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The Day Before the Big News


Its been several days since I’ve had a chance to post something on the blog. I’ve been busy executing the plans I’ve discussed in recent posts:

1. Reducing risk in fixed income holdings by lowering exposure to credit (except adjustable rate credit) and reducing overall duration – the purpose of this has been to reduce credit risk and interest rate risk. In previous posts I told you how uncomfortable I have gotten with the bond market, where everyone has been taking money out of bank accounts and out of stocks and putting the proceeds into bonds and bond funds. There is just too much money flowing into these assets which inevitably leads to trouble.

2. Moving money from fixed income and cash equivalents into stocks – in previous posts I explained the graph above: the green box represents the buying zone, so as we are near the bottom of it, we move cash out of fixed income and cash equivalents into our favorite equity areas. As the market moves to the pink box (and we touched the bottom of it around August 9, we start rotating out of our less favored equity areas into cash or short-term bonds.

The big news tomorrow is the non-farm payroll report. Economists expect there to be a loss of 120,000 jobs for the month of August and an unemployment rate of 9.6%. If there is a loss less than this or even slightly bigger than this, expect the market to go up. If its less, investors will believe that the double dip recession is not going to happen and they’ll add to stock positions. If it is slightly bigger, they will believe that the Federal Reserve will add to their monetary stimulus and that will make the stock market go up.

For the foreseeable future, expect the stock market to be in a trading range that is bounded by the bottom of the green box on the low side and the top of the pink box on the upside. The gurus are all saying that we are in a deflationary or inflationary cycle – no one agrees on anything. When that happens, you have to take what the market gives you and update your portfolio near the top and bottom of the range – buy things you believe have good fundamentals at the bottom of the range, sell things that have run their course or that have disappointed in earnings at the top of the range.

What I like to do in a market like this is take a step back and see what real business is doing – not the market participants. To do that, you look at the swelling number of mergers that are taking place to see where the managers of businesses see opportunities. Today, the people that operate successful business are paying premiums for companies that operate in Agriculture, Technology, Biotech, Energy and Commodities (ag, base metals, rare metals).

I think you also have to look at the economies of the world that are drawing money to them based upon their sound financial position, sound currency, and GDP growth prospects: Chile, Taiwan, South Korea, India, Brazil, and Poland. Then, you have to look at the countries that are on the cusp of joining the group above based upon desirable demographics and significantly improved fiscal situations: Vietnam, Indonesia, Turkey, South Africa and Columbia.

Finding the premier growth and value stories in the industries that are demanding premiums from buyers that understand them best, as well as the premier growth and value stories in the countries with the best economic prospects will provide a portfolio that outpaces the S&P 500.

I’m going to be writing about Japan a bit in coming posts, because I truly believe they are a train wreck waiting to happen. But we need to learn a lesson from Japan’s stock market: two decades of economic malaise (much like our past two years) that included stock market crashes, low interest rates that penalize savers, misguided government stimulus, and significant quantitative easing have all added up to a losing proposition for investors in that market.

No one know how long our own economy will take to get out of the doldrums, but my best assessment is that it will be quite some time before we see anything like sustained 4% GDP growth and 5% unemployment. Without that, a trading range market is the best we can hope for, and as investment managers we have to have a strategy that works in that environment. For us, that strategy is focusing on the areas that are seeing premium valuations by willing buyers and concentrating on the economies of the world that can’t go bankrupt because they have no debt.

Oh how things have change in just a generation when the developed markets of the world have moved to indigent debtor status and the emerging markets have become their bankers. To be successful, investment managers have to change their thinking as well.

I’ll be back to you after the jobs report tomorrow.