The Short Run

Over the past ten months the world stock markets have staged a remarkable rally on the back of hope that a vast powerful economic recovery will occur in short order.  Those hopes will likely be dashed when it becomes apparent that global capacity (supply) exceeds demand and that demand in the excess capacity nations will not pick up at nearly the rates necessary to clear inventories that have been rebuilt in the last few quarters.

Excess capacity will remind economists and the public alike that in the short run, deflation, not inflation is the issue.  Those who are employed with stable incomes, well less than half of the U.S. population, will do well, everybody else will suffer.

In the equity markets we appear to be running into what well regarded money manager John Hussman, PhD calls a "Reckless Myopia" in which "investors chase prevailing trends and (are unwilling) to concern themselves with predictable longer-term risks."  Short run, investors chase returns, however, as investors get back to even or at least closer than they were months ago on their portfolios, fewer will be willing to take the risks they perceive as necessary to grow their investment balances as markets stall or fall.  When the next fall occurs, it could then have a lot of downward momentum as investors flee.  The next rebound then might be slow to emerge, as many, suffering high debt loads and reduced household income will spend their retirement funds well ahead of schedule, or at least not contribute to their retirement funds as they worry about what will happen in the next few years versus in their retirement decades, thus quelling demand for financial investments.  Further forced selling of real estate in response to a second wave of mortgage problems, might trigger the next equity market shock, and could very likely cause the broader U.S. equity markets to chop along in a range for years.

The tendency of investors to buy high and to extend risk as markets crest, can support the markets for awhile, however, as predictable events become reality, and some black swan appear (i.e. a sovereign debt default or military conflict), equity markets at least, and likely others, will again correct in way that is disheartening to investor confidence.

The Longer Term

The next decade will be challenging for the planet.  How we respond to these challenges, could either lead us to a sustainable peace and prosperity, or a series of catastrophes and conflicts never before seen, but of course quite likely somewhere in between.  While this is broad and imprecise, what I have taken away from my and many other's analysis is that the range of what is possible over the next decade is more extreme at the both the good and bad edges than ever before in my lifetime or my parent's lifetimes.

Let's first consider what I believe to be higher probability likelihoods:

  • China's currency will become stronger versus a basket of international currencies.  This will happen primarily because China is a creditor nation, but also because the Chinese will benefit from such an occurance, thus they will stop fighting it as they have been.  Because China is sitting on a huge excess inventory of goods due to slackened international demand they must find a way to clear that inventory.  Simultaneously, China also faces pressure by their population for an improved standard of living.  To further grow and satisfy their population, China must import commodities.  By raising the value of the Yuan versus the dollar, China effectively addresses all three issues.  With stronger money, the Chinese can consume more, thus clearing inventory while improving their standard of living.  A stronger currency also means that China can import needed commodities, not the least of which are food and energy, at lower prices.  Eventually China's stronger currency will serve as a mechanism for it to export inflation from its very strong growing economy to nations with relatively weakened currencies as the world economy mends and grows over the course of the decade.
  • Due to their commodity resources, national stability, strong national balance sheets and relative safety, Australia and Canada will be among the bigger global economic winners.
  • Gold will hit new historic highs on speculation, then collapse when investors realize there is little use, and little end market for gold.
  • There will be mind boggling advancements in medicine due to the advancements of genetics in biotech and pharma.  At some point biotech company prices will soar, then collapse again, just as they have done before.
  • Commentators on television, in an attempt to sound astute and profound will keep saying the word "bubble," hoping they get one right.
  • Agriculture stuffs and clean fresh water will become noticeably more scarce, driving prices for food and potable water up significantly by mid to late decade.
  • 80% of investors will continue to fail to match or beat even the mediocre inflation adjusted equity market returns that we should expect this decade.
  • The United States, as a nation with a weakened currency and a late start on a viable national energy policy, will face rising inflation approaching double figures later in the decade.
  • The United States will have double and triple dip recessions that will more properly be viewed by historians as a long depression of varying ferocity that began in 2007.  This depression will not be as severe as the Great Depression but will be worse than the four recessions from 1969 to 1982.
  • After doing things wrong for a long time with regard to energy policy, and water policy, the United States will eventually embrace sustainable policies by expanding nuclear, wind and solar development, while also using natural gas more efficiently and committing to a massive build out of new sewage and water reclamation facilities in most American cities.  As soon as appropriate decisions are made regarding energy and water policy, the United States ship will turn quickly and dramatically back in the right direction.

