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Markets Rolling – Look For More Of The Same

Markets Rolling – Look For More Of The Same

During the last two weeks, global markets have moved their way to higher ground and indications point to a healthier finish than expected to an otherwise sickly 2011.

We see several developments supporting a continued equity market rally. They have to do with measures taken in China, Europe, and by central bankers around the globe.  We discussed these actions briefly last week and now we’d like to take a more detailed look at them.

 

Reason # 1: China Revving Up Its Growth Engine!

In the three-month quarter ending September 30, the Chinese national gross domestic product grew at a rate of 9.1 percent. By any “normal” global standard, that’s quite an enviable growth rate but not in China where such a level actually reflects a slowdown compared to previous months.  Moreover, we believe that growth for this quarter will come in at around 8.5 percent and even drop to 8 percent in the first three months of 2012, during which time we expect it may hit a “low point” of 7.5 percent – probably in March.

China has now begun taking steps to reverse the slowdown and incentivize consumer demand.  As a result, we envision a dynamic expansion of lending activity and a sea change in growth by April-June 2012.

Here’s what going on: The Chinese housing boom of the last few years has been largely stoked and financed from savings. Housing purchases require a minimum of a 30 percent down payment. That means people spend less on consumer goods and save to buy a house. This behavior has been exacerbated by the fact that real estate prices were rising and potential home buyers believed that they had to buy now to avoid higher prices later.  This scenario has changed. Housing prices are falling, making buyers less likely to defer other purchases in order to save for a home.  That’s one part of the growth picture.

On the banking front, the government has cut bank reserve requirements for the first time in three years. We expect this recent cut to be followed by perhaps two more similar moves over the next couple of months. Banks will now be able to keep less cash in the kitty and lend more. The implications are clear: More available capital means more economic activity and more growth. Lending allows businesses to expand by enlarging facilities, building new ones, acquiring new equipment and inventory and hiring employees.

We expect signs of economic stimulation to become apparent in about four to seven months. In our opinion, GDP will bottom out in March and then rise from there. Some pundits have expressed fear that Chinese exports will be hurt by the recession in Europe. They may fall but will not collapse. However, we do believe that financial turmoil in Europe has influenced Beijing’s decision to cut reserve requirements and stimulate bank lending.

China’s long-term goal is to bring hundreds of millions of Chinese into the middle class. That requires job creation, migration from the countryside to cities, and construction of housing and transportation infrastructure – all on a massive scale for many years to come.

China is stimulating business and consumer lending and spending. It has taken action, and will continue to take more action, to revive the kind of GDP growth rate that we have long seen as a major driver for global economic growth. When China begins to grow more rapidly, much of the world will follow, especially those countries who export to them, such as Brazil, Canada, and Australia.

 

Reason # 2: Europe Moving In The Right Direction

Yet another European chief of state summit on the Euro zone financial predicament takes place this weekend. While many experts believe the continent’s leaders are not giving sufficient urgency to the ongoing banking system crisis, we think otherwise.  We are encouraged by consistent moves to cut costs, rein in spending, and raise taxes throughout Italy, Spain, and other debt-ridden countries. To be sure, news reports often feature confounding and unwise comments made by politicians for home country consumption, indicative of a political solution to the European unity dilemma that will be slow in the making, and will be replete with unwise statements by politicians.

Such political posturing was addressed last week by Mario Draghi, head of the European Central Bank.  According to a report in the New York Times, he was “suggesting the bank could increase its support for the European economy if political leaders took more radical steps to enforce spending discipline among members”. Please click here to view the article.

The European summit this weekend will attempt to address the political difficulties.  Resolution could take a long time and be quite contentious. We expect to see small market corrections during the process, but in our opinion the bottom of the market has occurred.

 

Reason # 3: Central Bank Solidarity

The most important point is that the central banks of the developed world have made it clear they will stand behind the banking system of Europe in order to avoid a repeat of the Lehman Brothers collapse of 2008.  Declarations from the U.S., Japanese, Canadian, Swiss, U.K., and other central banks indicate a unified resolve to keep major banks and clearing institutions of the world up and running.

