2010 has been an odd year in investing. When we look back at this year in the future, can we say that there was any definitive movements or events? If 2008 and 2009 were years where we received clarity, 2010 was a year of fogginess. The market was a giant see-saw more or less, getting pulled in both directions by various currents around the world.
The one thing about this year, however, is that it has set the stage for some of the things that will play out over the next half-decade. The euro crisis, in particular, will radically change Europe; no one right now could possibly be expecting the status quo to remain the same in the eurozone in 2020.
With that in mind, here are my ten thoughts for investing in 2011 and beyond:
- The eurozone is a scary place to be. The basic problem is that there are huge economic distortions that have resulted from the introduction of the euro as the sole currency. What needs to happen is "price convergence"; nominal prices are too high relative to intrinsic values in the PIIGS and too low in the "Northern Block" of Germany, Netherlands, Finland, and Austria relative. Unless eurozone officials begin to recognize that the issue has absolutely nothing to do with sovereign debt (which is merely a symptom of the "price convergence" issue), then it's almost inevitable that there will eventually be a national bankruptcy. As "cheap" as things look in the eurozone, I'm still hesitant to invest there, until I see some indication that eurozone policymakers "get it."
- China could very well see its bubble burst sometime in the next few years. Official have no control over the "shadow banking" system, which will continue to pump money into the economy, in spite of economic signals that suggest there needs to be less money there. All of this goes back to the dollar peg, which has eroded purchasing power and has squeezed consumers, which is driving inflation. It's also driving the asset bubbles there; it makes sense from a logical perspective if you are a consumer to buy hard assets so that your money does not erode in value, as your currency continues to be artifically weakened. Yet, the Chinese economy does not need more real estate or gold. Nor does it need more manufacturing capacity. There is massive oversupply to external economies and undersupply to the consumer space. I don't know how long it will take, but eventually, the house of cards will crumble and the carnage might be ugly.
- The United States is slowly recovering. It is held back by the currency distortions in Asia and the eurozone crisis; however, things in the domestic sphere are starting to look better. Only problem is that aggregate demand is lagging behind everything else. Businesses are now sitting on massive cash hordes, but won't invest that money, because they see nowhere to invest it. Until aggregate demand rises, this pattern could continue. My guess is that we continue to see recovery at slow pace, but the economy will recover all the same. The US will be one of the better places to invest this decade if you are looking at the long-haul.
- Latin America and South America are the two best "emerging market" areas to invest. Latin American economies have actually been held back by the currency wars in East Asia. The currency manipulations of the East Asian nations are starting to backfire and this benefits Latin America more in the future.
- US homebuilders are very cheap right now. Who knows how long before we see "normalized" production again, but at the current prices, I see no reason not to buy in, sit around, and wait on it.
- Small and regional banks will eventually prove to be a great investment, but it may take awhile, and one must be very careful about which banks they are buying. But even if you want to play it safe, you can find well capitalized banks that are selling at or below tangible common equity and will probably benefit from higher interest rates in the future. I'm looking at you Hudson City (HCBK) --- but there are others out there, as well.
- Public REITs with lots of cash and liquid assets could potentially benefit from some of the distressed debt coming due in the next few years. The private RE companies' suffering will be the public REITs' gain.
- Pain in Asia has the potential to filter out quite a ways. Think Australia. And maybe Canada.
- If China's economy dramatically slows, gold, silver, and copper could all see negative price action. China's gold buying in 2010 has increased five-fold from gold buying in 2009. If this demand collapses, gold prices could drop considerably. While this might only mean a 10% - 30% drop in the price of gold, it could be much more harsh on vulnerable gold miners, particularly the major gold miners who have been purchasing new resources at inflated prices. Silver miners are also a very scary bet right now and extraction costs are nowhere near the spot price. Of course, the bubble could continue to motor on for another 6-24 months; but I think the risks are definitely starting to get higher and investors need to be more concerned about the downside.
- Investors might be forgetting the rule of "abnormal earnings" in regards to Netflix (NFLX). "Abnormal earnings" is an economic term that implies that a "normal profit" exists and that if a firm is earning above that, it achieves an "abnormal" profit. Abnormal profits entice new competitors to enter into an industry. Unless there are significant barriers to entry, a firm will have difficulty maintaining those abnormal earnings for an extended period of time.
In regards to NFLX, it has a competitive moat around the DVD-by-mail market; so it can protect its abnormal earnings in that sphere. Unfortunately, that sphere is dying and it's now competiting in a sphere (streaming content) that theoretically has fewer barriers to entry. To be sure, NFLX has executed very well and is ahead of the game on streaming content, but they'd have to grow earnings at an astronomical rate to catch up to the stock price. Even if no competition moves in for the next five years, I am not sure whether NFLX's current valuation is realistic.
So those are my thoughts heading into 2011. I'd be happy to hear any intelligent rebuttals or any arguments furthering mine on any of these issues.
Disclosure: I am investing in long, short, and option position in regards to most of these themes. I own long-dated puts on NFLX and long-dated calls on HCBK.