January 2011 Market Outlook
CCR Wealth Management greets the New Year with more sanguine market and economic reflections for our clients’ consideration—at last! We view the confluence of several events over the last few months as constructive in nurturing an anemic US economic growth rate to more robust recovery in the next 12 to 24 months.
1) Quantitative easing announced by Ben Bernanke in September, begun in earnest in November, and scheduled to continue through the spring of 2011, will buy approximately $600 billion in US Treasuries in an effort to maintain the current low-interest rate environment. This is the second-round of this program (hence the “QE2” moniker), and while legitimate questions arise with regard to its effect on the Dollar, we trace the most recent market optimism to the announcement of QE2 shortly after Labor Day. Given the forward-looking nature of equity markets, we’re more impressed with the expectations of growth this policy has engendered than the actual (quantifiable) results achieved from QE1.
2) Election Day 2010 has returned us to a divided government. Historically, the markets have tended to view checks on singular political agendas positively. We see neither the resurgence of the Republican party (or policies), nor the decline of the Democratic party (or policies) as specific reasons for optimism. We do, however, regard Washington “gridlock” much more positively than most political punditry does. As we pointed out in our November Outlook—the greatest bull market in history was likely helped by so-called gridlock; affording decision makers a modicum of policy visibility which they can adapt to.
3) Fiscal compromise—born out of the 2010 election cycle—gives this rally legs, in our opinion. We’ve alluded to the expiration of the Bush-era tax-cuts more than once in our written communications as a point of some concern—or a potential catalyst for further market advancement. It appears the latter scenario has taken root (at the eleventh hour!), and a significant tax-hike is one less item for investors to be concerned about in the near-term.
There are of course many potential hazards ahead in 2011—a stubbornly elusive housing recovery, a stubbornly high unemployment rate, potential inflation, inflation in Emerging Markets, and continuing confidence erosion in the European economic zone. As always, we will endeavor to navigate this turbulence through diversification strategies.
One cautionary theme from 2010 which we bring forward to 2011 pertains to rising market interest rates—and their impact on the bond market. We have more to say on this in the Fixed Income section of this Outlook.
- Our increased confidence in US economic growth also translates into a reduced expectation of a double-dip recession. We still believe we are in the early part of the economic cycle and reiterate our recommendation that clients ensure a meaningful allocation to small-cap equities—generally the best performers in this environment.
- CCR Wealth Management’s investment models continue to maintain parity between growth and value equity allocations. While the status of the current economic cycle generally bodes well for growth stocks (and particularly B2B technology companies), we also expect a comparatively positive environment for energy stocks—which are generally found on the “value” side of the ledger.
- We continue to recommend a “baseline” weighting in diversified emerging markets equities of at least 16% of the total equity allocation. We note that while emerging markets equities “paused” their advance in the 4th quarter this year, the MSCI Emerging Markets Index still outpaces the S&P 500 for 2010—and far-outpaces US and other developed markets over the long term.
We continue to have confidence this dynamic will persist—and we also believe we are witnessing the transition from largely export-driven economies to markets where consumption has an increasingly important impact not only on domestic growth—but internationally. As an example; in 2011 it is quite possible we could see Germany’s exports to China equal their trade with France!
The Investment Committee at CCR Wealth Management sees the current interest rate and bond yield environment as perhaps one of the biggest challenges we face in 2011. Of course the issue is never whether to own bonds or not (we do not apply absolutes to any asset class)—but how to manage an asset class that most certainly is due for a decline in value?
- As we began, we are more optimistic in higher economic growth rates in the next two years. While evidence may not present itself in the very near term—it most likely will drive bond prices lower (and interest rates higher) when it does. Throughout 2010, our communication to clients regarding bond allocations has consistently stressed moving asset weightings “down the credit curve”, which primarily has entailed selling or reducing Treasury, government-backed, and higher credit rating bonds in favor of diversification into high-yield and emerging market bonds. We continue to recommend this strategy.
Our expectation is that while money leaving low-paying bonds will have a broad-based effect in the short term (all boats dropping lower as the tide goes out) we feel strongly that this money will not necessarily be leaving the bond market, but will find its way into higher yielding bonds (often economically sensitive), finding both value and opportunity as credit spreads tighten. Again, we see these opportunities in the low-grade corporate, emerging market (particularly local-currency based), and high-yield municipal bond markets. Higher coupons should serve to offset some of the expected volatility.
Additional strategies being employed (where appropriate) to offset a rising interest rate environment:
- Addition of Floating Rate funds: These funds invest in the generally un-rated very short-term debt of corporations. Because the debt continually is coming due and being rolled-over, interest rates (and the fund’s distribution) generally reflect the current rate environment, and will go up as the rate trend rises.
- Inverse ETF’s: In some instances it may be appropriate to offset higher interest rate trends with ETFs (index funds) that track major bond indexes in reverse. For example, an ETF that goes up in price in mirror image to the daily downward move in the 20 year Treasury index can offset the reduction in bond prices within a portfolio.
We use this strategy sparingly, and always in conjunction with the others mentioned above.
- We believe we are once again in a bull market for crude oil. We are echoing statements made here almost 12 months ago, but oil then stumbled in the first half of 2010 along with US and European economic data. Currently at $91/barrel, it would seem the crude oil futures market also predicts an economic pick-up on a global scale.
It may be wise to consider rebalancing commodity allocations into oil at this time, as many gold and silver positions have advanced into triple digit returns over the preceding 12 to 18 months.
- Along with oil, base metals (primarily copper and aluminum) continue to advance apace. As with oil, these commodities are economically sensitive (in addition to being Dollar-sensitive), and may see higher prices ahead as things improve. Rebalancing into base metals from highly-appreciated precious metals positions may make sense.
- Precious metals (Gold and Silver) have shown spectacular returns over the last 12 months, with our preferred gold holding nearing 27% (at this writing), and our preferred silver holding nearing 73% over the same period!
Unlike other commodities, silver, and especially gold have limited industrial application, though they have historically represented special reserves of value by themselves. We are thinking aloud here—nothing more—but we see profit-taking opportunity as interest rates rise, and investors become motivated more by improving economic fundamentals. Neither silver nor gold pay a dividend, of course.