A number of Asian countries have lowered their interest rates, and such declines are bullish for the markets.   Meanwhile, we also expect that the European Central Bank (ECB) reduced interest rates this week, continuing a trend which began last month when Mr. Draghi took over. In summary, world central bankers are watching closely and will not let European banks fail. They will intervene and do it very aggressively to avoid a banking collapse.

 

What Investors Need To Know

We see signs of more coherence in financial and monetary system management. Central bankers will take correct action to support banks in spite of the dawdling, continued failures, and lack of wisdom demonstrated by European politicians.

Investors need to understand that the European, U.S. and world banking systems is not destined to implode, even if the politicians are more or less clueless about the impact their gesturing and shenanigans have on world banking confidence.

In our opinion, world stock markets function by discounting future events. On today’s global stage, future events revolve rather intimately around the growth of China and the continued stability of the world banking system. Even if many countries have problems with sovereign debt, and even if many banks are horrendously burdened by ownership of such debt, the central bankers of the world will support them and keep them solvent.

The recent developments in China and unity among the central banks have been discounted in the markets.  Short sellers have been buying stocks, and long buyers bought increased their exposure to the markets…this spells rally.

U.S. S&P 500 – 1 Month Chart

Courtesy of Bloomberg

 

MSCI Emerging Market Index Fund – 1 Month

Courtesy of Bloomberg

 

Inflationary Pressures Are Building As Evidenced By The Guild Basic Needs IndexTM

Even though it has been a year where deflationary fears have had the upper hand, our analysis of the prices of basic elements suggest more inflation is around the corner.  The recent lowering of interest rates in the developing world and in Europe increases the attraction of accumulating raw materials and commodities.  Cheap money tends to feed asset prices, especially the prices of assets with restricted supply growth.  Even though the U.S. has high unemployment and excess slack in its economy, its population is not immune to rising global inflationary pressures.

Credit Rating Agencies Getting The Congressional Eye

During the last five years, some 132 employees of the major rating agencies have reportedly left their positions to work for firms that the agencies help to rate. The agencies are now coming under Congressional scrutiny for their close ties to the organizations they rate. We applaud meaningful investigations, and beyond that to the prospect of positive reform, needed to clean up alleged conflict of interest behavior.  But will the scrutiny only focus on lower level analysts and not on senior management who authorized the use of bad financial models?  Such inaccurate rating models led to companies being rated far more highly than they deserved and cost investors hundreds of billions.

 

India Watch: No Whoopee For The Rupee Yet

We have completed a thorough analysis of the Indian currency and found many persistent problems. The rupee has fared weakly during the last several months and is not poised yet to rise. However, we believe that the cyclical downturn in India that has led to a currency decline will end within a year and then the rupee should become a stunningly good buy due to high interest rates and a low valuation.

 

The Khan Academy: A Fun, Educational Resource For The Whole Family

We wanted to share this free resource with our readers. I have used it to review math studied in the past. The Khan Academy, created by Salman Khan in 2006, is a free educational resource designed to expand the knowledge of individuals at any age level in numerous subjects in a very simple way. The online academy provides 12 minute video tutorials that are fun and easily absorbed by the viewer. These short video lessons are intended for audiences of all skill and age levels.  Each tutorial starts with the basics of each subject and builds to the most complex; while providing fun tools to get each viewer to their desired level. The list of subjects covered by the Khan Academy is extensive, and the depth of each subject is good.

The Fields Covered in the Khan Academy Are:

Math (basic arithmetic through beginning differential equations), American Civics, Art History, Banking and Money, Biology, Chemistry, Computer Science, Cosmology and Astronomy, Credit Crisis, Currency, Current Economics, Finance, GMAT Preparation, Healthcare and Medicine, History, Organic Chemistry, Physics, Probability, SAT Preparation, Singapore Math, Statistics, Valuation and Investing, Venture Capital and Capital Markets, and more. See for yourself at www.khanacademy.org

 

Recommendations

Our current recommendations continue in force.

