2010 Investment Thoughts
Note and partial disclaimer: My thoughts are not my personal views (politics especially) but how I see
the world unfolding based on the past year and historical trends. My personal views often clash with
my investing views but as I learned long ago, you should not invest with your emotions but rather
invest with conviction based on what is actually happening in the market.
Interest Rates and Currencies
The decision by Australia to raise interest rates is important in that Australia and to a larger extent Asia
will lead the rate raising cycle. Quantitative easing and economic stimulus packages in Asia will be
eased back in the coming 12 months in order to prevent potential asset bubbles down the road.
This is an important step in the decoupling of Asian economies from US and European markets.
Capital market flows have already shifted to Hong Kong as evidenced by the tremendous IPO volume.
No longer do Asian companies need to do a primary IPO in New York as there is sufficient capital
available in Hong Kong and Shanghai to allow for a single IPO in Hong Kong alone.
Going forward INTER-Asian trade will become more important than INTRA-Asian trade and
companies which provide the necessary goods and services will be the winners in the next Asian bull
market.
All of this should have a neutral effect on the USD Index since only the Japanese Yen is included
within the US Index so exchange movements between the USD and other Asian currencies will have
more effect individually than on the USD Index as a whole.
As a point of reference, the Euro makes up 57.6% of the USD Index and the Japanese Yen makes up
13.6%. No other Asian currency has representation and South America has no representation in the
Index.
This obscures the collapse of the dollar, as dollar depreciation will be greatest against emerging market
economies.
US interest rates will not rise in 2010 due to the Congressional elections later in 2010 and the massive
quantitative easing programs still in place. It would not be surprising to see no interest rate increases
before the end of 2011.
Given the amount of debt issued by the US Government this year to fund the budget deficit, combined
with the removal of funding caps on Fannie Mae and Freddie Mac there is no possible way for the
Federal Reserve to raise interest rates without considerably adding to the budget deficit.
If three month interest rates were to rise from the current 9 basis points to 100 basis points what would
that do for the overall interest expense on Treasury debt? Simple example but it drives home a point on
why interest rates cannot rise.
Anyone that trades the Gold and Silver markets knows that when the government is involved as an
invisible hand it makes the market inefficient and obscures the real value over time. The same is
happening now with the US Treasury Yield curve and MBS markets where the Federal Reserve is
buying securities.
The USD will bottom out again around 70 and test the long-term support. The question will be the
response from Central Banks around the world. A retest of long-term support is not bad as support
levels need to be retested in order to build an effective base.
The real story could be coming out of the IBAC countries (India, Brazil, Australia, and China). These
countries have for the most part sidestepped the global recession and have resumed a growth track.
Please note that the IBAC countries have no representation in the USD Index, which as I mentioned
earlier, obscures the depreciation of the US Dollar against global currencies.
I tend to believe that we will begin to see a slow round of interest rate increases across the IBAC
countries and Asia as they end their quantitative easing programs and return rates to normalized levels.
Will the story of 2010 be a decoupling between IBAC + Asia versus Europe + US?
Could the next story be an emerging carry trade where you short US Treasuries and go long Australian
bonds?
Equity Markets
I guess we have to ask ourselves what the drivers will be in 2010. The market appears to be forming a
distribution top which would likely lead to a downturn sometime in 2010. We had massive quantitative
easing, an expected recovery, government stimulus, and a retraction of mark-to-market to drive us from
the March lows. Now we need a new story to push the market higher.
We could see one final move higher but I am worried about the BULL-BEAR data. There is a distinct
lack of bears and an overabundance of bulls. Sometimes this data takes months to play out in terms of
a correction but I think we will see a significant correction sometime before the end of 2010. In fact,
the stock market charts remind me of the 1970’s.
The Dow and S&P appear to be forming distribution tops. Be cautious if you are putting new money
into the market.
I expect the ultimate top to come at a point in time where Gold and Silver are blazing to new highs, the
Federal Reserve announces an end to quantitative easing, and the US Dollar retests its 2008 lows. This
may not happen all at the same time but happen over a period of weeks or a month or so.
