Alamo Asset Advisors Outlook

August, 2009

With untold ramifications, capitalism, capitalists, profits, and entrepreneurs are out of favor, and bureaucracy is the only real growth industry in America.  Stimulus has failed to stimulate anything but deficits.  Investors are choosing security over risks as their first and foremost priority.
 

The looming crisis in Commercial Real Estate will be focused on refinancing commercial property loans that will be coming due.  Collateralized Mortgage Backed Securities provided the fuel that fed the boom from 2000.  These loans are starting to come due and there is no one to refinance.  Industry observers are expecting the delinquency rate to double by the end of this year and go higher next year.   There are literally Billions with a B on the sidelines waiting for distressed assets to be offered at fire sale rates.  With the lack of buyers, this will become a self fulfilling prophecy. 
 
As with all investing, waiting for the bottom doesn’t work.  We can only see the bottom in hindsight.  Opportunities that others pass on, when things seem uncertain, often turn out to prove smart.  Bill Gates says you make money when others “don’t get it.” Warren Buffett says you make money when “there is blood in the streets.”   We believe that in a couple of years, long term investors will look back at this time of uncertainty as having been one of the best times to invest in many years.
 
In spite of the looming commercial real estate crash, we at Alamo Asset Advisors are very bullish for the intermediate term and more cautious for the long term. We define intermediate term to be 12 – 18 months and the long term to be, well, longer than that. We do expect the remainder of the summer to be a see-saw.

We expect that as we approach the year end we will view the spring and summer market action to reflect a 3 wave affair: March-July - Up, July – September sideways or down to 825-830 on the S&P and the fall to be the next leg up.  Most economists expect GDP to be positive in last half 09.  

For you technical investors when the S&P turned up at 870 it broke a well defined head & shoulders top, giving the market a “head fake.”  Right now, we are staying tactical, looking to load up if the S&P retraces back to the mid 800’s. 

We expect long term structural head winds in the economy.  We also are aware that more governmental spending is on the way. Mr. Obama, whether you like him or not, is a savvy campaigner. He has a friendly Congress and together they have designed a plan to release more money as we approach mid-term elections. Relapse in the economy is a risk that we believe is at least 1 year out and more likely after the mid-term elections. Inflation risk appears to be more than 1 year out and probably closer to two. The consensuses of “experts” expect the S&P to hit 1200 by mid March 2010.  Since the market attempts to predict the economic gyrations with a 6 month lead (give or take) we believe 1200 is a reasonable assumption but expect the market to get dicey in the summer and fall of 2010 going forward. Our political view is that the extreme spending and impending regulation ramp up will lead to increased taxes.
 
For now the economy is heading into “re-flation” quadrant. Near term extreme deficit spending is very, very bullish.  In recent weeks we have seen a narrowing of the credit spreads in the bond market. This is the difference in yield between the AA rated bonds and the Baa rated bonds. The Baa rated bonds still command a bit of a “fear premium” but not nearly what they did just 60 days ago. We recognize that narrowing credit spreads are a solid leading indicator and we have had a massive narrowing of credit spreads in the last 60 days. We also currently have a very steep yield curve which is an earnings growth leading indicator.
 
As a note about unemployment; credit spreads tend to lead jobless claims by 2 quarters. If history repeats itself, this would indicate unemployment will begin to show improvement sometime around the end of the year.

 So far during this current earnings season profit margins are spectacular as companies are producing with much less labor cost. This improved efficiency will help earnings for the next couple of quarters. You will notice the trend that companies are reporting lower revenue numbers yet higher profit numbers. If we get increased revenue in the next couple of quarters this will be a very bullish sign for several quarters going forward. The issue here is that companies aren’t indicating a positive outlook on the revenue front. If and when the revenue numbers return to growth mode vs. shrinkage we will notice employment stabling, the housing market stabling, and a multitude of other positive indicators for the economic recovery. If we do not see the revenue growth we will surely have our economic relapse.

Currently we view the risk of over regulation and consumer retrenchment as paramount. For the past year we have utilized riskless assets; cash, treasuries, and gold.  We believe this is not where you want to be going forward. We expect to be heavy in commodities (copper, agri), hi-yield bonds, & equities (emerging markets). Although historical performance is no guarantee of future results, typical when inflation starts to flare up the asset classes to do well are; commodities, MLPs, Utilities, REITS.
 
Economists define GDP as: money supply x velocity of money circulation.  We have not seen velocity of money increase.  If we believe Mr. Bernanke and the Fed. we expect to see increase velocity in late 2010 or 2011.  At issue here is the independence of the Fed. with Congress hauling Bernanke in every time he turns around. Currently monetary policy accounts for 30% of GDP. The norm is 8%.  Most institutional investors expect gold to break out when the Fed has to drain its balance sheet which should happen in 2011.  If Bernanke is not there, then all bets are off.  We at, Alamo Asset Advisors, believe Bernanke is absolutely the right person to handle things.  If Obama replaces him then the Fed. independence will be very suspect and the trade off in monetary policy will be bad.  Either way, expect 2011 and 2012 to be very dicey for investors.