Summer Forecast (and Beyond)
Emerald Asset Advisors
The Emerald Team
June 30, 2010
Will the rain in Spain bring global investor pain?
With Spain and its PIIG friends continuing to cause anxiety in global investment circles, it's a good time to focus on the potential risks and rewards facing investors right now. In reviewing the GreenThought$ issue released on February 1st of this year, as well as our investment committee's market outlook from earlier this year, we find that little has changed in the reward/risk tradeoffs we see. Themes identified earlier this year are now starting to play out and come into focus, as often happens simply with the passage of time. So, here is a brief update on those themes and more importantly, how they are influencing the management of the portfolios we run. Quotes and thoughts from that February 1 issue are shown in italics:
1. It's a great time to be flexible! After seeing the S&P 500 Stock Index decline over 50% in seven months, then recover close to 80% in 14 months, we have recently experienced a decline from recent highs of over 10%. What happens next? We know one thing - the environment is such that trying to be a hero is not advised. Instead, we must manage more like we did in 2008 than in 2009, taking a very cautious approach. Since markets have different moods over time (think investor time-frame, not trader time-frame), it only makes sense that those who are navigating through them should be able to express their true mood by the portfolio's allocation. The broader the asset allocation range allowed, the more freedom to satisfy their hunger for a certain type of market positioning and asset allocation, and the better off the investor may be, long-term. Asset Allocation is a constant balance between risk and reward.
2. Back in February, I expressed my opinion that the S&P 500 will spend 2010 in a range of 950-1250 (it closed at 1090 on February 1, when it appeared in print), although I had no idea when and in what order that might happen. With that index peaking at about 1220 on April 26, and our favorite indicators (technical, fundamental, news, sentiment) telling us that the bigger risk is losing capital, not missing out on gains, this prediction looks good so far. Our investment committee sees that 950 figure "on the table" now. Our reasoning is based on the thematic summary below.
3. Back in February, Michael Kahn, our Technical Analyst, had a stronger opinion on gold than anything else. This jives with our thoughts on gold below. We are clearly bullish on the "yellow metal."
4. We strongly believe that the financial crisis is not over and there will be big swings in both directions. This is not something to fear, but rather something to capitalize on! Investing as we know it is dead. The rules are different as too many people are doing the same analysis. The markets are the same but the rules have changed. Adapt or perish.
5. Still, we believe that among the expected undulations in the stock markets around the world, a generational buying opportunity is slowly approaching. However, continued pumping of liquidity into the financial system by the U.S. Government can delay all of this. That would potentially prolong the rally (as it did from February through April), but make the eventual decline steeper as a result. We believe that another big leg down is coming, not necessarily to new lows but scary enough to finally get people wondering if stocks really are a good long term bet. That will be our major buy signal. That "leg" may be underway now, but the part about the major buy signal is not in sight yet.
6. Importantly, that does not mean our portfolios will suddenly be sold out at the next sign of trouble. Remember, there is a balancing act between risk AND reward going on at all times. The cost to you and us of betting on a forecast and being wrong is extreme.
SUMMARY OF MAJOR ISSUES AND THEMES as of June 30, 2010
SHORT-TERM (3 months to 1 year outlook)
1. Possibility that selling based on fundamental data and news (as we assume happened in May) gives way to panic selling in stocks around the world.
2. Europe's strife stoking continued concern about "contagion" as other countries such as the UK and US are viewed to be staring at similar fates down the road.
3. The next round of mortgage problems: delinquencies could be due to surge again from June through November, before peaking in 2011. Will this contribute to a "second shoe" dropping in the stock market?
4. Unemployment drags economies in the U.S. and Europe. In particular, the U.S. must work very hard to noticeably reduce "U-6" employment, which includes those who stopped looking for work or who cannot gain full-time employment. Not doing so could cause a generation of displaced workers, and the economy may not get back to full capacity for a long time.
CYCLICAL (1-4 years outlook)
1. A series of up and down cycles in stock prices is the most likely scenario, with several rounds of 20-50% moves in both directions possible. This is typical behavior for secular bear markets, and we believe we are now in the second half of one, which implies that a gradual pattern of higher-highs and higher-lows develops in the coming years. This could finally lead to a sustainable, general uptrend in stock prices which starts in the next few years. Many investors may not recognize this, we suspect, until the pattern is well underway.
2. China's real estate bubble pops, as all bubbles do. However, the impact may be swifter as the population, while still inexperienced as consumers, has shown the ability to learn from the developed world's mistakes. This allows us to look at China as both a cyclical and secular investment opportunity, in between the occasional bursting bubble. Same thoughts apply to India.
3. The battle between those who expect inflation, and those who see global deflation, finally has a winner (of course, neither is a winning scenario for investors). Depending on which way it goes, gold either becomes a valuable long-term member of portfolios (if global inflation), or perhaps the foreign currency/global bond sector deserves more attention (if US deflation).
4. Amidst the uneven trend in equities, some solid theme-driven winners become available at very attractive prices. This allows portfolios to be built for long-term success.
5. US Municipalities are in rough financial shape and there are no easy solutions. Until some progress is made balancing state and local budgets, this is a treacherous area.
6. Latin America becomes an increasingly intriguing topic for long-term investors. Some Latin economies such as Brazil have developed at a time when much of the world was hurting. As China, that continent's prominent trading partner, finds its footing, a secular story may begin to develop for Brazil and perhaps for some of its neighbors. This may happen sooner rather than later, in that the notoriously volatile stock markets there allow oversold regions to be purchased at a long-term discount.
SECULAR (5-10+ years outlook)
1. That same pattern of up and down cycles in global stock prices scenario ultimately resolves itself, first with a gradual uptrend, then with the emergence of a new secular bull market. However, that period of sustainable secular bull is probably at least 4-5 years off.
2. The era of consumer and government deleveraging is gradually accepted by its participants, and a period of tremendous "moral hazard" ends. The business cycle resumes its natural course, business inventories trough, and production ramps up. Jobs are finally created in a new, more austere economy around the globe. Different corners of the world are impacted differently based on what their life was like before all the problems started. Emerging economies continue to lead, and more mature economies grow but are less vibrant.
3. China and India "emerge" into developed economies and take a leadership role alongside the U.S.
4. Europe continues to struggle with both its identity as an economic zone, and with the growing threats to its vitality due to the influence of extremist political factions, whose gradual emergence causes persistent problems for governments of the European "old guard."
5. Life goes on...and on and on...and with people living longer, the need to help them improve their quality of live as they age is recognized in a major way. Those companies that hold the key to solving those problems flourish.
6. Global natural resource issues finally become too great for politicians to ignore. Alternatives to fossil fuel, development of more potable water, and demand for scarce raw materials in emerging nations are all contributors to a focus on a cleaner, greener planet. Younger generations are driving this thinking and in the long-run, it's their world. The race to solve these problems produces winners and losers, much like the Internet era of the 1990s. This goes hand in hand with long-term initiatives around the world to rebuild weakened infrastructure, and build for the first time in places formerly known as farmland, deserts and swamps.
The information herein has been obtained from sources believed to be reliable, but Emerald Asset Advisors, LLC ("Emerald") does not warrant its completeness or accuracy. Prices, opinions and estimates reflect Emerald's judgment on the date hereof and are subject to change at any time without notice. Any statements nonfactual in nature constitute current opinions, which are subject to change. Projections are not guaranteed and may vary significantly. Further information on the firm and its advisory fees may be obtained from the firm's Form ADV Part II, which is available without charge upon request. Complete descriptions of all Emerald's products and benchmarks are available upon request.
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