The consumer could be the story in 2010 but in order for that to happen we are going to need to see
increased consumer confidence, which will come from businesses resuming the hiring of employees,
which will come from an increase in business confidence.
Non-performing loans continue to cause problems in the US banking sector. In fact, financial stocks
remind me of post crash Internet stocks. Some recovered all of their losses 10 years later but ask the
shareholders of stocks like Microsoft, Cisco, Yahoo, and Intel about their 10-year returns.
There are values but you should not be buying now for a buy-and-hold strategy. If you are trying to
capture the last 10% of a move where you missed the first 70-80% you are better off staying off to the
side and wait for another 70-80% move to come along.
As financial stocks go, so goes the US markets and overseas markets will likely follow.
Growth in employment will determine consumer demand and GDP growth going forward in 2010.
Even if we see a significant drop in unemployment consumers will be cautious for a year until they feel
more comfortable about their futures.
As the US recovers and consumers begin to spend, however the trade balance will weaken as
consumers resume their appetite for foreign made goods.
Buffett buying Burlington Northern is a vote towards much higher oil prices over the next decade.
Remember his comment about the high cost of hauling freight by truck as opposed to rail. Truck costs
rise by a 3:1 ratio over rail due to high gasoline prices.
Stock markets and Gold are likely to top out at the time qualitative easing ends leading to a bear market
that will take everything down by 20%. This will lead to the final bottom before prices begin to head
higher.
Agriculture stocks will continue to do well but you need to search for value. Potash, Monsanto,
Caterpillar, and Deere are safe plays with low returns. The real story lies in the vertically companies
which actually grow, package, and resell their crops to the public. Difficult plays but fantastic gains
last year.
There is still value in these names if you are willing to do your homework.
This is a time to consider drug stocks as the beginning of the next great twenty-year bull market but
there are some very important dark swans not being noticed by Mr. Market that may destroy the
industry in a similar manner to how Philip Morris was hit with class action lawsuits.
It is too early to call the winners and losers in the healthcare bill but any bill that favors Big Pharma
will discourage innovation and necessary industry changes. It now costs more than $1 billion dollars to
bring a drug to market and the process needs to be reformed on both sides (pharma and FDA) if the
industry is expected to grow and meet the demands from an ever increasing aging global population the
process of bringing new drugs to market needs meaningful reform.
Finally, if one goes back to look at decennial statistics years ending in 0 and the early part of the decade
tend to do worse than later years. I have attached two charts from thechartstore.com to put this into
perspective.
Canada’s banking sector could not be stronger. They do face a significant problem which is directly
related to their success and that is an overabundance of equity. As we go forward, it will be difficult to
maintain strong ROE and ROA ratios.
Canadian banks have a couple of choices here. Loosen lending standards and increase risk or return
capital to shareholders in the form of dividends and buybacks. Moving along the current track will lead
to decay and lower returns.
Asian markets have rolled over and yet to recover to their prior highs. I want to see the HSI move to
new highs and begin to lead Asia higher before I consider getting bullish on Asia.
If I had to put myself on the spot, I would be long Gold and Silver through the first quarter at which
point I would switch to Short ETF’s. Oil and Natural gas stocks are interesting especially those stocks
with nice dividends to provide a cushion to a potential decline.
Investors should take a long look at increasing the dividend yield on their portfolio and lowering their
portfolio beta.
Someone buying for a longer-term horizon should really stay on the sidelines for at least a year.
Global Politics
Regional conflicts will flare up in early 2010 around the world. We are already seeing this with an
increased focus on activities in Yemen.
With the close proximity to Somalia, you can expect a greater focus on ship piracy as the world
attempts to find a solution to this regional hot spot.
Sovereign problems are likely to be a non-story in the case of Greece and California. We know the
problems and have known about them for some time now. Unless there is a major surprise, it is likely
that they have little effect on the markets. Talk of the EU collapsing to me is now like ‘The Little Boy
Who Cried Wolf’. Every year there are whispers but will anything ever happen? The cost of an EU
collapse will far outweigh the costs from the housing collapse due to the savings businesses have
realized from tariffs, currencies, etc.
