Uncertain Times For Investing? Think Like a Sovereign Wealth Fund

Both the Fed's disappointing 25bps rate cut and announcement of a plan for co-ordinated additional infusions of cash into money markets was met with investor skepticism.

Meanwhile, the US economy is generally expected to continue slowing, at least through Q1 of 2008, and recent quarterly profit growth has turned negative?i.e., we are seeing the development of a classic stagflation scenario?waning economic growth with accelerating inflation.

But the recycling of massive excess savings in Asia, the Persian Gulf and the BRICs is one powerful explanation why the US equity market has not already crashed along with the US dollar.

As the US treasury market has become somewhat of a black hole for the world's excess savings, these savings are now being re-invested in a portfolio fashion through sovereign wealth funds that are increasingly investing in everything from diversified equity portfolios, global fixed income, private equity and hedge funds instead of passively parking this money in US treasuries.

Because most of the world's excess savings are in US dollars, the last thing countries with excess savings want to do is sell those dollars in sufficient quantity to crash the dollar. Nor do they want to see a financial crisis in the U.S. markets.

In fact, given the current market circumstances, we believe other investors should think and act like sovereign funds, i.e., buying big, global blue chips with strong global franchises and managements as their stock prices get pounded down with overly negative market sentiment from subprime concerns. The latest SWF on the hunt for bargains hit by the supprime "crisis" is the $60 billion Qatar Investment Agency, who is reportedly particularly interested in financial institutions.

Given that Japan's stock market has been such a laggard over the past two years, we expect to hear a lot more about the investment activities of the SWF in Japan, particularly the large-cap bluechips with good global brand names and stock prices at secular lows because of subprime and indigenous Japanese concerns.

Comments

[Kunst]

Let's see, those SWFs have a ton of dollars, both existing and incoming every month. Up to now, they have bought US government bonds, which haven't been a real good investment recently, with the dollar dropping by more than the yield. But you can only buy stuff with US dollars in the US. Anything else (e.g., buying oil) just moves the dollars from one foreign entity to another. If you aren't going to buy treasuries, what else is there? Goods, I suppose. But seriously, property and equities. Property can't absorb enough dollars. Or build a factory here, but again too small a scale. The only thing left is stocks.

So where does that lead? Yes, it pushes US stock prices higher. But our dear federal government needs a few hundred billion a year in net new treasury sales. If our SWFs try to move significant money from treasuries to stocks, what happens to interest rates? That's right, they go up, until they are perceived as an investment equally as good as stocks. What do higher interest rates do to stocks? Nothing good. And to the US economy? Nothing good. And by the way, what happens to the federal deficit when interest rates rise? We're already paying $400B a year just in interest. Oops. Nasty little cycle there. US interest rates are irrationally low. When they start up, watch out!