I know that what I wrote sounds dire in many respects, but we have the ability to speed up recovery, regain the wealth and standards of living that we enjoyed in the 1990s and promote global peace.  We don't have to wait the better part of another decade for things to recover.  We do not have to fight more wars destined for high personal and financial loss, and mixed results.  Here are some potential surprises that could bring the United States and world roaring back.

  • China, Russia and the United States will work out a deal with Iran that will promote a more secular government, prevent war, stop the Iranian nuclear bomb program, supply nuclear material for Iran's energy program, facilitate oil production and distribution which will stall global inflation later in the decade.
  • India will cut it's bureaucracy a smidge (a smidge is a special unit of measurement reserved for economics and chefs) resulting in productivity and equity booms in that nation.
  • The American and Venezuelan governments will work out deals on the premise that Venezuela is a valuable neighbor of the United States, not an enemy.  The change in direction of media coverage about Venezuela as they become an ally will be interesting to say the least.
  • Mexico will finally have a long anticipated economic boom.
  • The United States will get out of Iraq and Afghanistan on time.
  • Americans will stop arguing about global warming and realize that preserving the air, water and arable land is a worthwhile goal regardless of global warming.
  • Centrist Democrats and Republicans will remake the nation's politics by working together more often and ignoring their more radical vitriolic party members more often, which will lead to better governance.
  • Recognizing that a strong strategic energy policy is probably the only thing that can jump start the American economy, thwart inflation and increase our energy security, the U.S. Congress in the next year or two, before commodity prices spike again, embrace natural gas for the truck and bus fleets, electric cars, wind and solar power for residential and light commercial energy needs and nuclear power for industrial energy needs.

Crossing Mountains

While we have deep issues to resolve in the United States, none are insurmountable.  Given the tenacity, strength and will power of the American people when called upon, I have great hope that the United States will continue as one of the great nations of the twenty first century.  However, as we have learned before, we like our past in a way that sometimes stifles our future.  Because of that, we are taking the rockier road, as usual.  But, also as usual, presuming we do not become too stubborn or too complacent, we will emerge from our challenges, it is just a matter of when.

Around the world, as growth occurs and nations slowly become stable, there will be great opportunity to go along with the great challenges.  America will have a hand in contributing to and profiting from global development.  Americans who selectively invest over the course of the decade might very well, and I believe will, be making the types of investments that benefit them for the rest of their lifetimes.  Personally, I plan on focusing on what I have identified as core trends, finding a handful of great companies to invest in, possibly starting another business or two, as well as, finding some real estate to have, hold and pass on.  Each investor is different of course, with different goals, different competencies and varied risk tolerances, however, something akin to what I am describing will make a lot of sense for many people.

As investors the first and foremost thing we can do is to be more aware of risk.  Contrary to what you hear from commentators and pundits, and too many financial people, for most investors, it is not necessary to take more risk to make more money.  In fact, it is almost completely the opposite.  By searching for and cutting risk on an ongoing basis in your investment portfolio, you will ultimately do better than reaching for more risk.  Of course this means you must be invested.  Not being invested is a guarantee of a loss of purchasing power to the ravages of future inflation.  This approach, while imperfect of course, is the way to invest for those choosing active management of their investment portfolios.  Reviewing the dictums of any great investor makes this abundantly clear.

Next as investors, we need to be more selective in what we invest in, and think as business owners, not price speculators.  If we can identify the most likely scenarios for the global and domestic economies we can invest in spaces with higher probability for gain with lower risk. Recognizing that both the United States and the world have energy, food, water and healthcare issues to address, I am focused on those areas for investment.

Cautiously entering the New Decade with hope and a plan.


Kirk Spano

This newsletter contains forward looking statements that may not come true.  Past performance does not guarantee future results.  This letter is intended for informational purposes only, and reflects only my thoughts and opinions in general, and do not constitute individual advice.  Opinions expressed may change without prior notice.