When markets reached a bottom this spring, we realized that an interesting change was happening. The way the market absorbed new information was changing slightly and bad news was having less of an impact - i.e., driving price declines. That’s when we got interested again. Now on top of our compelling and thoroughly researched investment ideas, we got extremely compelling valuations and a market that was beginning to respond more positively to news of any kind, even bad news wasn’t so bad anymore. That’s when we entered the market again and started to build up our equity and corporate bond positions.
Of course, there were and are still enough negative factors out there that we don’t know currently whether we are in for a long-term recovery here…BUT, no matter what the reason is for rising prices, we want to be in markets that go up and we are not betting against markets that WANT to go higher. Honestly, sometimes we don’t know all the reasons why a market is moving upwards but I guess nobody does – all though many of today’s financial “gurus” will tell you they do. It is, however, important to realize that markets can’t be explained only with economic data and logic. When we spoke at various investment events and conferences in April 2009, we realized how skeptical people were when we told them that we had started to buy back into markets. Now, five months later, global markets have risen between 40% and 60%.
While we still do not think that everything looks rosy, avoiding the pessimism of the masses yielded great results and we now get to lock in those returns. So, while many investors missed this rally, and are probably still trying to talk it down, we continue to monitor markets carefully. We have recently moved our stop-loss levels closer to actual market prices. This way we make sure to leave the party early enough, just in case there is a sudden ’last call’.
So what can drive equity markets higher from here? It is clear that the market needs some sort of additional stimulus in order to keep moving upwards. We think that the upcoming earnings season will be somewhat mixed but probably be more biased towards the upside. The reason for this is, in our view, the increased operating leverage and efficiency that many companies have achieved in the past decade. The current crises forced many of them to get even leaner and increase efficiency even more. This will result in rapidly expanding profits when the global economy starts recovering – a process which we expect to see over the next 24 months. However, it will likely be an uneven recovery, with emerging markets and the BRIC countries accounting for two thirds of global growth.
We anticipate emerging economies leading the global economy out of recession and experiencing a rather quick return to normal growth rates. For parts of the western world and the U.S. in particular, we see a longer and more moderate recovery path. We should also need to keep in mind that the market recovery in the past few months has been driven by relatively small volumes and huge amounts of cash have not yet been invested. We believe that the longer the current recovery remains in place, the more robust and well supported equity prices will become.
What does a gradual recovery of the world economy mean for inflation? Should we be worried about upcoming inflationary pressures in the western world? The answer in our view is: not yet. While we are vigilant with regard to the threat of inflation, we are not rushing to join the vast majority of people who think that all this money printing must result in strong inflationary pressure or even hyper inflation. We regard this as a somewhat oversimplified view since monetization of debt does not automatically result in inflation. This is especially the case when the lending activity of banks is still low and only slowly increasing. Although we are worried that central banks might not be willing or able to withdraw excess liquidity on time, we feel that most central banks are taking a more proactive approach that in the past. The Central Bank of Australia has already started to hike rates and I think other central banks are soon to follow as the economic recovery gathers momentum. The forecasts made in previous issues of our newsletters have been pretty successful, with the only exception being that we did not expect long-term interest rates to move down so significantly. Our specific forecasts for the next 6 months look as follows:
- Global economy to show modest growth again
- Emerging economies to make up for most of world GDP
- Global equity markets to recover a further 10-20%, emerging markets to outperform
- U.S. Dollar to remain structurally weak and fall by another 5-10%
- Sharp price increases in energy and soft commodities
- Oil to move upwards and possibly break above USD 100/barrel
- Gold to move towards USD 1,300 mark
Readers who have been following our publications are realizing that most of these forecasts have been made already earlier this year and that most of the projected developments have indeed taken place and are expected to continue in coming months.