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2006-11-10 :: Looking Toward 2007

As we are getting closer to year-end, I thought it might be interesting to examine what we can expect for 2007.

The national mood, I think, will shift from a navel gazing examination of everything that is wrong with the current moment to a hopeful view of life getting better.  Change can be painful at times, but it can also be cathartic, providing a fresh perspective on things.  My gut feeling, with all of the fairly conservative democrats that were elected, we have the opportunity to accomplish some things that people with mainstream views will appreciate.  That should convert itself into a more favorable national mood that in turn increases optimism for the future. 

Optimism for the future has in past years led to increased P/E ratios, and (as long as earnings continue to grow) rising  stock prices.    There is currently $5 trillion in cash sitting in money market funds and bank accounts that at one time was in the stock market.  As optimism increases, and as baby boomers turn 50 in greater numbers than in any previous year, you should see that cash go to work in buying stocks.

What sectors will see the greatest cash influx and the biggest price moves in their stocks?  My analysis says that it will likely be the consumer electronics stocks (piggy backing on some big trends – HDTV’s below $1,000; the mass downloading of the new Windows product, Vista; the continued move toward Apple entertainment products with the introduction of the iPhone, and filling the 500,000 order backlog for iMac’s) and a return of the commodity stocks (metals and energy, although you’ll likely see that the Asian producers will outperform the US and European producers over the coming years) and cyclical stocks as the Fed begins to reduce interest rates.  We will also likely see moves toward alternative energy producers (since that was a near universal pledge during the campaigns) although I’m not sure yet whether it will be an Ethanol play, a nuclear energy play, or a technology play that wins out here. 

Conventional wisdom says that health care companies will be more heavily scrtinized and be pushed toward a nationalized medicine / medicare type program, now that a new party is in power.  This has sold off the health care stocks since Tuesday, providing a good buy-in point for companies with high growth rates and profit margins.  We are beginning to take advantage of this (likely short-term) mis-pricing.  The conservative/moderate democrats that gained office came to power with the help of a lot of moderates and conservative of both parties, and nationalized health care is not something that they favor.  Fixing the inequities of the current system will be the priority, not scrapping it and starting over.

Historically, as the Fed begins to ease rates, financial institutions’ stock performance is one of the market leaders.  This congress will likely (and correctly) begin to examine hedge funds and derivatives.  This could have a negative impact on some of the money center banks and investment houses, but small and regional banks should flourish.

And, most importantly for the future of investment portfolios, 2006 was the year that the countries in the Emerging Markets had a collective GDP greater than those of the developed markets.   The world’s financial powerbase has shifted to these “poor” countries whose savings rates are so significantly higher than those in the developed countries that they are now the net capital suppliers (equity and debt financing) to the West.  This shift will increase the move of the citizens of the emerging economies to the middle class and increase the need for energy, alternative energy, metals, water, and food. 

So, in coming posts, you will see these ideas begin to take shape in the form of investments.  We’ve already begun to add certain companies to the list in the consumer electronics area, ahead of the Christmas season:  Digital River, Apple (we have a good til canceled buy that has not yet filled), Silicon Motion, Silicon Image, and CREE.  We’ve also started to build positions in Imunocor to take advantage of the health care mispricing opportunity.  In the financial sector, we’ve increased our exposure to Alliance-Bernstein and small reginal banks Carolina Bank Holdings and City Bank (Seattle).

Have a great weekend and get excited as 2007 should be a big year for investors!

Mark