First Quarter, 2006
Judging from the positive price action of
domestic stock markets during the first quarter, all appears to be going quite
well. Indeed, investor complacency seems to be the rule as evidenced by the low
level of the volatility index and the continuing decline in risk premiums for
all types of low-quality investments. Even concerns regarding rising domestic
and global inflation and interest rates are (for the moment, at least) of no
concern to equity investors. Credit for this presently optimistic state of
affairs should be given where it is due. The domestic economy is growing at a
solid rate. Perhaps most important in this regard are the employment figures
which present an encouraging picture of strong corporate growth.
Client portfolio have experienced an
extraordinarily strong first quarter in this current environment as the various
investment themes and strategies we have described in previous quarterly letters
continue to work in our favor.
How long these trends will continue is
impossible to predict. It seems to us that the explosion in the price of gold
and other precious metals is reflective not only of rising inflation, but also
diminishing faith on the part of our global neighbors in the reserve currency
status of the dollar. Around the world there is a growing trend to begin
diversifying countries’ reserve currencies away from the dollar. As global
demand for the dollar begins to decline (as may now be happening), domestic
interest rates are likely to increase to entice foreigners to continue lending
us money. We think there is a high probability this trend will continue with
eventual negative implications for domestic stocks and bonds.
Last quarter we discussed the yield curve
inversion with its negative implications for GDP growth six to nine months into
the future. We are happy to report now that the inversion risk has receded. You
see, for the first time since the Fed began raising short-term interest rates
approximately two years ago, long-term rates are now moving higher in line with
short rates. Thus, domestic recession concerns (based upon the yield curve) are
no longer influencing stock market behavior.
Every six months the International Monetary
Fund (www.imf.org) updates its economic databases of
world economic growth by regions and by countries in a document entitled
"World Economic Outlook." This study enables an interested observer to
get their arms around the big picture of capital flows between countries. Why is
this important? Perhaps the reason is best explained by the old investment maxim
which says that in order to make money with your investments you’ve got to
"follow the money." The "World Economic Outlook" puts into
clear perspective where "the money" is going. Here is a summary of
some interesting facts from the most recent report dated September 30, 2020.
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Growth in consumption in the U.S. and
other industrial countries has been fueled to a significant extent through
consumer borrowing, which has its limits. Our fiscal health continues to
deteriorate and our debt loads are growing at rapid rates. We are import
driven. |
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Emerging markets are increasingly export
driven and many emerging market countries are generating governmental budget
surpluses for the first time and using these surpluses to pay down their
government debt and lend money to the industrialized countries. |
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Inflation rates in emerging market and
developing countries continue to decline, while at the same time inflation
is gradually increasing in the world’s industrial or developed nations. |
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Private consumption growth in emerging
markets is almost twice the rate of industrial countries. |
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Growth rates of global investment in
emerging markets are significantly higher than that of industrial countries. |
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Financing conditions in emerging markets
are very favorable. Their cost of capital continues to decline. Emerging
market bonds of many countries are moving towards investment grade status. |
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Emerging countries’ equity markets have
been the best performers in ’03, ’04, ’05 and to date in 2006. |
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Industrial nations of Western Europe,
Japan and the U.S. are facing massive increasing fiscal hemorrhaging due to
the monetary demands of aging populations and low relative birthrates by
global standards. Emerging markets on the other hand, have younger age
demographics and rapidly expanding population growth with considerably less
strain on their budgets from entitlement programs. |
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Energy consumption is expected to continue
rising at a rapid rate in emerging markets for years to come, placing
continuous pressure on oil prices. In India, for example, auto ownership is
forecast to quadruple by 2030. Some 75-110 million people are projected to
enter the labor force in India in the next decade. |
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Ten emerging market countries have repaid
their loans to the IMF ahead of schedule in recent years. The IMF’s
current loan portfolio is the smallest it’s been since the 1980’s. |
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The report cites a rise in protectionist
sentiment in industrialized nations as a potentially significant fly in the
ointment for continued robust global growth. U.S. politicians have clearly
demonstrated a growing xenophobia in spite of U.S. free trade rhetoric. But
China and India, the two most important emerging markets, also contribute to
the problem with their own restrictive trade policies. |
Atlanta,
GA 30339