Saturday, January 31, 2009 2 comments ++[ CLICK TO COMMENT ]++

Investment Outlook I: 2009

This is the second post in a series covering my investment strategy for 2009 and beyond. The first post dealt with my macroeconmic view. This post will cover my investing ideas for the year. And in the final post, I will outline my investment ideas and list my watchlist of specific stocks/bonds/etc I'm attracted to.

It is important that you not blindly follow anything I do. My stockpicking has been terrible and you should simply consider anything I say as ideas that you should accept or dismiss. I may change my mind at any point. All of this is obvious but I think my readership has gone up and I don't want any newbies losing their life savings. Not a pretty sight if I started getting mentioned in the same breath as Bernie Madoff ;)



Views Going Into 2009

As one may sense from my macro outlook, I disagree with the consensus view of a strong recovery in the later part of the year. There is a possibility of a rally in the markets but it is difficult to see it being sustained. Remember, sucker's rallies may be the most dangerous of all. People, including me, tend to be overconfident on a sucker rally and commit way too much capital.

My feeling for the next few years is that the economy will be in a long slump, but not a depression, with low growth. I think the stock market may stay in a bear market for many years. However, this is a highly attractive time for stockpickers!!! (Traders will also have potential of doing well.) I remember seeing many newbies and amateurs aspiring to be the next Buffett, complaining that Buffett had it easy in the markets of the 60's and 70's--LOL only a newbie would call the 70's easy--since valuations were very low and wished we had the same type of market. Well, these guys & gals got their wish. It's make or break time for stockpickers like me and probably most reading this.

Miscellaneous Thoughts


  • Stock market will not lead the economy: (If you were totally bottom-up, you wouldn't care about this at all.) I haven't read his book yet but I'm going with what John Napier says about the 4 big market crashes in the past. The consensus view is that the market leads the economy. This has been true for many decades and hence has resulted in everyone being scared of missing the train, and hence loading up early. I am taking the contrarian view that the stock market will not rally before the economy recovers. (Napier also suggests that the best signals of a recovery is the behaviour of copper and automobiles. Given the commodities bubble, I would rely less on copper; but autos look like a good signal)
  • Most overrated word of 2009, capitulation: I think we are going to see all sorts of crazy behaviour being rationalized by the notion of capitulation. We have seen many claiming the bottom for financials had been hit all throughout last year, and well, it is going to continue this year--not the decline in financials, but the concept of capitulation being reached.


Investing Stance (as of January 2009)

This is not all-encompassing and only covers some areas that interest me...

Bearish

  • Index funds and momentum investing: Both of these are very similar in that they do well when trending. I think we may see a sideways market as in the 30's-40's or late 60's-70's. To make matters worse, dividend yields--dividends still likely to be cut--are very low compared to the past 100 years. In the past, passive investors did poorly, but not terribly, due to high dividend yields. This time around, they may get clobbered and may have a rough time beating corporate bonds.
  • Bears: Bears ruled Wall Street last year. Short sellers looked like geniuses and had their day but I suspect their life will be tough this year. The market won't decline like last year, and even if it drops a bit, it will be volatile and shorts will be forced to cover every rally.
  • China: Potential for deflationary bust and the banking system, which is mostly owned by the government so it's all opaque, likely insolvent. I'm not predicting that there will be deflationary bust but, given the high probability, I would avoid China. (On an unrelated note, although highly unlikely, if China devalues its currency (I realize everyone assumes it will strengthen,) it will start a trade war and it should be avoided.)
  • Developing world stock market (in general): Counterintuitively, and contrary to some views of Austrian Economists and others, my feeling is that the current account surplus countries may suffer more than the deficit ones (similar to the period during the Great Depression.)
  • Inflation: We may get a temporary spike but don't see the inflation case at all. Ironically, the inflation bet seems to be popular everywhere except the market that inflation would decimate the most: the bond market.
  • Commodities: I'm maintaining my bearishness over the last few years, albeit I'm less bearish now. Unless the world economy--not just one or two countries but the whole world--recovers, likely to stay weak. Not that insiders are ever good investors, but the fact that management of many leading commodity businesses are significantly curtailing capex implies that they don't see a quick rebound either. Furthermore, from a psychological point of view, it was a highly popular sector and is unlikely to become a leader any time soon.
  • Gold: Way too popular and best major asset in at least 10 years. Some may look at that as bullish but contrarians like me consider it bearish. The time for gold was 10 years ago when no one wanted it; not when we have someone starting a hedge fund denominated in gold. The US$ strengthening, if it stays this way, will hurt gold. Since I'm in the mild-deflation/disinflation camp, I take the stance that cash is king, not gold. (If I'm wrong with my macro call and we get high inflation, gold will do really well.)
  • Insurers: This is a wild guess but we'll see. I have been reading Jim Grant's Trouble With Prosperity--I disagree with his econopolitical views but he's one of America's top writers and it's a good read if you are into history; will post a review when done--and one thing I observe is that, deflation is very bad for insurance companies. What happens is that a lot of insurance companies invest their premiums in stocks and bonds--mostly bonds back then but the scenario is the same--and the income from them is what really keeps the company going. In the 40's and 50's, bond yields kept declining and yielded almost nothing so the insurers had difficulty making money. I have a bad feeling that if stocks don't enter a bull market soon, or if bond yields stay low for many years, insurers will face prolonged difficulty.
  • Branded consumer staples: This is a low conviction call and I may turn out to be wrong. I would avoid branded consumer product companies, one of Buffett's favourites, like P&G, Kraft, Unilever, and so on. A lot of these companies have been trading at above-market multiples in the past and many still do. Partly it's because of their potential for strong earnings during recessions, and partly it's because they have high ROE with low capex needs. They are favoured by the market right now because they are safer than other sectors. Without doing any deep analysis and simply thinking as a contrarian, I really wonder if they can keep the streak going. If we enter a period of low inflation with bouts of mild deflation, how well can these companies hold up? If consumer spending declines, relatively speaking, can these companies do well? I have a feeling that consumers are going to switch to no-name, house, brands. Branded products have been doing well for a long time because Americans' wealth has been rising for a long time. But if the rate of incrase declines, or if incomes decline, it is possible that people just won't care about buying branded products anymore. What you see with Wal-mart taking away market share from more prestigous retailers, may happen with consumer products as well.



