What’s Worrying Investors & What You Should Do About it Today

Lance Spicer, Editor - Trident Confidential, 26 May 2011, 8:04 AM

It seems there is much to worry about, but then again every cloud has a silver lining. In today’s Stock Market Update I want to give you some perspective and reveal the sliver lining. However, it’s true that in the very near term we are faced with a few little problems that seem to be disturbing investors and scaring them out of the markets and they are:

Commodity prices falling
Perceived lack of strength in the US recovery
US levels of debt, along with everybody else in the industrialized world for that matter
Concerns of a slowing of growth in China
Uncertainty over the Carbon Tax in Australia – Will it be $20 and rising or $60 and rising
European Debt, particularly Greece, Portugal, Spain and Italy

Uncertainty rattles markets and makes many investors nervous and after the events of 2008-2010, keeps a lot of cash on the sidelines – not surprising I suppose. However, when you consider all the issues are they really as serious from a longer-term perspective as many would have you believe? I don’t think so.

Commodities

Looking at commodities, they were getting simply too expensive and needed to correct simply because high input costs (and commodities are where all products start) can be damaging to economies and inflationary. However, from an Australian stock market point of view (not that all we do is mine stuff, or so it would seem) a fall in commodity prices coupled with a high AUD$ is crippling, so to be in losses in an Australian stocks only portfolio is hardly surprising – not good, but not surprising. I expect commodity prices to stabilize around current prices and that should lift some of the uncertainty from the market and we should see a little more confidence return to commodity related stocks. Investors always fear that a drop in commodities (or anything else) will precipitate more falls ad-infinitum. This is never true, of course, but fear has a way of making the market irrational. As an example, we have seen shares in agriculture related stocks pullback with commodity prices although the 2 Trident Confidential stocks in this sector have both stated that forward earnings will be at record levels of sales and revenues and their order books have never been more full. Both companies being driven by increased production rather than soft commodity prices as opposed to miners who are more concerned with prices because most mines operate at capacity anyway. Don’t let a minor, and expected correction in commodity prices fool you, they do not reflect a slowing global economy in any way, shape or form.

The US Economy

Everybody’s reason to worry. Yes, the US will lift it’s ceiling of debt closer to 20 Trillion dollars even though some people say they won’t, they will and this little worry will go away very soon. As far as the economic data goes - it’s 70% good, 30% as expected or missing slightly. Overall the recovery is steady and will increase momentum. What’s holding back a stronger recovery is media “over hype” regarding debt, inflation, a weak US dollar etc., when in fact the debt is manageable with an economy the size of the US, inflation is still almost non-existent and the US dollar being weak is deliberate and the best remedy for the US. The US economy is 70% consumer driven and if you spook Americans into believing the worst is not over, they won’t spend their money they’ll save it and that’s exactly what many Americans are doing with the highest savings rates since World War 2. That’s the reason for the slowish recovery.

You see, commentators are running around screaming “14 TRILLION DOLLARS DEBT!” and not realising that this number is only relevant when viewed as a percentage of GDP and the US has had higher real debt to GDP in the past than it is now. As GDP growth ramps up further later this year and next, the debt as a percentage will become smaller. Inflation, when it appears, which is normal, will erode the true value of this debt even further. Time has a way of making debt smaller in a relative sense. Remember, when you took out your first mortgage? It may have been say, $150,000 fifteen years ago. A big mortgage you thought. Now? A debt of $150,000 is regarded as a small mortgage. See what I mean? A month or so ago I also revealed the truth to Trident Confidential subscribers about who this debt of the US is owed to and revealed a large part of the debt taken out by the US government is actually owed to the US government itself (in accounting this is called this a consolidation contra, meaning the debt nets off overall) and the debt has also been used to buy assets like AIG, invest in car makers etc, which the US still holds on it’s balance sheet. The Chinese only own around 8% of the debt and this seems to be the number everyone is concerned about. It’s one thing to have a huge debt with assets bought with the money. It’s a whole other thing to have a huge debt with nothing to show for it.

Slowing Growth in China?

There’s no doubt the Chinese government is trying to slow down the rate of lending in China by steadily increasing capital requirements on Chinese banks but this is simply smart economics. The Chinese are in danger of having an almighty real estate bust if lending goes unchecked and slowing down the pace of lending may hopefully result in a slow deflation of real estate rather than a bubble bursting. As far as other parts of their economy, manufacturing is strong both domestically and now the US is recovering slowly, internationally as well. The nation building projects of roads, power supply etc have not slowed up one bit. So, talk of a significant slowing of China’s economy is probably a lot more fiction than fact.

