US Economic & Financial Markets Outlook: The Year Ends Strongly, Why The Equity Markets Performed Well, and Thoughts About 2010
First, I would like to wish everyone a Happy New Year, may it be a healthy year for everyone. The equity markets in 2009 rallied strongly with the Dow Jones Industrial Average up 19%, the S&P 500 up 23%, and the NASDAQ up 44%. There were several reasons for the strong stock performance: First, the equity market was extremely undervalued during the start of the year, with investor sentiment incredibly pessimistic. Second, the steps the U.S. government took to stabilize the economy have worked at this point. Injecting capital into money center banks, keeping interest rates extremely low, and changing the mark to market accounting rules helped the banks. The steep yield curve and rising stocks helped these institutions stabilize their balance sheets, make more income, and ultimately raise more equity. Once investors gained confidence in financial companies, the market sensed the investing environment was better than what was priced in, and buying took place for months. Third, with no major Lehman type blowups, business slowly has improved, so earning comparisons have become very easy to beat and companies have complied, helped by major cost cutting in almost every industry. With 2009 ending, the key issue becomes how will 2010 unfold for investors?
I believe the U.S. economy will continue to slowly improve, as long as no large company in the financial or insurance sector has a credit issue. The reason why this is critical is because financial institutions are so intertwined as creditors of each other’s positions, not only domestically but globally, if one institution has credit issues it will affect the liquidity of 10-100 others, not to mention hedge fund positions as the banks are prime brokers to hedge funds. All of this interconnectedness can possibly put in motion a whole chain of dominos starting to fall, similar to the Lehman situation one year ago. I would expect the large institutions have been very concerned with this kind of event, and corporate boards should be doing everything possible to monitor their counterparty risks, as well as being very aware of their risk management exposures and strategies. Given the sovereign debt issues facing some European governments (Greece, Spain, etc), I believe investors will be forced to look at the U.S. dollar in a more favorable way. There is a good chance the U.S. dollar will strengthen against many major international currencies (at least the Euro, Yen, and Pound), and a stronger dollar has repercussions in both the equity and debt markets.
In my opinion, the debt market is a place investors should avoid, especially long dated U.S. Treasury securities (especially 30- yr bond, even the 10 year). If the U.S. economy continually strengthens, and the dollar also strengthens, the Federal Reserve will raise interest rates. Bond prices, especially U.S. Treasuries, are currently priced for perfection, and when higher interest rates inevitably arrive, that segment of the bond market is precisely where investors should not have a lot of exposure to.
In the equity markets, I believe investors have to be cautiously optimistic, and focused on being patient and persistent in their selection and ownership of high quality companies. The equity markets are always full of potential risk and reward, and this year will be no different.
On the risk side, the continued high unemployment rate (over 10%), threat of a rapid increase in inflation, a higher interest rate environment, the continued decline of the dollar, a more stringent regulatory and tax burden for individuals and businesses, and weak or negative GDP growth are all potential land mines for stock market investors.
On the positive side, the fact that the Dow Jones Industrial Average and S&P 500 are virtually in the same place as they stood 10 years ago is a very good sign for the market. In fact, the 1999-2009 decade was the worst decade ever for stocks. Will the next decade be worse? Nobody can predict the future, but certainly one can buy stocks of companies that have long term competitive advantages, great balance sheets, and the opportunity to sell more products for a long period of time. I certainly believe the continued belief the stock market is headed for a major decline only helps investors buy at much more attractive prices. Time will tell, and for long term investors of good companies, time is usually on their side.
Global Economic & Financial Markets Outlook: Mighty Fine in 2009, A Rising Tide Lifts all Boats. In 2010, Will It Happen Again?
2009 was an incredible year for investors with positions in international markets. As we all know, the international markets had a rough few months at the start of the year, but since then have strongly rebounded. For example, the overall indexes in China, Hong Kong, India, Taiwan, and Russia are all up close to 100% from the end of last year! Most European Indexes are up anywhere from 20-30%. In South America, the main index for the continent is up 35%. In Brazil, the largest country in the continent, the index is up 75%. If one compares the emerging markets index versus developed markets, the emerging markets are up over 50% whereas developed markets are up 25% for 2009. A serious difference in returns, wouldn't you say? Given all the great returns all over the world, how might 2010 unfold in global markets?
