2011 Investment Commentary – Part 2 of 3
Global Sectors from Equities to Commodities
After two strong years equity markets are sitting in a slightly overbought status. Technical indicators are flashing 'pause' and sentiment indicators are in areas which usually precede a correction. Looking back over some historical indicators there is reason to be bullish for 2011.
We are currently within the sweet spot of the four year Presidential cycle for the equity markets as the 4th Quarter of Year 2 and the first 2 quarters of Year 3 have the best returns. This means that the current rally should last into April at the very least at which time investors should look to book some profits and take money off the table.
Overlaid on the Presidential cycle is the decennial cycle in which Years ending in 1 are mostly negative.
What may cause the current rally to run out of steam? The end of Bernanke's QE2 in the second quarter of 2011.
Valuation metrics, while on the high side are still attractive. Global multinational firms are showing strong profits on the back of a weaker dollar and increased sales penetration in the BRIC countries. Both factors should continue to drive profit growth in 2011.
Every 3rd year of the Presidential Cycle since 1939 has been positive which makes it likely that 2011 is an up year as well.
The US Dollar Index is currently in a trading range with 89 being the top and 70 being the bottom. More than likely the US Dollar Index will end the year higher and closer to the 89 level although a test of the 70 level is not out of the question.
Europe will need a weaker Euro in order to help the PIIGS and refinance debt in 2011. That means a stronger US Dollar since the Euro makes up more than 50% of the US Dollar Index.
The problem with a weaker Euro is that it feeds the German export engine which pushes up German economic growth numbers which will increase calls for removing excess stimulus.
Germany has been experiencing an export boom and strong growth relative to the rest of Europe in 2010. France is experiencing strong consumer led growth as well on the backs of low interest rates. If the Euro were to begin depreciating economic growth in Germany would rise and when combined with the consumption led growth in France would begin to fan the inflationary flames across Europe.
The Dollar will continue to depreciate against most Asian and other EMEA countries. Since these countries are not part of the US Dollar Index the depreciation is invisible to those not watching the individual countries.
China will continue to encourage domestic firms to write overseas contracts in the Yuan instead of Dollars. This is a trend that started about 5 years ago and has been picking up speed. It is mostly off the radar but is important in that global firms, not just Chinese firms, are feeling more and more comfortable dealing in currencies other than the US Dollar.
As we enter 2011 precious metals demand will continue to increase driven by the buildout of EMEA economies.
The easy money, however, has already been made in this cycle and investors would be well served to play the substitution effect as high commodity prices for precious metals such as Gold, Copper, Tin, and Platinum will force industrial users to switch to alternative and cheaper metals.
One particular example is Copper whose primary use in electrical wires and residential piping is well known. At $9,000 it becomes more effective for industrial users to substitute Aluminum in electrical wiring and PVC piping in residential pipes. Given the high inventories and lagging price for Aluminum versus Copper there is a good chance the Aluminum outperforms Copper in 2011.
This story should play out across the commodity spectrum as the year goes on.
It is a bit worrisome that so many investors are on one side of a trade, especially with respect to certain hard commodities. When this happens demand destruction and substitution begins to take effect causing a ripple effect across the commodity spectrum.
Gold and Silver should continue to see a flight from investors worldwide seeking a security marking another year of strong gains after a small correction in January.
Oil will continue to climb, moderately, on the back of a strengthening global economy.
Natural gas prices will be constrained my weather and strong production issues. While there may be a strong rally to start the year prices should fall back over the summer months.
The fixed income bubble is continuing with the markets moving from consumer debt, whose debt bubble popped in 2008, to sovereign debt and eventually to corporate debt which will lead to a corporate recession preceded by a mergers and acquisition boom in which corporations lever up their balance sheets and put the enormous amounts of cash to work.
We are likely to see a move upward in fixed income yields as long as QE2 is in effect. Once QE2 ends however, traders will move back into the fixed income space creating a solid rally.
Agriculture will do the best amongst commodities. By agriculture I mean companies that actually grow and harvest their own crops.
The strong La Nina is still in effect and should remain so throughout the year. It will begin easing up shortly but return towards the end of the year.
This means a wetter than expected rust belt and drier than expected southeast and southwest in the United States.
In Asia this will likely mean a dryer than normal northern China and a wetter than normal Southeast Asia and Australia.
The Mount Merapi eruption will not have a major effect on Asian agriculture as the ash that was thrown up into the atmosphere was of a low sulfur content.
Green energy begins to heat up once again as the oil price moves higher.
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