It Was a Very Good Year. Harvest time is arriving and the financial markets have experienced several starts and stops since the beginning of the Summer. An ever accommodating Federal Reserve is supplying financial fertilizer to the banking system with current 25% growth in M-2 money supply on an annual basis. Wars and rumors of wars all around the globe over borders, dictatorships, monarchy, tribal warfare, and oil confiscation have been prevalent during 2011. Instability has plagued the markets over the past six months as fiscal problems in Greece, Ireland, Spain, Italy and Portugal threatened the capital structures of a beleaguered European banking system. Except for China, Brazil, New Zealand and Australia, worldwide short-term interest rates are near zero.
All or Nothing At All. Deflationary threats persist as the U.S. economy remains stagnate and unemployment high. After completing QE I and QE II, the Federal Reserve is ready, willing, and not quite as able to perform more stimulus if necessary. The announced program called “Twist” is swapping short-term Treasury bills for long-term Treasury bonds that are held on the Fed’s balance sheet. Already, the 30-year Treasury yield has dropped to 3%. The collision of monetary and political will is being challenged to jumpstart the economy. Worldwide equity markets have fallen substantially more than the recent decline in the U.S. We remain cautiously optimistic that policy will promote economic growth in the coming Presidential election year.
Love and Marriage. On the Eastern Front (or the Western depending on your perspective), the Chinese have been less vocal regarding U.S. and European fiscal woes. All the while, they remain large investors in our U.S. government debt bidding up prices and artificially driving down yields to record lows. Alternative investments must not appeal to the foreign investor as many good corporate dividend yields are significantly higher than risk free returns of U.S. Treasury obligations. Since the S&P downgraded U.S. Treasury debt during the summer, the stock market has dropped approximately 10%, while Treasury bond prices rose. Maybe, the Chinese thought the S&P raised its rating! Usually, bonds drop in prices after such a downgrade. Current debate amongst very smart people cannot agree whether we are in an inflationary or deflationary period of time. We believe that inflation remains the modus operandi for the Fed and U.S. government.
Fly Me to the Moon. Historically, interest rates rise when significant economic activity occurs. Lending remains anemic, though banks have ample reserves to lend. Housing remains anemic with housing starts remaining at recessionary levels. Jobs are not being created, at present. Jump starting and expediting the mortgage lending business would help tremendously. Cutting taxes would help encourage private sector spending and hiring that would literally get the economy humming. Leadership must recognize the current morass and move to market based solutions over further government spending. Recent moves by China and Brazil to reduce their short-term interest rates should help global economic growth.
Night and Day. The Federal Reserve recently announced its program to provide liquidity to European Banks that are struggling with growing debt issues with Greece and other countries in the Eurozone. The move comes at a time when even a rumor can cause great damage. Attracting liquidity into markets that are down is the main drive in this process. We believe that it is a necessary step in providing investors with some assurance of stability.
That Old Black Magic. We believe we are now in the third year of economic recovery which began in 2009. Historically, economic recovery can last four to five years in duration. No offense to the Mayan calendar, we see 2012 as an exceptional economy. The world needs to recover as well. Any price break in oil and gasoline could fan the recovery in a big way. Although finding oil remains paramount in sustaining long-term economic success, oil prices may take a breather in the coming twelve to eighteen months as recent Baker Hughes Rig Count Index suggests a coming short-term glut in crude oil. Demand for crude remains steady though forecasts have recently been lowered.
Stardust. For the first time in several years, we believe that the great commodity boom is showing signs that prices are in the peak stage. We believe that once the financial institutions experienced higher interest rates alongside higher Treasury yields then commodity prices would peak. Record Treasury prices and low yields suggest that the commodity price stability has not been completed. The recent volatility in gold prices indicates that holders of gold have been selling into strength including some European banks. The run-up in price from $1500 to $1800 was fueled by Far Eastern Sovereign wealth funds. Unfortunately, gold remains a rare metal. Therefore, we do not attempt to predict specific prices. However, we have not seen a trading frenzy, yet.
Mack The Knife. We do believe the markets are in a transitional phase. Crossing over from declining interest rates to rising interest rates will be tricky. During inflationary periods, market price earnings ratios will actually decrease, not expand. Dividend yields rise as stock prices stagnate. Economies of scale are lost for big corporations as rising prices affect overhead. Smaller companies do better during inflationary times as corporate cash flow improves corporate balance sheets and debt servicing. The overall markets get locked into price ranges with succinct price ceilings. The markets become dominated by institutions.
Come Fly With Me. Our equity strategy continues to favor good industrial companies that pay dividends and have adequate cash levels to weather financial storms. Though the stock market has fallen since the S&P downgrade of U.S. Treasury bonds, we believe the current shape of the U.S. Treasury yield curve continues to predict favorable economic activity for the next twelve to eighteen months. We favor chemicals, defense contractors, energy, medical device manufacturers, steel, retail, telecommunications, and pharmaceuticals. We continue to avoid the financial sector until interest rates rise significantly.
On the Sunny Side of the Street. We consider it an honor and privilege to serve you as investment advisor. We still view investing as a long-term process. Day trading, high frequency trading is not investing. We are optimistic about the future and hope to hear from you soon.
Russell L. Robinson
Robinson Investment Group
5301 Virginia Way, Suite 150
Brentwood, Tennessee 37027