In recent days, amidst the holiday festivities, party revelers seemed to be unable to resist breaking from the theme of the season to inquire about markets, stocks, portfolio positions, what to “like” in 2011, “what about interest rates”, “how about gold?!”, etc.
Where memory served me well, I made note of some of these conversations and have shared them with you below. I hope you find them to be thought-provoking, and in some cases, quite entertaining. Here goes….
Q: Gold….wow! What a year! Did I miss the rally?
A: If you’re talking about the ETF for gold, GLD, the YTD price move is over 25%, so, yes, I’d say you missed the rally…..the rally of 2010…but possibly not the rally of 2011.
Q: Why is gold on fire, and why might it continue in 2011?
A: All kinds of reasons. One household explanation is that in times of inflationary fears, gold is viewed as a commodity that will retain value, and inflationary expectations have been fueled by the enormity of government (US and European, in particular) borrowing and spending…fiscal imbalances that many gold buyers think can only result in depreciation of the value of the USD and the euro, ultimately benefiting gold as a value protector.
There’s also “panic protection” buying going on….people who believe that markets are still very vulnerable to another ’08 style implosion believe that protecting themselves in hard asset commodities is the safer bet.
You also have had central bank buyers…central banks around the globe who have been buying more gold to diversify their reserves. This was countered by the IMF’s programmatic selling of gold over the past year which came to an end earlier this month.
As for commercial uses of gold, despite periodic articles highlighting India’s demand for the metal, you’ll find more folks pointing to silver, platinum and copper for commercial justifications, but overall, the tide for most metals was on the rise.
As for 2011, it’s hard to see most of these reasons fading in importance, so that might keep the bid alive. That said, there are sure to be speculative excesses which will ‘pop’ and send the prices back down, but there still appears to be quite a robust bid for gold (and other metals) based on all the reasons above.
Q: Where do stocks go from here?
A: Good question…if I knew the answer with certainty, we’d really be celebrating. On a serious note, much like gold, 2010 was a banner year for equities in general. While most of the year felt like a worry-fest in anticipation of another market meltdown, other than the springtime ‘flash crash’ experience, the markets were more appropriately defined as moving higher in a very choppy fashion.
Heading into 2011, there’s more reason to be optimistic on the US economy with the tailwinds of fiscal stimulus and monetary quantitative easing hopefully pushing consumer sentiment higher and motivating corporations to start spending their cash hoards on investment and, most importantly, new jobs! Add to that the global growth that continues to be seen especially in Asia and Latin America and there’s good reason to expect US corporations to continue to see robust business and in turn, to generate healthy returns given how lean and mean most of them have become. The operating leverage of many US corporations continues to drop more dollars to the bottom line, in many cases, benefiting shareholders with increased dividend payouts and share buybacks.
Q: What about interest rates? My cash earns NOTHING! What can I do?
A: If you don’t see the term “bond bubble” at least a thousand times a day on every market related website then you’ve got to tell me which sites you’re visiting! The phrase ‘de jour’ for some time now has been “bond bubble”. Many market commentators, especially on the heels of the President’s agreement with Republicans on tax cut extensions, presumed, in a Pavlovian fashion, that the so-called bond bubble would burst and rates would be off to the races, exploding to higher and higher levels.
I struggle with that conclusion. I wonder why the Fed would allow long term rates, the very target of QE 1 and 2, to rise meaningfully. A little increase? Sure. A relatively steep yield curve is always a good remedy for ailing banks. But to presume that the US is poised for an imminent skyrocketing o f long term rates seems premature.
There’s no question that the US fiscal imbalances, if not dealt with in coming years, will lead to greater disenchantment with the USD and with the US as a debtor nation thereby making it harder and more expensive to fund the obnoxiously burgeoning deficit, but that’s not today’s trade. At a time when the economy has enormous capacity available of both the human and plant & equipment variety, there should be no inflationary pressures to push long rates up.