The Carbon Tax Uncertainty

This is just a giant “Shemozzle” (have I spelt that correctly?). Somebody, anybody needs to give industry some certainty and tell us the price and on what basis it will increase so industry has something to work with and we can move on. Constant delay, or bickering with the Greens will end up in economic stagnation. I heard yesterday that PM Gillard’s approval rating is now at 19%…. Is it possible to go to zero? It would seem the Carbon Tax may get her there unless she does something about the price uncertainty.

Until, the Carbon Price debate concludes, the market will stay pretty much where it is or drift lower. If the Greens do manage to flex their authority on the debate and the Carbon Price kicks off above $30 (God help us at their preferred $60) then we’ll have a significant fall in the market with manufacturers, energy companies and miners being slammed. But at least uncertainty will be removed.

European Debt - Greece

It’s actually the Europeans sending the market south at the moment. On Monday we saw stock markets around the globe plummet by between 1% and 2%, as Greece slipped even further into oblivion, as their government debt rating was lowered even further and fears that Italy, Portugal and Spain may follow. However, Spain was offered some hope when the ruling and big spending Socialists were tossed out on their ear. European markets took the brunt of the fall with most of them tumbling 2%. So, while you can understand why European markets fall as Greece continues to collapse economically, you may be wondering why the US and Australian market fell like it did?

Well, in times like this, the first thing panicked investors do is buy the US dollar! Yes, as much as people keep calling the US dollar complete rubbish etc, the first place they run is back into the “greenback”. This buying of the world’s safe haven and reserve currency sent commodity prices down, notably oil. It also makes US exports more expensive and this sent the US markets tumbling as well. Commodity prices falling therefore puts the skids under the Australian stock market and also send the Australian dollar down too.

Conclusion and What to do Next

There is rarely a time as an investor when we don’t have a mile of things to worry about. There is always something that commentators focus on and blow out of proportion in an attempt to worry us sick. This time, it’s debt in Europe and the US, a couple of months ago it was the “Chernobyl like crisis” in Japan. A couple of years ago it was the complete collapse of the US banking system. Go back even further and we have a range of oil crises, the Asian currency crisis, September 11 terrorist attacks, Enron collapse, Iraqi wars and the “recession we had to have”. The list goes on and how many of these events stopped the market from hitting new highs? None. The market on all occasions had a conniption, that some investors thought was a permanent change and the start of a long-term bear market, but ultimately they were proved wrong. The market has always recovered. The market has a short memory. Just like a stock can be sold off dramatically two weeks after beating expectations and raising guidance. The market has a very short memory, just like the Japan crisis, which in March sent the market tumbling only to recover all it’s losses within weeks. Fear and the flight to safety is one of the markets most common reactions to negative events. At these times the market always over-reacts to the downside, which usually days later, corrects itself with a bounce. Yes, sometimes the bounce can take a while to occur, but generally they come in days, not weeks or months. Knowing volatility is a factor of the market allows you to be a little smarter than most investors who, when fear strikes sell “at market” and slowly come back in after the market rises. Buying when selloffs occur is without a doubt one of the best ways to make long-term gains off the stock market. By sitting back and calmly deciding whether the current crisis is a permanent change or just a temporary aberration is one of the most important things you can do when investing in volatile markets like we have today. Panicking and listening to permanently negative people can be the worst thing you can do.

Yes, the stock market has plenty of uncertainty surrounding it at the moment. It’s often said that Wall St climbs a wall of worry and this is true. However, we must keep all events in perspective and not place too much emphasis on them, as we know the market has a short memory.

History will show that in May 2011 there was a market correction with little recollection why. Market corrections will come and go and this just another one. Yes, to some people it will seem like the end of the bull market, but it’s not. Corporate earnings are still rising, economically, most countries are improving and their GDP growing again. The bull market is definitely not over. For those who “sell this May and go away”, well, they will probably regret that decision. My advice is to take this opportunity with both hands and buy fundamentally great businesses (stocks) while they remain cheap. Fortunes are made by investors who have the foresight to realise that dips in the prices of good stocks are always temporary.

Subscribe now or for more information on Trident Confidential click here.