Ridgewood Group — Investment Update (December 2010)
December 2nd, 2010 by Kaushal MajmudarWhile the markets have been up and down as of late (though up big again today and yesterday) we are seeing unmistakable signs that the US and global economies are on the mend. These signs include improving auto sales, increasing rail transport volumes, improving manufacturing activity, and some upward surprises in employment (though the latter being slower than ideal).The reason stock markets have been rising (more or less) since bottoming in March/April 2009 is that they anticipated the steady recovery that is now already well underway.
Despite unemployment, as we finish December and enter 2011, it seems almost certain that the economic recovery will continue to broaden and be felt more widely next year.However, investors as a whole are still quite bearish and still have a lot of cash earning low returns. Since 2008, bond funds have had an unprecedented flow of cash into bonds and bond investments. This reflects the consensus view of investors who have spent the better part of the last two years trying to run away from “risk” In recent weeks however, for the first time in almost two years, bond flows temporarily went negative. We believe that there is evidence of a significant bond bubble well under way (we’ve said this before). If you own bonds (especially long maturity bonds and municipal securities, etc.) be very careful about credit quality and duration of these income/bond investments in particular. In typical fashion, investors have been pouring money into precisely the asset class (i.e. bonds) that probably offers the least value because it has been working well of late (i.e. chasing performance). A recent article pointed out that the amount of inflows into bonds (albeit a larger class of securities) over the last 20 months has been greater than the inflow into technology stocks in the late 1990s which caused the dot com bubble that hurt so many. Its not a perfect analogy, but the parallels should be informative to those thinking that “bonds are safe (and stocks risky)”There was also a lot of noise in the media about QE2 (i.e. the federal reserve’s quantitative easing program - essentially printing money to buy bonds). We think it is telling (and not necessary negative) that since QE2 was announced and started to be used to make purchases, interest rates have actually risen (when the purpose of the Fed program was to drive rates down).
Rates raising is due (partly) to investors recognizing that the economy is already recovering (with or without the Fed) and investors may start to weigh other factors more heavily in setting interest rates. Rising rates is another strong confirmation that the economy is recovering.Meanwhile, several European countries, most notably Ireland, but also Spain, Portugal have again come under scrutiny due to the underlying problem of too much debt. Ireland’s economy is only about the same size as the U.S. state of Connecticut. Not big enough to cause a permanent problem for the global recovery now underway. However, what is happening in Ireland can easily happen in other larger European countries that are similarly situated with too much debt - and probably will. Ultimately, markets are going to force these countries to restructure their obligations. In countries, unlike with mortgages, you cannot repossess and sell off assets when the country has trouble servicing its debts. Lenders to those countries eventually may have to take write offs (unless the ECB is willing to keep printing money) and the implications for the European central currency which is shared in common between the stronger (mostly Northern European countries) and the Southern European (mostly financial weaker countries) has not yet fully played out.
All of these interesting macro-economic factors are interesting to think about and relevant in the near term, but as Peter Lynch once observed, If you spend 10 minutes per year as a long-term investor focused on economic forecasting, you’ve wasted 7 minutes. Stocks, and particularly dividend paying value equities and value equities in general continue to be a reasonable place to keep long-term patient investment dollars that you do not anticipate spending in the short to intermediate term. Although equities had a terrible ten years when measured by the S&P500 - value stocks as a whole did much better, and valuations are now more reasonable. It is likely that the next ten will be much better than the last ten (though not as good as the bull market of the 1990s). Year end is also a good time to revisit investment, tax savings, and retirement plan allocations and/or to set up a new retirement plan and long-term savings plan account if you happen to be in a position (in your own business or practice) to take advantage of the significant tax advantages that the US government wants to give you to encourage you to save for your own retirement. As we have consistently preached to our clients, there is no better way to become (and stay) rich and successful than to implement a program based on sound/long-term/value based investments. As the cartoon below (see link) humorously illustrates, markets swinging back and forth day to day are often based on some irrational factors. Needless to say, the irrational individuals depicted in this cartoon are not far removed from the millions of American’s who get sucked into the short-term cacophony of markets and thereby make unsound long-term investment decisions - and thereby don not enjoy any degree of success in growing (or keeping) their money. In the last three years, our clients have witnessed (first hand) that following the disciplined and intelligent principles we espouse actually works. Now that our accounts have basically recovered from the temporary but traumatic downward volatility caused by the financial crisis (and well ahead of the overall market), we can look forward to some growth as the economic recovery continues.
We believe it is a good time to begin or continue a disciplined/long-term investment program. There are still wonderful opportunities to buy income securities, dividend paying stocks, and international value investments in growing emerging markets countries for the long-term. Selling bonds and moving intelligently into these areas of opportunity are what smart/long-term value investors should be thinking about. Besides the cartoon referred to above, we also include a handful of articles that touch on some of the themes above - for your consideration and reflection. As always, we welcome your questions, comments, and referrals.
Warm Regards and Seasons Greetings.
Ken Majmudar, JD, CFA
http://tinyurl.com/Financial-Cartoon
http://tinyurl.com/Ireland-s-Ripples
http://tinyurl.com/Europe-s-Crisis
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