Happy New Year!
Return to Normal. The market has rewarded patient investors in 2010. The New Year greets us with a sense of normality whether it is false or premature. The financial system has been somewhat restored and the emergency triage can be removed and policy makers can now address employment and housing issues. The stock market is a leading indicator and the DJIA was up for 2010 forecasting an improving economy for 2011. Fear and panic gripped the country in 2008 and 2009. The subtle move in the market in 2009 and the carry through in 2010 gives us all a sigh of relief. The Federal Reserve, with much opposition, announced its QE II program in October, 2010 at the advisement of the former Japanese central banker who weathered ten years or more of zero interest rates and economic recession. Washington has come to reason in the middle of the night and extended lower tax rates for the next two years signaling a united front against further recessionary forces.
Economy, Heal Thyself. Corporations are sitting on close to $2 trillion in cash. Except for the financial institutions, the industrial economy is flush with cash but very hesitant to spend on new capital projects that might employ people. More recently our government is discussing the possibility of reducing corporate tax rates which would be very positive for our economy. China and India continue to enjoy lower wages versus the rest of the world. The other part of the equation is housing. With 9.8% unemployment and an aging Baby Boomer population, the glut of housing remains. The poor demand for housing in the U.S. is a drag on recovery but not necessarily an impediment since it represents only 3% of the total U.S. GDP. American policy should focus on creating jobs based on products that the world needs and that Americans can competitively produce. Government policy should encourage manufacturing through tax incentives similar to local economic development agencies packages negotiated to attract commerce into their respective regions. If state governments can figure this out, surely leadership in Washington can!
Dire Predictions Long Forgotten. The stock market has reached levels that the naysayers said was impossible. One strategist said the DJIA would reach 1000. The Bearishness that gripped the financial markets twelve months ago has recently subsided as interest rates remain historically low and capital abounds for financing growth. Government stimulus has contributed to the recovery. However, basic market cycles have more to do with the positive market psychology than Keynesian type spending. Eighteen months after the World Trade Center fell, the markets were reeling from the dot.com collapse and financial theft by Tyco, Enron, and Worldcom. Bearishness gripped the markets in 2003 which served as a nice market bottom with the DJIA rising to new heights. Albeit, the easy money in housing policy probably propelled the recovery as houses became ATM’s for the American consumer. The final period before the decline was marked by Wall Street investment firms being greedy and issuing worthless securities signaling the market top in June 2008.
Determining Value. Value in the stock market is determined by the scarcity of an investment. Contrarily, markets become overvalued when an overabundance of an investment exists. We prefer to invest in companies that buy back shares. As investors, we really want to avoid companies that issue stock like a General Motors IPO. Another overabundance exists in bank stocks since they have issued many new shares to increase capital over the last eighteen months. Unfortunately, we cannot find any industry as a whole that is buying back stock currently. As we scour the stock universe, we do find individual companies that have plenty of cash and are buying back stock. Corporate cash flow remains very good in the industrial based companies which should be positive for overall stock market.
Government Crowding In. Finally, the U.S. Treasury market has seen yields rise rapidly since the announcement of the QE II. Many smart people thought that yields would drop as the Bernanke bond desk buys about $8 billion a day in U.S. Treasuries. However, some of our foreign investors have been selling their positions as a result of this policy. Whether you agree or disagree with the Fed’s decision to increase its permanent holdings in Treasuries from $774 billion to $1.374 trillion is irrelevant. At near zero percent interest on Fed Funds, Bernanke ran out of tools in his tool shed. You can bet he has been on the phone with Central Bankers in China, Japan and Europe. Our Treasury department has peddled bonds to everyone over the past twenty years. Japan, China and the Arabs are the biggest holders of our bonds as a result. We fully expect continued selling by foreign investors over the coming months. We believe ultimately Treasury yields will continue to rise and recommend avoiding bonds with a maturity greater than five years.
Further Monetary Easing. Once the world awakens to the fact that holding any currency is expensive, then you will see a rush to invest. Real estate, commodities, and underlying securities for these assets will be the only way to hedge against this imminent inflation. We are somewhat burrish as our Japanese friends used to say. We are constructive on the worldwide recovery. Yet this policy change at the Fed will put a ceiling on financial assets. What we do not know today is to what level Bernanke will go with QE II in order to restore a “normal level of inflation”. Rising yields indicates rising inflation. In the late 1970’s inflation reached double digits which pushed long term treasury bonds to double digits.
Room to Go. Stock market strategy is tricky at this juncture. We do not have any one panacea for asset management except for looking on the contrary side and not fall prey to the momentum crowd. Out of favor industries are hard to find these days. Pharmaceuticals and maybe defense contractors are relatively cheap due to Federal budget changes coming in the future. Energy stocks no longer are as attractive as they were twelve months ago. AT & T and Verizon, i.e., the telecommunications industry are no longer as undervalued as they were twelve months ago. Chemicals, basic industry and forest products have been pushed up with the rise in commodity prices. Utility stocks are less attractive as inflation hurts the cost structures of these investments. Airlines, rails and other select transports are certainly not undervalued. Technology companies are not undervalued. Selectivity is important and patience is important as we manage your assets.
As your investment manager, we remain optimistic about the future. We appreciate your confidence in us as we manage your assets. We believe we have benefitted you the most by investing in holdings with a very long term time horizon. We wish you a Happy and Prosperous New Year.
Russell L. Robinson
Robinson Investment Group
5301 Virginia Way, Suite 150
Brentwood, Tennessee 37027