowledged that his unit often provided investment ideas that the firm had already traded on. Sometimes Goldman has even taken the opposite approach, betting against particular instruments that the group has recommended.
‘We may trade, and may have existing positions, based on trading ideas before we have discussed those trading ideas with you,’ he wrote.  The statement comes as the firm faces growing criticism over its role in the financial crisis, and is a rare acknowledgment of Goldman’s conflicts with certain of its clients.”
We do not wish to focus entirely on Goldman Sachs.  In our opinion, conflicts of interest have existed at major investment banks in the past, and reports about these conflicts have appeared in the press over many years.  The investment world is, and has been, buyer beware.
As a result of a new program instituted after the credit collapse, banks have access to money at very low interest rates through a program called the Temporary Liquidity Guarantee Program or TLGP.  This program allows banks to borrow at 0.66% (less than 1%).
We agree with the spirit of Mr. Volcker’s proposal.  Clearly, trading and extreme risk taking on the part of banks, especially while enjoying access to money which allows them to pay very low interest rates while employing immense leverage, is risky. It is not rocket science to determine that such action is dangerous and unwise for the financial future of the nation, and for the financial well-being of the taxpayers who would have to bail them out if their gambles once again fail.
Although the President is taking the first tentative steps in trying to remove the control of Wall Street from his administration, Congress (which is still beholden to Wall Street for financing their re-election campaigns in November 2010), is not about to turn on their biggest donors in an election year. In our opinion, this legislation, wise though it may be, is not likely to pass for another two or three years.
Thanks for listening.


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