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Y H & C October 2010 Newsletter

US Economic & Financial Markets Outlook: Skepticism and Negativity Still Reign When Looking at the U.S. Economy, Is the October Curse Applicable in 2010?

Take a look at the following quotes from the last month about the investment environment the U.S. is in. "We are headed for a double dip recession. Housing prices are headed down another 15%. Unemployment is at 10%, but the real unemployment rate is 17-18%. Banks are not making loans. The fiscal and current account deficits are way too large, so the dollar is doomed. Gold prices are at an all time high, and they are the canary in the coal mine. Stocks had a good run, but it‟s a suckers rally because volume has been none existent. Advocates of the bond market are even more down on the stock market, in one case, an analyst overseas went so far as to say that anyone who owned stocks was an idiot." I don‟t know how much more extreme the skepticism and pessimism could be about the general health of the U.S. economy and the poor prospects stocks represent as an asset class.

The opinions of analysts and investors about the U.S. economy and stock market litter the investment environment on a daily basis. In my opinion, what is badly lacking to give a more balanced and analytical approach is disclosure and context. "Yeah, really, no kidding," you say. Sure, it‟s not like I am really going way out on a limb, but I believe if an investor has a position where they are short stocks, or long bonds, before they say a word, the media should disclose those positions, and the investor should mention them up front. In addition, the investor should mention what could go wrong with their point of view. I think these disclosures would at least give a possibility or present a little possibility of a chance the investor‟s positions will not automatically take place. The reason why I mention this is all summer long, economic commentators and the media brought on bond market investors who proceeded to talk their book by saying bonds are a good investment in the current environment, and they only foresee deflation coming, which means more great times in the future for bondholders. Maybe, but how about at least posing the possibility the future may not unfold so promisingly for bond markets. Investors have been listening to these bond bulls, moving billions of dollars over the last year into the bond market. With bond yields so low, I certainly want to mention the quote to consider-"Past performance is not a guarantee of future results."

With the U.S. economy currently exhibiting low GDP growth and not enough private sector job growth to help improve the general mood of the economy, many investors continue to believe gold will do well in a no growth, no inflation environment, or a deflationary situation. Other investors believe the U.S. dollar will continue to weaken against the yen, the Canadian dollar (the Looney), and the Chinese currency (Renmimbi), mostly because of the low interest rate situation in the U.S. and lack of inflation. My take is investors should remember the only constant is change. I don‟t think anyone should expect housing prices to explode higher any time soon, especially in California, Nevada, and Arizona. Also, I would not expect private sector

jobs to show more life until next year. However, in a month the mid term elections could see (one never knows though) the Republicans take control of the House of Representatives, and possibly the Senate. A win in either house would dramatically change the legislative prospects of the Obama Administration in many of their initiatives. A vote on the outcome of continuing the Bush tax cuts would provide clarity to the private sector for how to approach capital spending initiatives in the future. In addition, any improvement in the unemployment claims numbers or key economic indicators for the future, especially inflation, could cause the Federal Reserve to change how they see the economy, and investors might change their views on the risk/reward ratio of bonds versus stocks.

Finally, October is usually the month where stocks perform the worst, behind September. Bond market investors and many notable economists continue to warn people October is when the apocalypse is coming for the stock market. How do I see it? I always try to look at markets where I can get the most out of my invested capital. Stocks performed very well in September, which means nothing for the month of October. However, despite the repeated warnings about the upcoming stock collapse, I will tough it out and take my chances with stocks.

Global Economic & Financial Markets Outlook: A Tale of Two Investment Themes, One of the BRIC Countries Outperforms, and A Country Index with A Year to Date Gain of Over 100%.

(All country index data provided by the market data section of the WSJ on September 27, 2010)

The global economy continues to look like a tale of two dynamics. On one side is the impressive growth (5-15% annualized GDP growth) in Asia and the BRIC countries. Opposite the torrid growth lies the mature countries of the U.S. and Western Europe, where growth seems to be sluggish at best (+0-3% GDP growth). Based on these two macroeconomic themes, many investors have piled capital into the high growth geographic areas and tried to minimize exposure to mature economies.

One can see these ideas play out just be examining the stock returns on country indexes over the last year. Look at the impressive returns in Indonesia (+32.7% year to date), Malaysia (+26.3%), Philippines (+48.9%), Singapore (14.5%), and Thailand (+40.9%). At the opposite end of the spectrum are countries like the U.S. (+3.6%), Europe (+2.1%), the U.K (-2.1%), France (-7.5%), Germany (-3.1%), and Spain (-16.3%). Just as important as these viewpoints is the universally accepted idea the BRIC countries are where most of the world‟s growth will come from in the next decade. BRIC country index returns were exceptional in 2009, but 2010 results have proven to be a mixed bag. China has been a huge underperformer with index results down about 25% year to date. Russia and Brazilian indexes have been flat, ranging from 0-+5%. India has been very good for the year, up 14.8% with a majority of the gain during this month.

Finally, a tip of the hat must go to the Colombo Stock Exchange in Sri Lanka with an advance of 103.5% for the year. I certainly would not be a buyer of Sri Lanka today, but would look very hard in China for good value.

Y H & C Investments: The Psychology of Contrarian Investing: Bonds Vs Stocks Continued- Mohamed El-Erian and Bill Gross of Pimco (Bonds) Against Ken Fisher (Stocks).

A nice little war of ideas broke out today on the idea of the future of the U.S. economy and how it relates to investment returns, especially stocks and bonds. On the bond side, is Mohamed El-Erian, PIMCO Chief Executive Officer, who is responsible for the term, "The New Normal." The new normal thesis is based on the idea the U.S. economy is deleveraging and is subject to lower growth because of a more restrictive environment due to risk aversion. Within a context of higher unemployment with less bank lending, investors should expect returns will be more muted (2-3%) annualized for the next decade. "The new normal will be an environment where „future investment returns will be far lower than the historical average.‟" ("`Druckenmiller‟s Exit Mark‟s End of Old Normal for Investing,‟ "Gross Says, Liz McCormick, September 28, 2010. Bloomberg)

In rebuttal, Ken Fisher, billionaire CEO of Fisher Investments, said the concept of "a new normal" is idiotic. „We are chimpanzees with no memory. The next 10 years are going to be as good as the 1990‟s. The problems in the current environment we think are so different, and so new, and so unique. It‟s the same stupid old normal." (same Bloomberg article, author, day)

Those who have read my newsletter know I have the thought stocks currently provide more value than bonds, and have done so for the last year. In addition, it has been a pet peeve of mine that El-Erian takes every opportunity to tout the riskiness of stocks. I believe bonds are currently far more risky as an asset class, especially treasuries, than equities. It certainly is interesting PIMCO‟s Total Return Fund has reduced their Treasury debt in the portfolio from 36% from 54% in the last month. My opinion is investment returns are based on analysis, price, timing, and the performance of the business (or country) underneath the underlying asset. Do I expect to earn more than 2-3% annually over the next 10 years? If I didn‟t I would not invest mine and others capital. Thanks Bill and Mohamed, I‟ll keep your new normal concept in mind.

Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, please email me at

Disclosures- No positions mentioned.

Disclosure: none mentioned