Recent events
in the Middle East , combined with excessively
onerous winter weather, have put tremendous pressure upon raw materials
prices. The fear is that cyclical
pricing pressure might become secular (generational) trends, accelerating inflation
in energy prices, foodstuffs, and industrial components, thus undermining a
tenuous uptick in consumer spending, global trade, and consumer
confidence. While Wall Street rejoices
that something, anything, has
stimulated trading activity and profit margins, the world watches as surpluses
contract and statistics become human convoys of disaster. The earthquake in Japan
The fiscal
crisis of 2008-09 has transformed global secular cycles from
deflationary/consumer-led to epic manipulation of fiscal policy/reflation. The curve is expanding towards inflation and
major shifts in agricultural, energy, and industrial spending, as well as
geographic relocation/dislocation of centers of influence.
These changes
are not limited to trading and market machinations. Beyond the significance of secular shifts
upon financial markets, the political ramifications are being seen in social
protests in the Middle East, climatological changes in South America, economic
upheaval in the United States’ midwest, and, obviously, natural disasters
worldwide.
Climate and agricultural shifts are to the
millennium as industrial revolution was to the last century.
Broad general
analysis is just that, non-specific and vast.
But understanding the personal and economic impact of these secular
shifts helps us as investors, and citizens, to identify pockets of opportunity,
need, and social awareness. These shifts are not only prototypical of
prudent risk management in portfolio construction, but also socio-economic
phenomena which might govern global politics, economics, and sociology for
decades.
History has
shown us that it’s easier to “look back” and say that a secular change has
occurred than to forecast that it might. In this case, however, all the
stochastic measurements are aligned at the bottom, creating more than inference
that commodities including food, oil, metals, arable farmland and water are
poised for significance in our marketplace tapestry. Rising interest rates, along with price
increases in soy, corn, wheat, coffee, poultry, dairy and fruits could propel
double-digit percentage increases in these sectors. Just a few years ago investors were fixated
upon dot.com equities to the exclusion of natural resources. Today, with the attention span of a
nano-second, traders are perhaps getting the message that secular shifts are
about to occur.
Markets.
My data shows
that these evolutionary shifts toward pricing power and inflation are
durable. These trends not only favor
higher interest rates but consumer savings as well. Fiscal austerity is an absolute “must” if
monetary policy is to have a chance at generating recovery. The likelihood of a double-dip recession is
small, but the duration of a nascent recovery is elongated by these
factors. Higher prices might curb acceleration rates in earnings, but could
auger for a longer term sustainable economic recovery based upon real demand,
real margins, and real savings. In
contrast to where we started, we are certainly closer to the beginnings of a
rally than we are to the end of one.
For obvious
reasons, energy has been the sector most successfully to navigate the previous
quarter. Our goal, then, is to uncover
those sectors, those demographics, which might lead to capital gains
potential. As it looks right now,
Consumer Non-Cyclicals, Utilities, and Technology have such a profile,
acknowledging that the market might still be susceptible to contraction for a
significant period of time.
Additionally, a capital flight from low yields in fixed income could
also regenerate an asset allocation shift into stocks and away from bonds.
During the last
three decades yields had been declining until they reached a historic low in
2008, just before the credit market collapse.
With the Federal Reserve’s aggressive asset repurchase program since,
interest rates have held these levels from the crisis point, and have nowhere
else to go now but up.
Do bonds have a
future? Yes, but we need to adjust our
thinking and strategy regarding bond purchases and their role as a surrogate
for equities during economic hard times.
We have come to “accept” low yields as a firewall against credit abuse,
but the stress of noncompetitive returns takes its toll on maturing long-term
fixed income and portfolio performance. If
interest rates do turn up from here,
large portions of one’s fixed income portfolio could be at greater risk than
owning equities!! We might also infer
that rising rates are a coincidental indicator of economic expansion, making
stocks all the more attractive. We know
that rates don’t have to rise. Some
Asian economies have had low yields for decades. But will that model work for the mature and
emerging markets? Low rates can
sometimes be a boon to economic growth or a symptom of valuation collapse and
overvalued prices.
