Investment Outlook 2010
By Akber Zaidi
Yorba Lind , CA
We have just ended a decade that has been called by various publications as the Decade from Hell, the Decade of Broken Dreams or the Lost Decade. Any of these titles fits as we had 10 years of no job creation, no gains for homeowners and no gains for stocks. In fact, the US stock market had its worst decade in recorded history. It performed worse than all of the boom-and-bust cycles of the 19th century, worse than the Great Depression of the 1930s and worse than the stagflationary 1970s. The key question is: what will the next decade bring and in particular what will 2010 look like .
Demographics help in understanding longer term economic trends. The demographic age group that has the most discretionary income to spend is the one that is in its prime working years (35-49). When we compare this group’s growth relative to the younger or older groups we see that the decline in the high income group will continue until 2014. Total consumer debt is shrinking for the first time in 60 years and credit card delinquencies are hovering near all-time highs. Although real estate seems to be stabilizing foreclosures accounted for 33% of all recent sales and default notices reached the highest on record with 3.9 million notices sent to homeowners in default. This implies that deleveraging will continue for several more years.
Given all the negativity, the positives cannot be overlooked. Easy year-over-year comparisons for economic statistics and corporate earnings should ensure positive growth rates ahead that will show improvement in the economy. We will have achieved this growth because the Federal Reserve has lowered rates to virtually zero and embarked on the process of quantitative easing . Quantitative easing or money printing by the Fed has pumped at least $1.2 trillion into the US financial system.
The immediate consequence of the Fed’s relentlessly printing money is a long-term decline in the dollar. Creating massive new supplies of US dollars dilutes their value. Other countries, especially those holding large quantities of dollars, will start to demand that the dollar be replaced as the world’s dominant reserve currency.
As the dollar declines, global investors will perceive US dollars as high-risk investments. They will buy alternative forms of money for their wealth including gold, silver, copper and other commodities. They will also buy other tangible assets like real estate which will at some point join the rise of other hard assets. They could buy stocks that provide a stake in those tangibles as well.
Another outcome of the declining dollar will be increased inflation. Inflation will not come from excess money supply but from a declining dollar. Imported products will soar in price in dollar terms because the US is a net importer. We will see inflation in those things tied to “human need” because people will still need to eat, drink and heat their homes.
The US Treasury’s yield curve is signaling a major outbreak of inflation as well, with the spread between 30-year and 6-month yields steepening to the widest in three decades. Higher inflation is also being signaled by the Economic Cycle Research Institute's US Future Inflation Gauge (USFIG). The USFIG was designed to anticipate cyclical swings in the rate of inflation and it was up for the ninth consecutive month. The data implies we will have rising inflation this year.
Over the last 100 years, the Consumer Price Index (CPI) has had a pattern of double peaks. If the pattern repeats, the second top in the CPI cycle would fall sometime in 2012. The Commodity index also has a pattern of double peaks with the second top 3 to 5 years after the first peak. Commodities peaked in July 2008 and would project to a second peak between July 2011 and July 2013. Both the CPI and Commodities cycle imply that inflation should continue higher for another few years.
In 2010 we could see increasing economic growth followed by an inflation surge. Will a positive growth picture for the economy translate into higher stock prices? The stock market has likely priced in much of the improved economic rebound and 2010 may look a lot like 2004, just as 2009 was a replay of 2003. During the middle stages of a recovery, which is where we are now, industrials, basic materials and energy tend to outperform the broader market.
Although the US may grow slowly, emerging markets will grow a lot faster. Their consumers do not rely on credit cards or home equity as a source of spending power and do not face record unemployment. The economies of Brazil , China and India could grow up to four times faster than the US .
The biggest risks to sustained global economic recovery are devaluation of the US dollar, inflation and interest rate hikes. These risks can be mitigated with sound techniques.
The simplest and most practical insight from modern portfolio theory is that investors should “avoid concentrated risk.” One of the most basic tenets of portfolio risk management is: “do not lose money.” Both objectives can be achieved in 2010 by holding positions in non-correlated assets and employing good stop management techniques to preserve your capital.
(Akber Zaidi is President ofAlpha Asset Management LLC)