Neutral:

  • Developed world stock market (in general): I'm generally bearish but this doesn't mean that the developed markets won't finish the year with, say, +5% return. Overall, developed world looks far more attractive than emerging markets. As long as economic growth is not imminent, it's safer to hunt around in this part of the world.
  • US govt bonds: Looks overvalued but I can't argue for a collapse with deflationary threats present. Also, competitor bonds, such as other emerging market and developed world sovereign bonds are in worse shape. For example, would you really buy a British bond, or an Irish bond, or a Spanish bond, or even possibly a French bond over an American one right now? I would say no. Bonds of Austrialia, Canada, and the like, may be more attractive but there is a currency risk. Finally, FedRes has indicated it is willing to monetize US govt bonds so the downside is capped--we just don't know where.
  • Japan: Valuations have been attractive--for a while. Many overcapitalized firms with high cash on books, but poorly run and not shareholder-friendly. A sizeable chunk of the market in cyclicals and export-oriented industries that will suffer as Yen strengthens and/or the world trade slows. For the long-term, poor demographics along with super-high debt-to-GDP of around 180% presents serious issues.
  • Canadian dollar: Not a major call but important for me since that's my local currency. I think it will bounce around but stay around current levels relative to the US$, with possibly slight weakening. Unlikely to rally without a commodities boom (and I don't see that.)


Bullish:
  • Mild deflation: Bullish on mild deflation. I don't anticipate anything like the Great Depression or Japan in the 90's but it will somewhat resemble Japan. American consumer balance sheet needs to be repaired and the collapse in demand will likely unleash deflationary forces from China (this is assuming that China has overcapacity in manufacturing, which I believe to be true but many economists and investment analysts disagree.)
  • US$: Capital flight will likely to persist with risky assets being sold and a shift into safer US$-denominated assets.
  • Yen: Unwinding of carry trade likely to continue for a long time. There is the possibility of the Japanese government selling the Yen to keep it down but they haven't signalled anything like that (it usually doesn't work in the long-run anyway.)
  • Select high-yield corporate bonds (non-autos; non-LBO): Too bad small investors don't have much access to the bond market. This is actually one of my main investment suggestions for the year but I am unable to participate at reasonable prices or with small amounts of capital.
  • Technology: This is one of my main bullish calls, not just for the year but for the next 5 years. Tech has been out of favour for 8 years so it is attractive from a contrarian point of view. I have a theory that tech may do well during low inflation or mild deflation periods. Tech is inherently deflationary and, although declining sales would hurt, may end up being more adaptable to small price increases (or even declining prices.) Most companies have zero debt and often have sizeable cash. P/Es of some high quality large-caps near 12 (unlike similarly valued consumer staples or energy companies, these are non-cyclical earnings with high growth rates.)
  • High quality large caps in general: Jeremy Grantham likes these companies and I share similar views of them. These are the strongest and highest chance of survival if world economy slumps for many years. Valuations quite low for certain companies. These do not have to be American and one can look in Europe or Asia for some brand-name companies with decent corporate governance.
  • Patience: After a long time, patience is going to be rewarded. There is no need to act for the sake of missing the train. First of all, valuations may decline much more than anyone expects. Also, even if a stock you like rallies, you will have opportunities in many other stocks. Depending on the type of investor, you should start coming up with a bunch of ideas and then try to purchase a few of them, over the year, at what you think is a good price.


Specific stock ideas coming in a future post...

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2 Response to Investment Outlook I: 2009

February 2, 2009 at 3:49 PM

As, usual, good write up... I still can't get behind a deflationary arguement. :-)

February 2, 2009 at 4:48 PM

Well, you have good company. But I just don't see how we can have $30 trillion in wealth being destroyed and somehow expect inflation, not just a little bit but high inflation down the road.

Gold is in your favour but it is very volatile so we'll see how things unfold...

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