  • As we explained last week, we are bullish on U.S stocks.
  • Gold continues to be attractive. Sellers of gold sellers have primarily been hedge funds faced with redemptions. South Korea recently announced new gold purchases, joining a large group of central banks that have been steady gold buyers.
  • Wheat represents an attractive buy. First of all, it provides more protein than corn and thus meets an increased global demand for a higher protein diet. Secondly, it is not subject to the price gyrations plaguing corn that is used in creating ethanol.
  • The Canadian and Singapore dollars are well-managed currencies in countries with conservative banking systems. They are good candidates for continued long- term appreciation versus the Euro and U.S. dollar.

 

Investment

Recommended

Closed

in U.S. Dollars

Current Recommendations
Gold

6/25/2002

Open

+435.7%

Wheat

10/24/2011

Open

-7.8%

Long Canadian Dollar

10/24/2011

Open

-0.3%

Long Singapore Dollar

10/24/2011

Open

-0.9%

U.S. Equity Market

11/30/2011

Open

+5.6%

Closed Commodity Recommendations
Oil

10/24/2011

11/17/2011

+16.4%

Corn

4/20/2011

8/3/201

-6.3%

Oil

2/11/2009

8/3/2011

+157.1%

Corn

12/31/2008

3/3/2011

+81.0%

Soybeans

12/31/2008

3/3/2011

+44.1%

Wheat

12/31/2008

3/3/2011 

+35.0%

Closed Currency Recommendations
Long Canadian Dollar

9/13/2010

9/21/2011

+2.2%

Long Chinese Yuan

9/13/2010

9/21/2011

+5.8%

Long Swiss Franc

9/13/2010

9/21/2011

+12.1%

Long Brazilian Real

9/13/2010

9/1/2011

+6.4%

Long Singapore Dollar

9/13/2010

8/3/2011

+10.9%

Long Australian Dollar

9/13/2010

6/29/2011

+14.1%

Long Thai Baht

9/13/2010

6/22/2011

+6.5%

Short Japanese Yen

4/6/2011

7/27/2011

-9.7%

Short Japanese Yen

9/14/2010

10/20/2010

-3.3%

Closed Equity Market Recommendations
IShares MSCI Emerging Market Index

10/24/2011

11/21/2011

-0.8%

U.S.

10/24/2011

11/21/2011

-1.6%

U.S.

9/14/2011

9/21/2011

-2.3%

India

4/6/2011

9/21/2011

-21.6%

Malaysia

6/29/2011

8/3/2011

+0.1%

U.S.

6/29/2011

8/3/2011

-4.6%

Japan

2/15/2011

8/3/2011

-9.5%

Australia

2/15/2011

6/22/2011

-0.9%

Canada

3/24/2011

6/22/2011

-7.1%

Colombia

9/13/2010

6/22/2011

+2.6%

Malaysia

4/6/2011

6/22/2011

+0.8%

Canada

12/16/2010

3/11/2011

+7.9%

U.S.

9/9/2010

3/11/2011

+18.1%

South Korea

1/6/2011

3/3/2011

-2.9%

Colombia

9/13/2010

2/2/2011

+3.9%

China

9/13/2010

1/27/2011

+5.0%

India

9/13/2010

1/6/2011

+7.9%

Chile

9/13/2010

12/16/2010

+8.9%

Indonesia

9/13/2010

12/16/2010

+9.5%

Malaysia

9/13/2010

12/16/2010

+1.3%

Peru

9/13/2010

12/16/2010

+32.2%

Singapore

9/13/2010

12/16/2010

+4.8%

Thailand

9/13/2010

12/16/2010

+11.9%

Closed Bond Market Recommendations
 30 YR Long Term
U.S. Treasury Bond

8/27/2010

10/20/2010

0.0%

 

 

Thank You To Our Readers

 

For 40 years we have been managing investment portfolios for clients. We hope our newsletter serves to sharpen your investment perspectives and strategies.  Please feel free to forward our commentary to friends, family, colleagues.

 

To request information about Guild Investment Management services and offerings please call (310) 826-8600 or email us at guild@guildinvestment.com