Furthermore, the borrowing needs of the US Treasury are unlikely to be crowded out by corporate borrowing largely due to the fact that the latter constituency has well over $1.3Trillion dollars in cash on their balance sheets and have little need for new rounds of large public debt issuances.
As for what to do with cash in such a low interest rate environment? You and millions of pensioners and others relying on fixed-income coupons for subsistence (most notably, my 90 year old mother) are asking that question every day. There is no good answer. The only way to get yield in this environment is to take some form of risk. You could look for ‘teaser’ rates at banks and get CD’s that compare well with T-bills, and up to some limit are protected by FDIC insurance, but that’s about it. Most other short-term money market vehicles offer underwhelming yields.
Many people, as a result, have moved maturing money from bonds into stocks of relatively high quality that pay reasonable dividends. And this is something that should be watched closely in 2011….many investors have moved out on their ‘risk curves’, essentially accepting higher levels of risk in order to achieve higher current yield. From a valuation point of view, that could inflate the prices of stocks beyond prices that would be justified based on earnings and growth.
Q: What about emerging markets? There’s lots of talk that the EM game is over. Agree?
A: No. But that doesn’t mean you can proceed without caution…and lots of it. China’s recent moves to fight inflation are raising all kinds of fears in the market that this assault on inflation will bring the economy that has been heralded as the engine of global growth to a halt. I’ve been on the other side of that argument.
In my recent article, “I’m a China Bull, Not a Bull in a China Shop”, I made the point that fighting inflation is a good thing, and the Chinese authorities have been using a broad range of measures to temper the problem without causing the overall economy to come to a crashing halt. In that same article, two readers followed on with a back and forth commentary that I’d suggest you read….it goes into great depth into the realities of the China housing market…not just in the large, globally well-known cities, but across the country, and among various constituencies within China’s society…and discusses the likely need, use and demand of housing supply in coming years.
Away from China, there are many countries within the EM asset class that continue to grow and continue to build out their infrastructures, which is likely to keep demand strong for machinery, farming equipment, resources, etc. These same countries have truly ‘emerged’ in many ways….one very informative article on this theme that is chock full of data to support the view appeared in the IMF’s “Finance and Development” magazine, entitled, Emerging Markets Come of Age.
The article goes into great depth on each of the following categories that are presented as explaining the relative resilience of emerging markets during this past financial crisis:
- Better macroeconomic policies in most emerging markets succeeded over the past decade in bringing inflation under control through a combination of more disciplined fiscal and monetary policies.
- Less dependence on foreign finance and changes in the composition of external debt reduced their vulnerability to swings in capital flows.
- Large buffers of foreign exchange reserves also insured against sudden reversals in investor sentiment.
- Emerging markets have become more diversified in their production and export patterns.
- Greater trade and financial linkages among the emerging economies have increased their resilience as a group.
- Broader divergence of emerging market business cycles from those of the advanced economies has also increased resilience.
- Rising per capita income levels and a burgeoning middle class have increased the size of domestic markets, making emerging markets potentially less reliant on foreign trade to benefit from economies of scale in their production structures and less susceptible to export collapses.
There were far more questions thrown at me than there is room to include in this space. Suffice to say, the inevitable outcome of a strong market performance is some combination of euphoria that feeds a “there’s no stopping it now” mentality with a fear of “the train left the station” or “you’ve missed the boat”.
This past year certainly leaves market participants spread between these two worlds, with many left somewhere in between, acknowledging the robust run of 2010, and mindful of the opportunities, and risks, that lie ahead in 2011.
Wherever you stand in this assessment, know that when the champagne corks pop on Friday night, whatever questions spring to mind or emerge among the festivities, the answers will start rolling in next Monday morning.
Happy New Year!
(Please note: This article is solely meant to be thought provoking and is not in any way meant to be personal investment advice. Each investor is obligated to opine and decide for themselves as to the appropriateness of anything said in this article to their unique financial profile, risk tolerances and portfolio goals).
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