January 5, 2009

Annual Asset Class Review

January 5, 2009
Featured Trades: (VIX), ($BVSP), (RSX), ($BSE), (FXI), ($KOSPI), (TBT), (JNK), (PHB), (HYG), (COPPER),(FCX), (CHK), ($XEU)

After the annus horriblus of 2008, I thought it would be a good time to review the major asset classes and suggest reallocations.

Equities: UP

The collapse of the volatility index (VIX) is telling us that the horrific, gut churning, 10% daily moves are over. But equities are no longer a US play. Extracting the insane leverage of the last decade means chopping the US growth rate down from a booming 5% to an anemic 2%. This is not a strong argument to buy American companies, which is why most analysts only see the indexes recovering 10%-20% this year. You might just get tedious range trading after the late 2008 dead cat bounce. The real action will be in the BRIC countries, which will see upside returns double what you will get with the S&P 500. Buy Brazil's Bovespa ($BVSP), Russia's RSX (RSX), India's Bombay Sensex ($BSE), and China's FXI (FXI) or Hang Seng. And it may be time to spell BRIC with a 'K' by throwing in the Korean Kospi ($KOSPI) as a sweetener.

Kospi.png picture by  sbronte

Bonds: Treasuries Down, Private Debt Up.

As I have been vociferously arguing in these pages for months, US Treasury bonds are witnessing the final stages of an overinflated bubble, and you don't want to be anywhere near this asset class when it bursts. Take out the flight to quality and year end balance sheet window dressing bid from this market, and you have an accident begging to happen. Take in the long term inflationary impact of Obama's plans, and you have a 30 year contract which peaked at 142 last week that is really only worth 70. It's just a matter of time before massive government issuance buries largely foreign buyers. Throw in the 50:1 leverage offered by a long bond futures contract, and the profit potential of a short position is so enormous, there are not enough zeros on my calculator to total it up. Buy the Lehman 20 year plus ultrashort bond ETF (TBT). Unfreezing of the debt markets will move the prices for every other type of debt off of their current throw away levels. Buy corporates of every grade with a heavy weighting in junk, or fixed income securities backed by REIT's, emerging markets, credit cards, student loans, or subprime loans. A convenient way to do this is to buy the ETF's for the Lehman High Yield Bond Fund (JNK), the PS Corporate High Yield Bond Fund (PHB), and the iShares iBoxx Fund (HYG).

tbt.png picture by  sbronte

Commodities: UP

After giving up almost all of their 21st century gains, virtually all commodities, including grains, softs, energies, and metals, are due for a recovery. A good part of the sell off resulted from the disappearance of financing, which is now slowly working its way back into the market. Now that newbie investors who never should have been involved, like pension funds, have bailed on this asset class, conditions are set for some serious base building. Commodities will be the principal beneficiaries of an epochal trend away from paper assets towards hard assets that will be the dominant investment theme for the next decade. Chinese and Indians still want to raise their standard of living faster than these substances can be grown or ripped or pumped out of the ground. Now Obama is adding America to the infrastructure build out story. A safe way to play this is through beaten down, dividend yielding, producing equities like Freeport McMoran (FCX) for copper, Chesapeake Energy (CHK) for natural gas, and US Steel (X) for steel and iron ore.  But don't expect huge gains until we see signs of a global economic recovery by the middle of the year. Then watch out.

fcx.png picture by  sbronte

Currencies: Dollar and Yen Down, Everything Else Up

Since we are smack dab in the middle of a six year trading range, I don't really have a handle on what the buck is going to do short term. Could we see $1.20 or $1.00 for the greenback in an event driven overshoot short term? You betcha! But longer term, the trend is still down. Obama's highly inflationary reflationary policies will eventually lead to an utter collapse in the dollar. If they are successful, the economy will recover, bringing Americans back to their old low saving, high consumption, high importing ways, adding fuel to the fire. Don't bet against the 45 year trend. Expect to pay $2.00 for a Euro in the years ahead. Take that European vacation now!

Eurodollar.png picture  by sbronte

Real Estate: Down

With markets still deleveraging, and the son of subprime, the Alt-A loans, on our doorstep, real estate is dead money at best. Although the cost of carry for home ownership is rapidly approaching equivalent rental costs on an after tax basis, fewer and fewer buyers are qualifying for loans. Add 1.2 million unsold homes from builders to three million existing homes already on the market and you have a staggering 4.2 million homes for sale in the US. This is 7% of the total American housing stock. Probably 20% of US homeowners are underwater on their mortgages, and they're not buying anything anytime soon. We also have an impending crisis in commercial real estate generating lots of mall bankruptcies and empty retail space to deal with. Remember, 'debt' is a four letter word. I don't see a meaningful recovery in residential real estate for five years, and then it will be a slow claw back at best.