2011, What’s in Store…
Happy New Year and may 2011 investing be as profitable as 2010. As we enter 2011 we can expect a mixed bag of opportunities and challenges. Emerging markets continue their growth while the U.S. hangs on and Europe fights for survival under mountains of debt and devaluing currencies. Since August, when Ben Bernanke, Fed Chairman, began telegraphing his intention to launch QE2, Treasury and corporate bond prices have dropped sharply, while the stock markets have climbed higher. This has the effect of prolonging our current positions of commodities, precious metals and stocks (those companies which have hard assets and/or sell to emerging markets). This trend can continue until interest rates rise high enough to compete with this list. At that time, bond fund investors will have been decimated and bonds will sell at discounts that should offer us very attractive returns as we rotate parts of our portfolio to the newly advantaged sectors.
One of the biggest errors in investing is the view that the economy and the markets act as one. It is important to understand that the European and U.S. markets are made-up of hundreds of multi-national companies (MNCs) whose revenues have grown so large that they dwarf the GDPs of many countries. The MNCs earn their profits outside their host country avoiding countries with adverse taxation (such as the U.S. which now has the highest corporate tax rates of any competitive country). It is estimated that there are more than 20,000 MNCs operating in the global economy, with over 100,000 overseas affiliates running cross-border businesses. Through a tactic known as “transfer pricing”, MNCs allocate income to subsidiaries in tax havens while attributing expenses to higher taxing countries. Governments will no longer be able to rely on corporate taxes as a means for more spending. However, countries like Brazil are realizing this now and have reduced corporate taxes and are reaping the benefits of full employment. They are actually importing labor as there are more jobs than people.
For investing, there is a more important ramification of QE2 and MNCs. In its simplest form, “quantitative easing,” (QE) is nothing more than massive money printing, designed to dilute the value of US-dollars floating in circulation. And since most globally traded commodities are priced in dollars, when the value of the dollar goes down, the prices of commodities and precious metals usually climb higher. China’s trade minister Chen Deming lamented, “Uncontrolled printing of dollars and rising international prices for commodities are causing an imported inflationary shock for China and are a key factor behind increasing uncertainty.” The US money supply, as measured by MZM, has mushroomed by nearly $500 billion since late April, and is fueling the explosive surge of the “Commodity Super Cycle,” to record heights.
Therefore, the only viable option left for Beijing that could hold down the cost of soaring raw materials, is to succumb to pressure from the Fed and US-Treasury, and allow the yuan to climb further against the US-dollar. Right now, Hong Kong based currency dealers expect the yuan to gain roughly 6% this year, hitting 6.25 /dollar in late 2011.
Further, QE2 is contributing to the global trend away from the dollar. I expect that sometime this decade we will see the dollar’s role as the world’s currency reserve, be replaced with a global basket of currencies and/or commodities. Though the dollar will certainly remain an important ingredient in such a basket, it will still have to weaken. Going from the sole currency reserve to a shared position means that precious metals and commodities will continue to rise in dollar prices.
Missing the importance of this has prevented most investors from participating in the gains that hard assets have provided. More unfortunate is the fact that most Americans are not investors – they may have a 401(k) which offers very limited choices. Sadly, those choices seldom offer much or any exposure to precious metals, commodities, or MLPs and participants are typically invested to a fairly large percentage in cash and bond funds – the two areas which will suffer the most.
There are very few Amazons, so investment opportunity, today, requires finding companies that are selling to the emerging markets or have needed resources or strategic hard assets. I’ve discussed emerging markets, high dividend stocks, hard assets, and natural resources in many issues over the past five years, so there is not much new to report, other than that they are still in tack and should remain so until interest rates rise enough to compete for investment dollars. At that time, bond fund investors will have been decimated and bonds will be selling at attractive discounts, providing us another opportunity.
Predicting the future of the Chinese economy rests on a trend that has held true for thirty years. Like a boulder rolling down a slope, China’s economic growth continues to pick up momentum. The immense force of 1.3 billion people struggling to rise above poverty is the driving force behind that momentum. Although China has become the world’s number two economy, the nation remains much poorer than western countries on a per-capita basis. That means the Chinese dominant obsession will continue to follow the maxim of the late Supreme Leader, Deng Xiao Ping. He famously said, “To get rich is glorious.”
The Chinese are doing just that and consumer spending is growing at a rate near 18% per year. Along with government spending, there are hundreds of billions of dollars being poured into companies building infrastructure or serving the needs and desires of the growing numbers of the middle class. From cell phones to hamburgers, the growing consumer class wants the same types of luxuries found here. Even Rolls Royce sales in China will soon eclipse those in the United States. This year, they expect to sell 800 of the ultra luxurious Ghost sedans at a price of nearly $1,000,000 each.
Though we only held a few positions in the BIC (Brazil, India, China) this year, and none in Russia (I don’t like the idea of making 30% until the government decides to own 100% of my assets), I expect their markets to be attractive again, once they no longer feel the need to raise interest rates or otherwise tighten fiscal policy. Another example of sector rotation, this should offer us another opportunity to re-enter these markets in a significant way, at attractive prices and attractive long-term growth potential.
Though the economy struggles to add enough jobs and the dollar is under attack, the U.S. is still the world’s biggest economy. It is the most innovative and it is highly efficient by any standard. Surprisingly, only one in five Americans believes that the U.S. has the largest and disappointingly, only 30% of Americans say their portfolios have reaped notable gains since the market low in March 2009.
This should be the year for the large multi-nationals which have accumulated mountains of cash and are operating lean and efficient businesses. Generally they are selling at attractive valuations and can offer growing dividends. Choosing those with the best valuations and the best exposure to emerging markets should provide us another profitable opportunity.
Of course we will pay close attention to the amount of leverage at hedge funds and banks, which combined with the bad mortgages, caused the worldwide pain of 2008. If interest rates rise, we will rotate our portfolios accordingly (as noted above). The wildcard is Europe. We will monitor the sovereign debt problems there and act accordingly as Europe and the U.S. are economically conjoined.
I never expect a smooth ride, but this year offers opportunities in almost every scenario, though it will certainly require making changes along the way. We should be able to make any rotations needed while still managing for another year of gains without much taxation.
May 2011 be your best year for good health, good luck and good fortune,
PH. 512.345.6789 (5, 1 thru 9)
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