How to Prosper, What to Protect in 2011

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Includes: AUNZ, BND, CYB, DIA, EWJ, EWP, FXA, FXB, FXC, FXE, FXF, FXI, FXY, IGOV, NORW, QQQ, SPY, TBT, TLT, UDN, UUP
by: Cliff Wachtel
If you could only read one short article to prepare for 2011, this is it. First we take a look at the consensus for 2011, and then our view.

Array of Bulls vs. Bears

The overall consensus for 2011 is overwhelmingly bullish, and that of course is a contrarian warning that the pool of buyers may be running low.
Bull Case
It's Official: Tim Geithner Has Been Vindicated For Writing "Welcome To The Recovery": Basically a collection of charts showing that US stocks, auto, and retail sales have been up in the past month. Duuuh, that’s why the overall consensus among investors is bullish. The question is, why does one believe that the trend will continue? Bulls generally site slowly improving data (true, but too slow to yet make a meaningful difference, especially in jobs) and coming QE stimulus, with more likely if needed.
That’s fine as long as there remain buyers for the debt used to finance the stimulus.
Bear Case
To balance the overall bullish view, consider the following articles for a bearish perspective:
Does This Make You Nervous?: Has a great chart showing mainstream magazine cover stories saying that the markets were likely to continue their current directions, superimposed on a chart of the S&P 500 that shows these indicators of popular sentiment marked major market reversal points. The clear implication is that a recent bullish USA Today headline suggests stocks are due for a pullback.
Finally! Someone On Wall Street Is Seriously Bearish!: Summarizes why Citibank is bearish based on similarities between the current Dow Jones Industrial Average (DJIA) Chart and those of other long term bear markets.
All Of The Huge Threats Facing The Economy Summarized In One Paragraph: A great summary from David Rosenberg of Gluskin-Sheff, one of the leading bearish analysts.
Our Take
The basic question is how long government money printing in the US, EU, UK, Japan and China can continue to effectively counteract deeply bearish fundamentals like the EU debt crisis and long term weaknesses in jobs, real estate and banking, and global debt overhang on a national, regional, and personal level. So far money printing has worked and continued economic weakness has kept the feared inflation at bay.
  • If one believes this can continue for 2011, be bullish and buy risk assets like stocks, commodities, and the riskier currencies like the CAD, NZD, and AUD.
  • If not, avoid or go short these assets and be long the CHF, USD, and related AAA bonds. The Norwegian Krone was recently suggested by a reader given it’s relatively high yield and strong underlying economic fundamentals.
We believe there are simply too many potential and likely time bombs ticking under the markets to avoid a major meltdown in 2011, though timing that is tough. That keeps us in risk assets while the party lasts (we don’t fight trends) but with stop losses at the ready and planned safety asset buys.

EU Sovereign Debt/Banking Crisis

Our primary concern is the EU sovereign debt and banking crisis. Lending more money to nations that can’t even service their current debt load is a delaying tactic, nothing more. The big questions haven’t been touched. Those include:
  • How to actually pay for all the eventual bailouts/restructures in the PIIGS bonds, the banks that then need additional capital to cover their losses on these bonds, etc? The final cost is largely unknown given the unknown web of indirect exposures. I’ve read $3 trillion, but no one really knows.
  • What mechanisms are needed to prevent further debt crises and how to enforce such rules. The debate on this usually comes down to the need for fiscal union and whether EZ nations are ready for the concomitant loss of sovereignty.
  • The total debt picture could in fact be much worse. Like the US, Spain and other PIIGS nations have significant regional and municipal debt issues that have remained largely below the radar of the financial media.

Additional Likely Sources Of Deep Trouble In 2011 Include:

  • China: Possible burst of China’s real estate market and banking sector
  • US:
    • Further US banking trouble from the ongoing double dip in US housing and still anemic jobs and spending picture.

    • A brewing state and municipal debt crisis which, per Meredith Whitney, is due in mid 2011 when bailout money for the states runs out. Unclear if another bailout will come.

  • US & International Local Debt
As I hope to discuss in depth in a coming article, the US is far from the only nation with huge brewing regional and municipal debt problem that has been largely ignored. There is evidence of similar trouble in Spain, Japan, and China.

Precious Metals An All Weather Investment?

PMs appear to be a long term buy on dips for a long term hold regardless of one’s view because:
  • Large scale expansion of the money supply for assorted bank and sovereign bailouts, extended unemployment benefits, etc, is supposed to bring inflation and thus loss of buying power for currencies. While it’s technically possibly that central banks like the Fed could withdraw stimulus in time to prevent inflation. However use of government stimulus is at historically unprecedented levels, making it very uncertain that inflation can in fact be avoided.
  • Asian and other export nation central banks have been buying PMs, especially gold, as a means of diversifying their large foreign exchange holdings out of US Dollars. Judging from how gold tends to rise during times of rising EU debt crisis tensions, gold is also being used as a Euro hedge.

Need Income Investments?

Unfortunately, most of the above suggestions don’t tend to yield much. For those needing income we recommend equities that provide a combination of both yield and linkage to diverse currencies (especially from the sounder economies like Canada and Australia) and commodities.
The classics include shares in US limited partnerships(yield), and Canadian/Australian materials stocks (yield, currency diversification, and tie to commodities). We hope to cover these in detail in the future, as we did back in early-Mid 2009 when we were still comfortable with equities.
DISCLOSURE & DISCLAIMER: AUTHOR SHORT EUR FOR PERSONAL PORTFOLIO, THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER