Monday, January 31, 2005

Victor Bremson: Investment Update

I have written from time to time about my investment strategies for a very tough time. I have been catching up on my reading and analysis lately and this memo is a quick summary of some of things that I am learning. I hope that these comments are helpful to you regardless of the amount that you have to invest. I would love to hear your thoughts.

MAJOR WARNING ABOUT MY COMMENTS. There is no major consensus among writers as to the investment future for the next few years. I tend to be bearish and afraid of the US dollar. One of the prime people that I listen to takes the opposite tack. He says don�t bet against the dollar. When pressed why he says that it is more intuitive than anything else. He says that I am seeing the negatives in my country but not clearly seeing the balancing problems in the other countries such as China. Despite what I am going to say below I still follow his advise on some of my investments.

Here are my general conclusions: (I will partially expand later)

  1. Be highly diversified. Try not to be invested in US stocks as the center of your strategy. Be active in both international and emerging economies equity and bond markets.
  2. Stay away from 10 year government bonds , high yield bonds and bond funds that are highly leveraged. The inflation rate is rising faster than the price indices are telling us. Inflation is getting worse, especially for people with lower incomes or fixed pensions. This means interest rates could be going up quicker than we are being told. The fed will continue to raise rates. The only question is how fast.
  3. Choose old economy stocks that pay reasonable dividends and that have good management. There are good mutual funds that specialize in these holdings.
  4. Real Estate is usually a good hedge against inflation but there is also great risk here due to the high values in certain cities. I am still invested in Reits but I have begun to reduce my holdings.
  5. Energy Companies. We are still running out of oil despite the fact that energy stocks have paid good returns the last few years. I have been looking at natural gas trusts in Canada, Oil Companies like BP that are continuing to diversify away from gas and alternative energy companies like Fuel Cell Energy and Gamesa.
  6. Gold and Commodities. Both of these markets have high valuations right nowbut both will do well against inflation.

Some supporting comments:

INFLATION, US DOLLAR AND STAGLATION

The major inflation index does not include the inflation rate for energy or food. This means that it is tends to follow interest rates and the cost of imported products. Interest rates are artificially low right now because the fed wanted to hype the equity market in order to ensure that our equity markets didn�t collapse after the fall of the high-tech economy and 9/11. They are gradually trying to remove the artificiality from the rates. As far as I can tell the reason that rates have not gone up faster is because of slow job growth and slow employee wage growth in the US. Recent reports have indicated that people are slowly falling below the poverty line because of the lack of jobs and salary growth. The conventional wisdom is that the Bush tax cuts were also needed to keep the equity markets from falling further. There is much argument though about the need to make them permanent.

Low priced imports from China, India and other places has held inflation down and interest rates down. People are tending to be more careful with their money and checking prices very carefully. The problem is that this is leading to a massive trade deficit with China and others. They in turn are investing in our ten year bonds. This is good as long as they don�t stop or try to sell what they have already bought. This would cause disruption in our interest rates and they would go up quickly with inflation. The massive US budget deficits need to be reduced in order to reduce this risk. This is of course very difficult to accomplish.

The 100 pound monkey continues to be what is China going to do with its official currency. It is reportedly 40% undervalued. This means that we are paying 40% less for that item than we should be. This is leading to huge growth in China and ruin for businesses in the US. Consider this last fact when you hear an argument that says inflation is not that bad. No one knows for certain what will happen when China is forced to move to fix its currency. There is some soft evidence to suggest that China is preparing todo something.

The conventional wisdom is that the economy always does better the third year of a president�s term of office. Things are allowed to go down during the early part of the 4 year term so that they can be going up before the elections.

Stagflation is the worse economic result for most people. It means that prices go up and investment values/asset values go down. This might be good for the environment but terrible for those without a good job.

US and INTERNATIONAL EQUITIES�

Value stocks have led the charge in the last few years. Growth stocks and high-tech stocks have not done as well with high-tech being the worst. The conventional wisdom is that US Stocks are still selling at a very high earnings multiple, meaning that they are overvalued. People continue to invest in them because they have been told that equities make the best long-term investment. Warren Buffet buys great companies and never sells. He likes big, well managed, companies who pay good dividends. He buys at good prices.

Value investing is always a good way to invest. However it is getting harder to find good values. Consider investing now in large cap companies with good dividend rates. There are several mutual funds that do this. I like an American Fund product called Capital Income Builder because the fund invests about 40% of its investments in overseas multi-national companies thereby providing some diversification. There have been a rash of large mergers in the news lately. The reason for this is because many companies have huge cash reserves and they are looking to expand through purchase. Microsoft and Intel are too high tech companies with huge reserves. Microsoft recently paid a large special dividend and is actively buying a percentage of their stock back in the open market.

Europe will eventually have some of the same deficit/program deficits that the US is facing.

CASH INVESTMENTS

Cash investing doesn�t exactly mean cash. It doesn�t make sense to get on investment return if its possible. Short-term bond funds for example are a good place to invest excess cash. You will earn a small investment return and have very low risk. In the event that a major market investment opportunity takes place you will be prepared to take advantage of it. For example often there is a opportunity to take advantage of a market sell off. Short-term funds will easy to sell off in order to take advantage of the buying rebound.

Good luck. Let me know if you have any good ideas.

Victor Bremson