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U.S. TAX CUTS EXTENDED-THIS IS BULLISH FOR STOCKS, AND IT MEANS MORE QE FROM THE U.S. AND EUROPE

U.S. TAX CUTS EXTENDED-THIS IS BULLISH FOR STOCKS, AND IT MEANS MORE QE FROM THE U.S. AND EUROPE

 

U.S. Tax Cuts Extended – This Is Bullish For Stocks, And It Means More QE From The U.S. And Europe
 
After the news broke of an agreement between U.S. lawmakers to extend the Bush tax breaks, some people concluded that the fiscal stimulus could reduce the pressure on the Fed from needing to do more QE.  We disagree.  We believe the tax breaks will mean even more QE…and the bond market seems to agree with us.  This weeks’ poorly bid U.S. Treasury auctions says that while investors agree that tax breaks are good for encouraging economic growth, they also drive government deficits higher.  Bond offerings from the U.S. Treasury are going to go up, and the Fed had better buy the Treasury’s bonds, because it is apparent investors don’t want them.  QE is here to stay.
 
 
Ripping Off The Band-Aid In Iceland
 
Our good friend, Larry Jeddeloh of The Institutional Strategist recently brought to light the differences in the way Iceland dealt with its financial crisis and the way the rest of the Western World has chosen to deal with theirs.  In 2006, Iceland’s central bankers miscalculated and thought everything was ‘stable’.  Larry points out that highly educated, capable central bankers may believe they have things under control, yet they can still make mistakes.  In his Market Intelligence Report, Larry goes on to discuss Iceland’s response to their financial crisis; they took some bitter medicine, let banks fail, let depositors lose money, and let their currency fall.  
 
In the large Western democracies, there is no political will to make the hard decisions needed to fix their ailing financial system, and policymakers appear to be opting for the Japanese method of prolonging the agony.  Jeddeloh writes,
 
“bailout fever…has a firm grip on the U.S. and is spreading quickly in Europe, evidence is emerging that our monetary policy chiefs are…wrong…again.  Take Iceland.  The country let its banks fail, it didn’t use taxpayer money to bail them out, and the country and its currency have paid a heavy price.  However, Iceland’s budget deficit just a couple years past the crash will be 6.3% this year, and 0% next year.  Contrast this with Ireland, which will have a 32% deficit, as estimated by the EC.  How long will this debt burden the economy?  How long will banks be frozen up, leading to stagnation?  If Japan is any guide, it could be decades.”
 
 
U.S. State Finances Are Going To Have To Be Addressed
 
We have discussed the risks to the so-called ‘conservative’ municipal bond market in recent months.  Nothing has been done to address the fiscal crisis in many states, counties, and municipalities across the U.S. who owe trillions of dollars to bondholders…and are seeing their tax receipts shrink rapidly.  This is another reason we believe that QE is going to continue for a long time.
 
Much has been written and reported about the European debt crisis, but if you look at the chart below, the capital markets are starting to anticipate defaults among some over-levered U.S. states.
 
 
The Federal Reserve’s work is far from being done.  To combat deflationary psychology, QE is the best policy response that the Fed has come up with.  Municipal bondholders must be hoping for a continued expansion of the Federal Reserve’s balance sheet (printing money), so that it can include many of these states’ loans.
 
 
What does this mean for investors? 
 
Continued QE by developed countries’ central banks means that stocks (especially in countries and industries that can grow faster than the rate of inflation) and investments in commodity related assets will continue to be attractive.
 
 
Our Recommendations
 
Investors should continue to hold gold for long-term investment.  We have been bullish on gold since June 25, 2002 when it was selling at about $325 per ounce.  In our opinion, it will move to $1,500 and then higher.  Traders should sell spikes and buy dips.  Gold closed today at $1,382.60 an ounce, an increase of 325% in almost 8 ½ years.
 
Investors should continue to hold oil-related investments.  We have been bullish on oil since February 11, 2009, at which time oil was trading at $35.94 per barrel.  After the recent pullback, oil is trading at $88.52 per barrel, which is up about 146%.
 
Currencies:  For long-term investment, we do not like the U.S. dollar, Japanese yen, British pound, or the euro.  As we mentioned in our September 14th letter, we like the Singapore, Thai, Canadian, Swiss, Brazilian, Chinese, and Australian currencies.  We would use the current pull-backs in these currencies as an opportunity to establish long-term positions.  Since September 14, 2010, these currencies have appreciated or depreciated versus the U.S. dollar by the following percentage: Singapore dollar +1.6%, Thai baht +7.4%, Canadian dollar +1.6%, Swiss franc +2.1%, Brazilian Real +1.2%, Chinese Yuan +1.3%, and Australian dollar +4.7%.
 
Investors should continue to hold shares of growing companies in India, China, Singapore, Malaysia, Thailand, Indonesia, Colombia, Chile, and Peru.  We have been recommending these markets in these commentaries since September 14, 2010, and we would use any pullbacks as an opportunity to add or initiate positions for long-term investors.  Stocks in these countries have appreciated in U.S. dollar terms by the following percentages since September 14, 2010:
 


Country
Stock Index Appreciation/Depreciation in USD
Singapore
6.6%
Malaysia
2.0%
India
5.9%
China
7.7%
Indonesia
15.9%
Thailand
11.5%
Colombia
5.4%
Chile
7.2%
Peru
31.5%

 

 
 
We believe long-term investors should continue to hold food-related shares such as grains, wheat, corn, soybeans, and farm suppliers.  Since we stated the grains bottomed on December 31, 2008, these have all appreciated substantially.  We see more price rises ahead.  Since December 31, 2008 the price of corn is up about 41.3%, wheat is up about 28.5%, and soybeans are up about 32.2%.
 
We believe U.S. stocks can rally further.  Our reason for becoming more bullish on U.S. stocks on September 9, 2010 is that over the longer-term, liquidity formation through QE will create demand for many assets, including U.S. stocks.  Since September 9th, the S&P 500 is up about 11.2%.
 

Thanks for listening.