Let’s take a look at the bullish side of the ledger for U.S. stocks for a change.
The November U.S. congressional election is likely to bring in more pro-business and anti-tax legislators and the U.S. stock market is already beginning to discount this news. The fact that political gridlock is the most likely prospect for the next two years is music to the market’s ears. This is because investors are nervous and unsettled by some political rhetoric that has been circulating, which portrays them as bad and even dangerous to the economic wellbeing of the nation.
P/E ratios for stocks are low and good quality, high dividend paying blue chips are selling at the lowest prices in decades. In fact, a number of blue chip stocks have dividend yields that are higher than the yield on 30-year U.S. government bonds. A large number have dividends that are larger than the yield on 10-year U.S. government bonds. It is certainly reasonable to expect that over the next 30 years the yields on these companies will rise, while the bond yield will stay fixed to maturity. This reinforces our view that 30-year government bonds are a poor investment at this juncture.
For the last 10 years as the baby boomer generation has aged they have been selling stocks to buy more bonds for their retirement. Given the situation explained in #2, it follows that logically more investors, including retirees may start to buy stocks for income.
Investors are frightened and pessimistic and share prices have reflected this fear. Part of the fear may recede as the negative rhetoric on business is toned down in the future.
There will soon be a reversal of flows as money moves from bonds to stocks. For 10 years money has been flowing out of stocks into bonds. This trend has been exacerbated in the last year and 8 months, as money has flowed into bonds and $11 billion has flowed into emerging market stocks, $17 billion additional into other foreign stocks and hundreds of billions into bonds according to the Investment Company Institute. When money starts to come back into stocks, it could easily cause rapid market rise as buyers look for stocks with strong dividends.
Ben Bernanke’s recent statement that the Fed will step in and support the U.S. economy, and by proxy the stock market, has quelled deflation fears. While we have never expected any other course of action, his statement has visibly revived the market. Clearly, should inflation begin to creep back into the U.S. investment picture in 2011 (as we anticipate it will), stocks will be a far superior investment to bonds.
GOLD ACTS VERY WELL TECHNICALLY AND FUNDAMENTALLY
How do we account for the fact that gold and silver have been strong, even while the rumors of a double dip recession, deflation, a collapse of demand from China, and many other panicky stories have been all over the financial news?
1. Commodities in general have done very well; not only food commodities but also metals commodities. Our friend, Dan Norcini, recently expounded on Jim Sinclair’s excellent website (www.jsmineset.com) about the continuous commodity index (CCI) and its performance. Dan points out that the CCI has gone from about 32,760 to 51,000 in about two years. Gold and silver are leading the way with some foods and base metals also participating. Energy has participated to a lesser degree. “What has transpired since (the summer of 2008) is most remarkable. The sector has now bested all of the major Fibonacci retracement levels and looks to be headed towards the next level of resistance just above the 55,000 level.”
2. Is there anyone out there who can honestly say they see deflation in the overall basket of goods that they purchase to live (food, energy, household expenses, education, travel and vacations)? Please let me know if you see such activity in your personal expense calculations. If you can, we will stand corrected.
3. Anxiety and fear of financial upheaval in the developed world has led people to seek the safety of gold.
4. Countries with economic growth and higher standards of living for their people often have an historical predisposition toward using gold as an insurance policy against economic and political tumult. Citizens of India, Vietnam, China, Thailand and others have a tradition of holding gold for security. They see gold as an alternative for a much larger percentage of their portfolio than do people in the developed world with the exception of Germany and Switzerland.
DEMAND PULL INFLATION IS RISING IN THE EMERGING WORLD
Strong economic growth in Malaysia, Singapore, China, India, and Brazil is leading to demand pull inflation. In these countries, rising demand leads to rising prices, which create demand pull inflation. Today, many people in the emerging world are enjoying more prosperity and thus they are spending more money. This spending and growth is causing prices to rise as demand exceeds supply.
In addition, demand for raw materials from Peru, Columbia, Chile, Thailand, and Indonesia are rising and will continue to grow. On the other hand, Venezuela’s self-inflicted implosion and Mexico’s ongoing internal war shifts orders from Mexico and Venezuela to more stable neighbors.
In order to diminish inflation central bankers in some countries will raise interest rates. The rise in interest rates will attract capital and cause the currency to rise versus the U.S. dollar and the Euro. Rising incomes lead to rising prices, which lead to rising interest rates. This causes their currencies to rise.
In the U.S. and European economies the situation is reversed. Economic growth is slow, and standards of living are eroding for the mass of the people. This is creating a non-inflationary atmosphere.
We predict that the U.S. dollar decline will continue over the longer term. During this period, we recommend that investors hold cash balances in Singapore Dollar, Thai Baht, Canadian Dollar, and Brazilian Real.
The future of the Australian currency is in doubt. The Labor party won in a delayed result in Australia. They have vowed to proceed with the previously proposed mining tax. We believe the effect will be to slow or stop growth in the Australian mining industry, a very important part of the economy. As an unintended consequence, it will cause more mining companies to sell their properties to the Chinese. The Chinese will minimize the Australian tax by exporting all mined products to their home country and declaring that they made very small profits in Australia and instead take the profits in China. In our opinion, this will have the effect of making the mining tax a smaller revenue producer than expected.
Suffice it to say that we believe as strongly as ever that gold is a wise investment. We hold substantial positions in gold for our clients and have been enjoying the recent price action. In our view, the price action of gold has been superb. It has been rising if the dollar rises, or falls. It has been rising if base metals rise or fall. It has been rising as economic problems beset Europe and many Europeans realize that they must have gold to protect their assets from the depreciation of the Euro. Soon, we expect the same realization will dawn on more citizens of the U.S. and gold will rise to greater highs. We suggest that after gold breaks out of its recent high level consolidation investors and traders focus of quality smaller capitalization gold mining shares which have not sold forward futures against their production.
We are optimistic about the demand for U.S. stocks in coming weeks. We believe that there will be a rally as investors see political gridlock ahead.
We continue to be enthusiastic about our long-term Asian picks: China, Singapore, Indonesia, Thailand, and Malaysia. We are concerned about higher interest rates in Brazil and will watch to see if this takes money out of stocks into bonds. We remain neutral short term and bullish long term on Brazil.
COLUMBIA, CHILE, AND PERU
A new area of interest for us is the three faster growing western countries of South America: Columbia, Chile and Peru. All three are enjoying strong demand for their exports of energy, minerals, farm, and fishing products. Chile is seeing demand for services. All three are demonstrating economic stability and their markets are selling at low price to cash flow. All three have seen substantial decreases of poverty and the rise of a larger and stronger middle class. We believe that all three present good long-term investment opportunities.
Seasonal factors and continued demand make us bullish on oil, especially high yielding Canadian oil companies.
Demand for more protein in diets of newly prosperous countries is leading to worldwide pressure to produce more grains as each pound of meat protein requires many pounds of grain.
Combine this with the weather problems that the world has faced in 2010, including too much rain in some regions and droughts in others, and it is obvious to us that there are long-term upward pressures on grain prices. We suggest that investors continue to look for opportunities in farm equipment, fertilizer, seed providers, and/or grain futures to participate in this trend.
We still remain bearish on long-term bonds, and especially many municipal bonds in the U.S. We will be happy to look at your municipal bond portfolio and offer our suggestions for free. Please do not hesitate to contact Aubrey Ford or Anthony Danaher at 310-826-8600.
Thanks for listening.
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