Interest rates are on the rise. Our expectations for economic rebound
supercede the need to recapitalize the markets with “easy money.” One cannot time the path of interest rate
increases, but we know, for example, that the last, best sell for bonds
occurred more than five years ago. That
set in motion the probability of an upward trajectory for the next cycle in
yields. If we do want economic and jobs
recovery worldwide, we must expect a modicum of inflation, like the kind we are
seeing in natural resources.
Certain
sectors, too, could be beneficiaries of these new-era fixed income
strategies. Investment in alternative
energy, healthcare, technology and food production will come from private borrowing
and public policy. For good reason,
being a bondholder (lender) might become vogue for economic fashion. I doubt that we would let, in these early
stages, borrowing and lending to become the risk endeavor it became at the
height of the real estate bubble.
Municipalities,
too, might mine the public for new initiatives in infrastructure. No investment is without risk, but high
quality projects with un-exaggerated expectations could help the economy and
the fixed income market to regain some luster.
Some countries
are better at managing finances than others.
I forecast an expansion in the emerging market’s debt arena, as
investors search for new ideas, new populations of resource and idea exchange
from which lending could lead to capital returns. Here again, no region is without risk. But careful due diligence might uncover some
long term opportunity.
Strategy.
Thus far, most
global bourses are responding to geo-events in unison. After the credit crisis in 2007-2008, most all
markets collapsed simultaneously, and have since rebounded tepidly with the
same degree of synchronicity. The bear
phase in stocks is universal, and not likely to change in the near-term.
Typically in
this scenario one might wait for a “hero” to emerge, a region or sector that
takes the lead. Concurrent with the boom
in commodities prices I believe the next beneficiary of top-down macro trends,
as well as a shift from over-extended short-term winners like gold and oil,
will be the agricultural foodstuffs including corn, coffee, wheat, soy,
poultry, beef, grains, sugar and dairy. Let me also add that those who seek a
rebound in the real estate market might find it not in cities but in arable farmland across the globe.
Prices in
agricultural commodities are expanding at a faster rate than any other tangible
asset. Industrial and population
explosions require sophistication in farming techniques to keep pace with the
demand for food and potable water. If
one subscribes to the belief that industrialized and emerging markets are the
places to invest, then a corollary to that thesis might be the expansion of
agricultural technology. A sophisticated economic infrastructure
cannot rely solely upon capricious weather patterns or the centralization of
food baskets to support its population’s needs.
While I favor
these sectors in the very long term, I am still cautious about allocating money
to the equity markets indiscriminately.
A bear trend currently rules over all sectors, even those about which we
currently posit. Core central economies
around the globe (Europe, America ,
China
I am expecting
that Q2 2011 will be a grey, dull quarter.
As I have previously written, I also believe 2011 is a throwaway year,
in transition between 2010 and 2012, when trends might have had a chance to
regain some upside momentum.
I think it
important to counterbalance the single minded focus upon gold and oil and to
“distribute the wealth” a bit. Methodologically, I remain a top-down investor
still quite averse to the overall risk posed by buying equities in the throes
of a bear market. Therefore, I am “fully
invested in equities,” but do so relative to the overall risk/reward
probabilities of owning any stocks,
versus cash reserves or bonds.
Many investors
misjudge the difference between methodology and risk. Whether by luck, happenstance, coincidence,
conviction, confidence, or one’s brother-in-law, investors sometimes feel
compelled to go outside of their comfort zone for that one big score. As a result, they lose sleep, allowing the
effects of the market to determine whether they are wealthy or poor, happy or
miserable. While no methodology is
foolproof, I have always featured a macro-strategy and asset allocation
philosophy to my investing. I know the difference between worst-case
and best case scenario, and try always to place as many of the risk factors in
my rear-view mirror. The net impact
is a portfolio that progresses, usually quicker, than a volatility-driven
approach.
Conclusion.
Population
explosion, natural and man-made disasters, natural resource shortages are
making it seem as if we are reverting to an earlier time when bread basket
migrations caused sociological, political, and economic shifts. The people who are rioting in the midst of
drought, disaster or oppression are not hungry for a piece of the profit, they
are hungry for their fair share of the food, water, and access to opportunity.
As investors we
are faced with similar opportunity to profit from capital gains, inventiveness,
and moral persuasion.
Asset
Allocation:
Equity 28%/Fixed
Income 37%/Cash 35%
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