What Does the World Need?
In order to construct an effective investment strategy, it helps to step back and examine the world and ask the question, what do people need? Unpacking this question illuminates a direction for investors. Ultimately, the receptacle of the greatest need can identify economic forces which can guide investors in determining if the stock market will go up or down.
Take a look at some of the highlighted problems throughout the world. The root cause of these problems is inadequate capital, not enough money. The latest unemployment readings are 9.4% and show slow recovery progress. Therefore, more decent paying jobs are needed. Many people can’t make their house payments and face economic hardship. These people need their financial situations to improve.
In addition state and local governments are under fiscal stress. Their pension plans are technically bankrupt. Tax revenues are simply not high enough to meet planned expenditures without painful cuts.
To compound matters, our federal government faces a potentially impassable mountain of debt that continues to build. It can’t continue to fulfill all of its roles without having adequate resources.
In Europe, several governments require continued bail outs. This assistance is necessary because of low productivity and poor export prospects for these countries. It is disturbing that these beleaguered European nations will need assistance for the indefinite future.
The solution to this deep list of problems is to create more money. Money would go a long way toward providing relief to all of the above problems. Basically, if all people and all organizations had more money, their problems would be remediated. As much as this sounds like an oasis, it could become reality.
Rising to the Rescue
It is clear that the world doesn’t have enough capital. What is a suitable remedy? How does the world get more money? The solution needs to intersect the problem. If stock markets world wide were to increase in value, all of the deficiencies listed above could be addressed and remedied. Economic problems throughout the world could be repaired by rising stock markets.
Rising stock prices would give corporate America a larger capital based from which to expand operations. This would require hiring. Profits from the stock market would add to the tax base and this would help governments at all levels. Pensions would benefit from asset values appreciating and this would reduce the current shortfall at government pension plans.
Worldwide, many governments and sovereign wealth funds own stocks. The US Government held a large investment in Citigroup up until recently. It also holds positions in General Motors, AIG, and of course, most of the securitized mortgage loans in this fair land. If these assets rise in value, this wealth affect can spillover into helping the condition of these governments. This would promise to assist the struggling European nations.
Uninvested cash can be the fuel to a rising stock market. Since the return on dormant cash is almost zero, the migration to the stock market would cause higher prices.
This remedy seems to be well under way. In the months ahead, it promises to continue to build and gain further traction. A rising stock market meeting economic needs is the intent behind Ben Bernanke’s notorious Quantitative Easing 2. (see 3rd Quarter Investment Overview)
4th Quarter Overview
The stock market surged in the fourth quarter on the heels of expected strong corporate earnings to be reported in January. During the final quarter of 2010, the S&P 500 gained 10.8%. This followed a 10% gain in the month of September. Looking back, the rush in the final four months of 2010 caught everyone by surprise. Before September, the threat of a double dip recession and the economic woes cast a gloomy shadow.
During the fourth quarter bonds of all kinds really suffered as a result of rising interest rates. This was a drag on all of the fixed income investments that we have for our clients. For the quarter, the Barclays Aggregate Bond Index fell 1.3% while long dated Treasuries fell 3.5%. Interest rates threaten to further increase as the economy improves and money flows out of bonds and into stocks. I’m not ready to buy into this threat just yet.
Overall, despite an economy that is still struggling to climb above a 2% annual growth rate, the outlook is sunny because of continued evidence pointing to possible acceleration in the economy in 2011. This is considered “marginal improvement”, and, if this happens, then we are better off. The private sector has been contributing steady job gains. Commerce data such as industrial production and the purchasing manager index also point to an improving economic picture.
For investors, the enticing idea of a “goldilocks” economy exists. Investors need an economy that is “not too hot or not too cold.” A deviation from this scenario would upset the stock market. More data that shows slow but steady economic growth would support further progress in stock prices. The rally in stocks could be derailed by an economy that threatens to grow too fast. This would stoke concerns about inflation and higher interest rates.
Peregrine Returns and Strategy
Our clients made solid returns in the back half of 2010. Naturally, our goal is to beat our competitive benchmarks. This objective is always balanced with the income and security needs of our clients. Our Equity Composite represents clients that have long term growth as an objective. Our Balanced Composite represents clients that have a blend of income needs and long term growth objectives.
For the quarter, our Equity Composite rose 6.35% and for the year our we gained 8.91%. A wide range of small stocks represented by the Russell 2000 gained 26.85% so it is evident that the stock market provided a means to earn very high returns for 2010.
Our Balanced Composite nudged higher by only .83%% for the quarter. For 2010 our Balanced Composite gained 6.93%. As mentioned earlier, bonds were a negative contributor to our balanced composite over the final three months of 2010. Earlier in 2010, when stocks had their sharp declines in the second and third quarters, bonds provided an effective hedge.
Investors will probably be well served to increase their weightings to stocks since the market outlook today is better than it was at the beginning of last quarter. We plan to add more stocks to our client accounts from thriving companies all over the world. Our clients should count on a heavier exposure to the stock market compared to their fixed income allocation.
Over 40% of the S&P 500 stocks are down more than 25% from their highs in 2007. This supports the notion that the stock market recovery has much further to go.
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.