US Economic & Financial Markets Outlook: An Overheated Bond Market, Strong Corporate Earnings, and A Culture of ‘Backseat Driving'.
In the month of January 2010, the Dow Jones Industrial Average lost %, the S&P 500 lost %, the NASDAQ lost %, and the Russell 2000 lost %. The U.S. economic outlook for 2010 remains an intriguing question which investors are eagerly trying to solve. The outlook is perplexing because many economic statistics, when viewed individually, lead to vastly different conclusions. For example, if one bases their assessment of the economy on U.S GDP growth for the past year, after three quarters of negative growth the most recent quarter saw a swing to +2.5% growth. Three down quarters followed by a positive quarter, hmmm, the facts dictate things are improving and 2010 will be a better year for the economy (maybe based on the idea that things have to get better, don’t they?). Not so fast. If one looks at current gold prices, almost $1100 per ounce, you would probably come to the conclusion the U.S. economy has major inflation and currency problems. Based on these two issues, investors won’t want any part of the U.S economy or markets.
Turning to the credit side, low bond yields, with the 2 yr Treasury at .86%, 5 yr at 2.38%, 10 yr at 3.64%, and 30 yr at 4.55%, generally are down from the previous month. The low yields would lead investors to come to the conclusion inflation is not an issue (but deflation might be a more pertinent problem). Corporate profits for the fourth quarter of 2009 have generally been strong, outside of the financial sector. Most companies have beaten their earnings estimates quite handily due to slightly improving demand, major cost cutting, and general dollar weakness. Non- financial companies have vastly improving balance sheets in as good a shape as they have been in a long time. Based on these situations, an investor would conclude, “the water is safe” as far as allocating capital, and why not, borrowing is cheap and profits are improving.
Looking at every one's favorite, the fiscal and monetary policies of the U.S. government, one contends with the vast contradiction of huge fiscal deficits and loose monetary policies (low interest rates and buying of mortgage backed and asset backed securities). If one adds to the mix an official unemployment rate of 10%, an unofficial rate of 17% or more, the strength or weakness of the dollar versus the Euro, Yen, Pound, Renminbi and others, the bottom line is for someone to try and come to a reasonable assessment of where the economy is headed, well, good luck. I would only say trying to estimate how the U.S. economy will do during the rest of 2010 is what I call “A Fool’s Errand.” One should also learn a lesson of doing significantly more research before coming to an economic conclusion based on one piece of information without putting it in the context of a complex issue.
One of the problems with being an investor today is the culture of 2nd guessing. Anybody who is married can understand what I am talking about. The culture of backseat driving exists almost everywhere. Just look at this week: During the State of The Union Address by Barack Obama, the President questioned a recent Supreme Court decision on allowing unlimited expenditures for corporations in financing political campaigns. Congress had hearings on the U.S. government assuming 80% of the insurance company AIG and the Treasury Secretary Tim Geithner was repeatedly second guessed about the terms of the deal and how unwilling Mr. Geithner was to use the government’s position to obtain better terms from large money center banks like Goldman Sachs and J.P Morgan Chase. The second guessing is enormous in the financial world with investors questioning money managers across the board on asset classes, sectors, positions, timing of buys and sells, currencies and on and on. Investing is difficult because your analysis must be accurate, but you also must have the conviction to hang in there when positions do not go according to plan. Returns on your investments often take years, not months. The second guessing does not make it any easier, I am sure, for any money manger but particularly those that handle vast sums of capital.
Finally, in my opinion, (repeated for a few months), the biggest area to stay from right now is the bond market. Based on what I have seen in many areas, bond prices are considerably over priced. I have read where one money manager has his biggest position in a fund which realizes 2X the inverse of the 30 yr bond market, which just means he gets double returns if the bond market goes down (bond prices go down when interest rates go up- so obviously he is betting interest rates are going up). If you look at Treasuries, Corporates, Junk Bonds, Mortgage Backed, Municipal bonds in local and state government, the prices a buyer pays are very high. Very simply, many investors have piled into this asset class on the thesis the world is ending. It may end, but for them, when interest rates rise. Time will tell if I am correct, so stay tuned on this one.
Global Economic & Financial Markets Outlook: "The More Things Change, The More They Stay the Same- Maybe Tree's Don't Grow to the Sky After All"
In 2009, global stock markets continued to go straight up, as most country indexes recorded gains around 35% for the year. So far, 2010 has proved an entirely different year and the results have been dramatically different as well. Global indexes typically lost around 5% for the month of January 2010. The old proverb about markets, "Tree's don't grow to the sky," may be a bit premature to cite, however, at least for January, it certainly is applicable.
In looking at specific countries, there are some noteworthy results. First, I believe an investor must look at the BRIC (Brazil, Russia, Indian, and China) countries to gauge how market sentiment is viewing the largest growth opportunities for the future. Brazil's market was down -4.4%, Russia was up +2.4%, India was down -6.6%, and China's Shanghai Index was down -8.6%. The two largest largest markets have the greatest volatility, it is either feast or famine, with dramatic out performance or severe under performance. I contend if January's results continue for any lengthy duration (more than 2 months), buyers will find those country attractive.
Turning to Europe, the nonperformance was dramatic in the European zone countries (-5.9%), Portugal (-6.3%), Italy (-7.1%), and Spain (-9.3%). Do you think the sovereign debt issues of Greece (Euro), Portugal, Spain, and Italy have anything to do with these outcomes (nah, couldn't be)? I also find it very interesting the PX-50 of Czechoslovakia (+6.2), OMX (Denmark) (+4.5%), and the OMX (Finland) (+2.6%) outperformed Euro zone and the U.K. as well. Lastly, I would only note 2009 started off very poorly as well, all over the world. Drawing any conclusions for the rest of the year from January's results may be very premature.
Y H & C Investments: The Psychology of Investing: What We Can Learn From the Saints, A Fashion Show, and Benjamin Graham
Well, the New Orleans Saints are in the Superbowl after 43 years of futility. If we rewind 5 years go, the Saints did not play a home game in their own stadium because of Hurricane Katrina. The city of New Orleans is understandably euphoric with the chance to be a world champion, and even if they do not win the Super Bowl, just to be in the game is an accomplishment the whole region takes enormous pride in. So what, you say, what do the New Orleans Saints have to do with investing? Actually, the key point is the world continually changes and in the investment world, what has worked for a long period of time can suddenly go very wrong, very quickly. What has not worked, especially for what seems like forever, can work and work in a big way for just as long as it did not work. Ultimately, looking for these changes in a company's condition is where big money can be made.
In many ways, the stock market is like a fashion show. During certain years, specific styles are wanted by everyone and other patterns nobody wants anything to do with. Three years later, everything flips around and old styles are the flavors in demand, and the previous trends go out the window. The stock market is very much like that in the sense specific company's have these immense valuations (currently AMZN, GMCR, HGSI, etc) where I just shake my head and wonder why anyone would buy these companies at the current prices. Other very good companies trade at much cheaper prices and cannot get anyone to touch them. And then, with no announcement, things change. With the change comes a completely different sentiment, and low and behold, different stocks start to go up. Welcome to the vagaries of the stock market.
Finally, let me close with a quote from Benjamin Graham, Warren Buffet's teacher at Columbia.
' Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.' (The Intelligent Investor, Pps 204-205. Ben Graham, 4th Revised Edition, First Collins Business Edition)
Thanks for reading and if you have any questions, 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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