Kelly Compton Market Outlook July 2009 You have heard many times, and as a matter of fact I have often said, CASH IS KING. Well, with interest rate falling well short of the expected inflation rate, one will actually lose buying power if invested in cash or even many of the Treasury Bonds.
AAA believes that we may be at the beginning of a financial recovery for the United States and other global economies. As such, we believe that investment assets that are being warehoused in cash are at significant risk of underperformance in the coming weeks and months. We stress that investments housed in cash or other short-term assets are at risk of earning nothing and actually presenting a significant opportunity risk. Since the beginning of the year, we believe we saw the bottom of the equity markets and the top of the U.S. Treasury market prices. We are calling investments in U.S. Treasuries as “rewardless risk” and believe that the historic, extreme risk aversion wave that swept the world actually mis-priced the treasury asset class. We believe that our case for corporate bond and equity investment can be based on the following data points: • The yield curve has turned from an inverted slope to a sharp positive slope, which historically has marked the beginning of an economic expansion. Corporate credit and mortgage asset prices were greatly dislocated during this recession. As the economy recovers, we believe these prices should again rise to adequately reflect the value of the assets. This trend has begun but many opportunities exist in both the investment grade assets as well as the more speculative “high yield” markets. • The FED is committed to using all of their tools to reinvigorate the banking system and the economy. They have openly supported the banking system along with direct investment by the U.S. Treasury in the form of preferred stock. It is our belief that the environment for banks to prosper is the best in years, if not ever. There are three drivers for this. First, the spreads being earned between the cost of funds and lending rates are at historic highs. Second, the average spread being earned in the capital markets operations of banks is also at or close to historic highs. Finally, the refinancing wave and recovery of the housing market will drive the need for increased loan demand. The banking system will earn its way out of withering loan assets and emerge as strong revenue producers. We believe the political risks of nationalization have abated and that the debt and equity of financial institutions present significant value to investors. The headline risks, although diminishing, can still present volatility risk to these assets. We believe the patient investor will be rewarded as these assets recover. For the non-believers, we point to past recessions and bank crises and remind them that this time probably won’t be different. Don’t fight the FED. • We are not believers in runaway inflation at this stage in the recovery. We think that in order to have inflation you need robust demand for wage increases as well as for goods and services. However, we don’t feel that this demand will emerge until the recovery is firmly underway. Unemployment is still rising so wage demands will be muted for some time to come. We believe that neither the FED nor other world banks will begin to raise rates until they are convinced the recovery is well baked in. Some people point to the recent rise in treasury rates as a harbinger of coming inflation. While we agree to an extent, we also look at the rate rise as money leaving treasuries and looking for greater opportunities. The treasury yields are merely returning to pre-recession levels. Rates fall in bad economic times and rise in economic expansions. • We believe that the economic expansion in Asia and India will resume and tax the known supplies of commodities beyond their capacity and as a result, prices will continue to be pushed higher. In addition, commodity cycles are fairly well marked and we believe that we are only half way into a 20 year cycle that began in 1999. We believe that currency creation and additional debt issuance could produce an inflationary environment and therefore commodities would provide a possible hedge to any loss of value. • We believe that income taxes must rise in the future and that the current administration will support higher tax and spending measures. As such, we believe that the preferred asset class for higher-rate taxpayers is municipal bonds. There have been many headwinds for this market given the increase in demand, the failure of many of the mono-line insurers, as well as the general trend in lowering the credit quality of the issuers. We feel that the pricing of these assets remains dislocated and may present value for high-net-worth investors. We think that an economic recovery will help to stem the credit deterioration of municipalities and that over time, credit quality can actually increase. As you can tell, our insight has led us down a path that would indicate that storing investment dollars in cash to ride out the storm is a self-defeating proposition. We like to quote Warren Buffett when he said “one should be greedy when everyone is scared and scared when everyone is greedy.” We feel that with fear in the markets and extreme values, it is time to be, at least, partially invested rather than be on the sidelines. We do recognize a likelihood that the Market we retract somewhat. We believe that that will be short-lived and a growth in the overall Market will continue. Even with this being stated, we do not believe that one should just throw money at the Market. A careful selection of investments is always wise. |