It was surprising to wake up to the pleasant sight of half my portfolio at 52-week highs.Apparently, gold has broken through its all-time nominal high, oil fast approaches $100 and not unrelated, the US dollar index precipitously sits right at the 76 level, threatening to drop even further. While these trends have further to run, it seems this train has left the station for value investors who don't like to pay full price. While I am still waiting for that increasingly unlikely pullback to add to positions, it's important to look ahead for the next phase. So what's next?
The tenor of the economic conversation has changed and the general markets are starting to recognize certain truths that so-called "bears" like Jim Rogers, Michael "Mish" Shedlock, Eric Jantzen, Peter Schiff, Marc Faber and all the housing-bubble bloggers have been pounding for months, if not over a year now.
Themes now half-recognized:
- Housing crash has no bottom in sight due to subprime defaults.
- Financials will be a wasteland for the forseeable future and earnings power will be diminished even when the mess clears due to evaporation of fees from securitizations, underwriting, M&A, etc.
- US dollar is doomed to devaluation.
- US economy is not the 1st place you want to put your money.
- Inflation might become a problem.
- Oil isn't getting cheaper.
- Credit is drying up.
The other halves yet to be recognized:
- The housing mess is usually couched in terms of subprime defaults. This is too narrow. The US housing market, all of it from prime to subprime, was in a massive bubble, comparable to the tech bubble. People understand that P/E ratios above 30,40,50 are not sustainable in the long-term. Recognize that the housing version of P/E ratios, the affordabiliy index, is still massively inflated, even today and and the market won't bottom until house values fall below historical affordability ratios (because markets have to overcorrect in order to balance).
- A few of the big financials will face bankruptcy without direct government (taxpayer) intervention.
- US dollar devaluation IS NOT GOOD FOR THE ECONOMY! In the short-term, it may boost exports in nominal terms. But our economy is 70% consumer-based. Many small businesses are wholly domestic. The costs of living and doing business can not rise at these levels for long without measurably affecting economic numbers even with fraudulent bureaucrats massaging the numbers. But perhaps more importantly, markets are highly influenced by psychology and a devalued dollar will eventually affect the public at large.
- The US economy is a sick, sick puppy. At a most general level, economies are about establishing priorites for resource allocation. People like Warren Buffett and Joel Greenblatt have briefly touched on the idea that an economy, a society may want to encourage their most promising citizens to engage in productive activities, like solving energy and water problems, medical research, etc. and not necessarily engaging in financial engineering en masse. Eventually, this will affect American productivity.
- Inflation is and has been a problem and you will start to hear the concept of stagflation bandied about more often.
- Expensive oil is primarily a supply/demand issue, not a geopolitical risk issue. Statistics suggest that oil production has peaked (in summer 2005) but since peak oil can only be confirmed in the rear-view mirror, we need a little more distance to be sure. If confirmed, all this talk of an over-valued Canadian dollar will disappear.
I'm still researching but two to three pending themes stand out:
- What's old is new. Everyone and their mother is enamored with tech right now but the next major trend points to back to basics, back to the earth literally and back to commodities, especially agriculture and basic industrial metals.
- US dollar and economic weakness is now pressuring any economy pegged to our currency. If this continues to build, the Chinese RMB looks unstoppable.
- Water may be reaching critical mass. From California to Florida, water issues are taking center stage. Jim Rogers states that the only potential risk to the Chinese growth story is water. The Malthussian concept of natural limits to human population has been discarded in recent years but it may soon make a comeback.
Recognizing the themes is only part of the task. The other part is finding investment opportunities related to these themes that satisfy our margin of safety requirements. Stay tuned.