First, there are serious issues taking place in Europe. Countries like Greece, Italy, Spain, and Portugal are having problems paying their debt obligations. The structural issues in these countries (large fiscal deficits, high unemployment rates, a large government sector with inflexible labor laws and onerous pay levels) make the global competitive landscape a struggle. Many question whether the people and their governments are willing to make serious changes in their business conditions to reform the situation. Economists see the result being a depreciating Euro versus major currencies, especially the dollar. Some countries are trying to make a start in reforms, like Greece, which has dramatically cut public sector pay. Ultimately, a depreciation of the Euro could be a good way to boost exports for European companies.
Second, specific countries in Asia (ex Japan) and India have to be viewed with a selective eye, taken on a country by country basis. I believe these regions will grow above mature countries rates, but the dramatic rise in stock prices probably results in those markets being well overbought. Investors need to do their research on a case by case basis, but on any kind of significant pullback (25% or more); I would certainly be a buyer of China and India. I don't believe 2010 will see the same kind of results as 2009, so if international markets are up 5-10% for the year, I would consider that a victory for investors.
Y H & C Investments: The Psychology of Investing: 2010 Will Be A Year Where Business Results Will Determine Economic Performance
In 2009, stock markets all over the world dramatically increased. In my opinion much of the gain was simply a matter of investors realizing many stocks were very cheap, and buying an asset at 50 or 60 cents on the dollar is always going to attract profit seekers. The year of 2010 should prove very different.
If 2008 was the year when everything was sold, 2009 the year everything was bought, then 2010 probably will be the year where companies growing revenues, profits, and expanding margins through superior performance will be rewarded.
However, because of the huge run up of stock prices, there are many companies where the stock price far exceeds economic reality (a condition that is always present in the market). In 2010, look for the froth to get wiped off of many of these market darlings.
So what is an investor to do? I know that consistently looking for situations where risk is minimize and reward is potentially very large is where investors should always be striving to be positioned. The risk assessment is probably just as important as the potential reward component. In that vein, I thought I would introduce some comments by Jim Rogers, who used to be George Soros partner and is regarded as one of the world’s great investors, although he has been down on the stock market for many years and is currently bullish on commodities (as he has been for 10 years or so).
“The smart investor learns to listen to the popular press with an ear tuned for panic extremes. At market tops, the tune will run: ‘This time it’s different from all other times. Trees will continue to grow and grow and grow. Buy yourself a tree and watch it reach 50 feet, 100 feet, 1000 feet. This is an investment to put your money in and forget.” I might add that many stocks of companies do go up for decades, but Mr. Rogers is talking about the rhetoric at market tops. The key attribute of Rogers to concentrate on is he does his homework. His take on market declines:
“At bottoms, the song will become a dinge. Prices are severely depressed… Words such as ‘disaster’ and ‘doomed’ and ‘dead’ will be used to describe such a market.”
Those words should be very familiar to anyone who has been paying attention to the stock market for the last couple of years. Finally, Mr. Rogers describes the intelligent investor’s analysis of the proper psychological approach:
“The smart investor—the one who doesn’t consider himself a financial genius but trains himself to analyze the newspapers and television and to pick tops and bottoms by the extreme’s in the public’s attitude—learns to buy fear and panic and sell greed and hysteria.” (Get Smart and Make a Fortune. Pgs 61-65. The Book of Investing Wisdom. Jim Rogers. John Wiley and Sons, 1999)
I would say the gold market or treasury market might be a current situation of greed and hysteria. Regarding fear and panic, it seems like there are always places in stock markets where the world is thought to be coming to an end.
I also wanted to quickly include another personal experience. A couple of years ago, I invested money in a company in China which made natural fertilizer for farmers. The stock was trading for around 2 bucks a share. After about a year, I sold it because I did not like the way their accounts receivable was handled. The firm was growing and there was a net cash position on the balance sheet. Fast forward a couple of years and it set an all time high at around 27 bucks a share. I don’t know how many times my head has to get pounded in before I realize that the name of this game is patience. Again, when people you know discount the possibilities in the stock market, ask them where in the world is it possible to make those kinds of returns (if you are smart enough to hold the stock)? Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, or you would like to discuss your personal investment situation, please email me at info @y-hc.com
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
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