California has been a basket case for at least a decade now and will continue to muddle through as they
have done in the past.
The average loss for a sitting President’s party in the House during his first set of elections is 28 seats.
Look for Democrats to lose a couple of seats in the Senate and somewhere near the average in the
House.
The Republicans have a number of problems hindering their progress.
First, the Republicans have a very weak bench and will struggle to field a full field of candidates. In
2008, the Republican Party was looking for candidates who could fund their own campaign. This is
not a roadmap for success in any election.
Secondly, the Democrats have an almost 5:1 cash advantage in terms of House races. This advantage is
significant and used to defend young Democrats who will face significant challenges in close races.
Finally, NY-23 provided a glimpse into the fractures, divides, and problems within the Republican
Party.
The Republican Party is undergoing an ideological fight for the future of the party similar to what the
Democrats went through after the 2004 elections. The question is will the next head of the party pull
them towards the center similar to Howard Dean after he ascended in 2004 or farther to the right in
advance of 2012.
The party needs to move towards the center and away from the far right if they intend on winning back
the White House in 2012.
Precious Metals and Commodities
Big run in Gold and Silver through the first quarter of 2010. As the year goes on, we turn towards
supply issues with new mines like Penasquito coming online.
If you go back to 2000 and look at a Gold chart, you will notice that Gold tends to move in a 12-18
month consolidation followed by a 6-9 month move up. We are currently in the uptrend and it should
last for another 3-6 months.
For those bearish about gold here is something to consider. The Comex has authorized participants to
deliver GLD shares in the place of physical Gold if a participant requests physical delivery.
Copper is in a seasonal uptrend that usually lasts through the end of the first quarter. Long-term
investors should avoid going long copper right now.
Oil will continue to trade along in opposition to the US Dollar index. As the US Dollar index moves
lower oil should move higher but at some point next year, more than likely in conjunction with
increased worries about the strength of the US economic recovery and a bottom in the US Dollar index.
Natural Gas is moving higher as inventories move lower but should turn around as move into summer
and inventories are replenished. A cold US winter is helping the price.
Base metals are likely to disappoint after a strong 2009. Inventories continue to rise along with prices
which will encourage questionable projects to come back online which should add to supply. If the
market heads lower base metals will be pulled lower.
Sugar had a very good run in 2009. I continue to be long the few publicly traded sugar stocks but
worry about 2010 as the leaders in one year tend to lag the next.
Avoid Argentina mining stocks until the political climate clears.
Real Estate
Canada’s real estate market reminds me of the US in 2003-04. How the banking system reacts to an
oversupply of capital will determine the future course of Canada’s real estate market.
The US real estate market will continue to be constrained by a significant amount of inventory
overhang, Option ARM’s resets, and weak commercial real estate markets. This weakness should
persist for a few more years.
Economic Growth
Slow growth in the USA as the economy continues to adjust to the new environment.
MZM and M2 growth is disinflationary and coming down to normalized levels, which is a very good
sign as it signals a coming end to quantitative easing.
The Federal Reserve cannot begin to wind down its balance sheet until they first end the purchases of
fixed income instruments.
When the balance sheet begins to shrink additional monies will move into the system in the form of
released collateral. When the Federal Reserve started taking toxic assets onto its balance sheet it
required banks to put up collateral and when those toxic assets are sold the collateral will be released.
Downward revisions to 3rd quarter US GDP foreshadow a weak recovery during 2010 and raise the
possibility of a double dip recession if government spending slows before the consumer is ready to take
over the slack.
The continuing obfuscation of US government statistics makes me question the strength of the potential
recovery. From the birth-death model in employment, lack of accurate housing data in CPI, the double
counting home sales, and lack of accurate data on the budget deficit one should question the numbers
coming out of Washington.
Watch how the market reacts to news. There is a difference between how the market should react and
how it actually does react.
Why has the 2009-10 US budget not yet been officially passed and signed into law? Check Wikipedia.
David Urban
davecurban@gmail.com
davecurban@yahoo.com
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