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Diversification. Or not.
January 17, 2014

Untitled Document

I love January! I love the Golden Globe awards, the Oscar nominations, the President’s State of the Union address, the earnings season. More importantly, I love the opportunity that a new year gives to implement the lessons I’ve learned in the past.

Looking back to 2013, I’ve confirmed what I’ve learned as an investor and observer of the market in the previous years:   “do not fight the FED”,” ignore the noise and focus on the facts “and “the trend is your friend”. Those who read my newsletters know that I became an optimist in regards to stocks, particularly US stocks in 2012. At that time the economic indicators in the US were getting better, Mario Draghi was the new ECB director, and Bernanke announced QE3 and operation twist. There were obstacles of course, such as the uncertainties in Spain and Greece, the Cyprus crisis, the fiscal drag due to the “sequestration” in the United States. There was a trend however, and the trend was positive for stocks.

In 2013, that trend continued, the FED stayed put in the course established for its easy monetary policy and so did the European Central Bank. There was still noise and as I mentioned several times, the non-believers, kept missing the boat and lost the potential 30% increase on their wealth.

That is it for the past…..Will 2014 bring another 30% appreciation in stocks? I don’t know. What I do know is that the positives are still in place and the headwinds had dissipated - for the most part.

The indicators in the United States are better, so much so that the FED announced a modest tapering starting now. At the same time, knowing that there is a fiscal drag and that inflation is not a threat, the FED decided to keep the interest rate near zero. The threshold for  a change in interest rate is the level of unemployment so we should expect no changes in 2014.Interesting enough, they kept the door wide open for a comeback in the  amount of bond buying if the situation deteriorates. On the fiscal side, the Congress approved a budget deal on January 15th. The deal reduces the impact of the sequestration and gives the market some stability from the market (who doesn’t remember the shutdown in October’ 2013?). So now we only have the debt ceiling battle, to occur sometime in February. With less instability coming from Washington, with Janet Yellen in the command of the FED and the economy doing well, chances are that 2014 will be a good year for stocks. Let’s see what the earning season bring us in the next 8 weeks. The results announced by JP Morgan and Wells Fargo   indicated that although mortgage refinancing   has receded, lending for business is up and consumer default is lower. As I said, I don’t know for sure what will happen, but for now the facts are good. Besides looking at the economic signs one need to have a vision and understand the bigger picture in order to succeed as an investor. When I look at the great picture, I hate to repeat and sound like a broken record, the United States pop out at the top of the list of where to invest. The chart below show how the different types of investment performed in 2013.

Asset Class Returns for 2013

Being an average, the data for non US stocks need some qualification: Europe and Japan had impressive positive returns while Latin America had a loss of 4% in USD. The European economy is better than it was in the past couple of years and it is getting better; the European Central Bank and the Bank of England are doing a good job by keeping the rates down. However, the European system has way too many restrains, the most important in the labor market. Brazil was the darling of the investors until a couple of years ago. Unfortunately once again, we repeated history; it seemed that we were getting better… until we got worse. Once again, it looked like we were going to be the “country of the future”. The Brazilian stock market is in a downtrend since 2010. Inflation in 2013 was almost 6%, exports are declining and the currency is falling. On the fiscal side, the Government is insisting in gimmicks to reach the fiscal “target” and satisfy the rating agencies.  I do not expect much for 2014 as the country pauses now for Carnival; them pause again for the world cup, then again for elections.

I know many people like China and think that it is the place to look and bet in the future. I just do not trust the Chinese political or economic system nor I believe in their official numbers; as a consequence, I rather “play” whatever good comes out of the Chinese economy through the American companies. Just this week AAPL reached a deal with China Mobile and will start selling I phones to   an estimated 760 million subscribers - the largest in the world. By the way, it looks like the Chinese agree as they just bought more of US treasuries.

I started talking about the bigger picture and my point is about diversification, the golden rule for investing successfully.  I cannot help but ask myself why bother diversifying.  For the reasons above I am not bullish with China or Latin America; Europe could be a good bet. Then there is Japan and as a picture is worth a thousand words, look at the chart below. Do I need to say anything?

Japan GDP Growth Rate

Of course there are opportunities in the rest of the world; if you are not a big institution, do not have offices around the world, I just think that it is just too hard and too risky.

Furthermore, there is an energy revolution going on in the United Sates: this revolution will bring energy costs down and as a consequence there will be resurgence in manufacturing, chemical and refining. Just to keep things in perspective, let’s look at the natural gas price and let’s compare the price of LNG per million btu in USD in different countries. (Data from the BP Statistical Review of World Energy))

Year

Japan

German

UK

OECD countries (cif)

USA

1996

3.66

2.46

1.87

3.54

2.76

2008

12.55

11.56

10.79

16.76

8.85

2012

16.8

11

9.5

18.8

2.8

 

What is amazing is not so much the increase in costs for the major countries but the declining in prices for the USA.

In summary, it seems to me that the United States will be leading the world again in a couple of years  and as companies do well and corporate profits improve, the rates of return improve, so again….why bother trying to diversify.

To summarize I am optimistic with the American stock market notwithstanding the fact that January didn’t start very well. There will be more volatility but even if you are conservative there is a chance that you can capture at least 8% to 10 % in stocks versus 3% in fixed income. If the facts change, my view will also change, but until there, let’s ride the wave.

 

November 23, 2015
Much ado about nothing
October 27, 2015
Brazil, we can only pray (or hope)
August 18, 2015
Looking back, looking forward
June 30, 2015
Lack of good news
April 14, 2015
What if...
February 24, 2015
What to expect in 2015
November 17, 2014
The American conundrum or just plain stupidity?
October 27, 2014
What is next?
September 09, 2014
Lessons we should have learned
August 12, 2014
US and Brazil: 2014, what to expect next
June 26, 2014
Headwinds ahead but still optimistic
April 26, 2014
Roller Coaster
March 14, 2014
Brazil in perspective
February 07, 2014
Stay the course. Change the course.
November 25, 2013
Who buys a US$ 500 pillow?
October 02, 2013
Disturbing
September 03, 2013
What a mess...
July 31, 2013
Of Protests and Stocks
June 19, 2013
Betting in the future
April 30, 2013
Nowhere else to go
March 26, 2013
Cyprus: not enough to stop the US market
February 25, 2013
The Sequester
January 23, 2013
2013: what is ahead for investments
December 07, 2012
Brazil: uncertainty and mixed signals
November 05, 2012
It is not about the economy!
September 20, 2012
The Country is better off
July 05, 2012
The New Normal
May 30, 2012
Half empty, half full
April 30, 2012
How to restore prosperity
April 21, 2012
Brazil became poorer
February 27, 2012
Romney, Obama and the American Imbroglio
January 25, 2012
On storms and calmness, waiting for next round
December 22, 2011
Happy Holidays!
November 23, 2011
Impasse and Paralysis
October 24, 2011
The rally has legs. Or not
September 23, 2011
Preparing for the crisis
August 24, 2011
Kicking the can down the road: is there an end in sight?
July 24, 2011
Can the politicians be rational?
June 24, 2011
Global Economy: where are the world leaders bringing us?