Investing – The Shifting Landscape

January 2, 2010 Aloki 0 Comments

In this month’s investing article:

New Terrain in 2010. It’s time to re-assess the market as the old patterns that drove markets in the last year shift to new ones.

Investing Strategies and Ideas for 2010. Investing themes for the next year, including product cycles, defensive plays with high dividends, inflation plays, caution in commodities in the short-term, avoiding real estate and exiting longer-term bonds. Plus a list of specific ideas.

Things to Watch Out For in 2010. Thinking about the possible downside is always a good idea. Macro things that may knock the markets off-balance include inflation concerns, interest rate increases, weakness in China, Eurozone problems, tensions in the Middle East and government regulation.

New Terrain in 2010

It’s the New Year, and as usual, we are reminiscing about the last year and imagining the year ahead. In the investing world, pundits are preoccupied with the same thoughts; predictions and prognostications for 2010 are being issued daily.

There’s another reason we should be reviewing our investment plans for 2010: the investment landscape is changing. For most of the last year, macroeconomic indicators determined what happened in the markets: when better-than-expected earnings appeared, whole sectors rose; when costs were cut, stocks climbed; when the dollar declined, the market rose; and when unemployment slowed down, the market moved up.

Those were the patterns of the past year, and all of them are changing. If earnings are better, that could be good, but it might also mean inflation, which is bad. If cost cuts continue, that might mean more unemployment, which is bad. Lately, the dollar has risen, and so has the market, so it’s no longer clear that the old lower-dollar-higher-market relationship holds. And last month, unemployment was much less than expected, which was good for the economy, but bad for gold and for interest rates. Yes, a mixed picture indeed.

As the economy shifts gears in 2010, we will have less clarity about what macroeconomic movements mean for stocks. Many questions will be hard to answer, and often, the right answer will be, “it depends…” For example, will the dollar fall or rise? Depends on what the Fed does and whether there are economic problems in other countries. Will the Fed raise rates sooner than expected? Depends on the economy, but truth is, no one knows (and in all probability, neither does the Fed). Will unemployment recede? Perhaps, if interest rates stay low, but perhaps not, if interest rates have to rise… and so on. In 2010, you’ll find that for every position, for every proposition, there will be plenty of people on the other side of the fence.

That’s not to say that the macroeconomic picture is irrelevant. The big picture will be important, but just not as decisive as it has been in the last year.

Generally, many expect the first quarter or so to be strong. Low interest rates will continue in the short-term, the economy has stabilized, and that may actually spur some spending. Also, many companies have reached the limit of cost cutting, which may mean that unemployment, while high, may start to decline. The real muddiness comes afterwards the first quarter or so. At mid-year, where interest rates, the dollar, inflation, unemployment and spending will be is anybody’s call.

Investing Strategies for 2010

In the midst of all this muddiness, what’s an investor to do? If you are aggressive, you can try to be a nimble trader. But for the average home-gamer, the next year will be a time for stock-picking, a trend that started in the fall but will be important as we move into 2010. For much of the last year, whole sectors moved together, spurred by macroeconomic moves. Now we have to look at the specifics of individual stocks and industry sectors. Generally, I favor the following strategies for 2010:

As I’ve advocated in past articles, invest in predictable product cycles. This includes new, “hot” products; products that favor upcoming economic trends; and old products that have been ignored and need to be refreshed. Examples include smartphones, computers, servers, storage, the desire for bandwith; airplanes and LEDs.
While the last year was about capital appreciation, the next year may very well be about defensive plays with high dividends. That’s because it’s unlikely that we’ll see anything like the huge run of the last year. Stocks are likely to meander and rest, or even be a bit down. In this type of environment, you can place money in defensive stocks that won’t go down much and pay a good dividend, or preferred stocks with high dividends. Certain ETFs would also be appropriate.
We all know that there are real estate problems hiding in the woodwork. The resolution of those real estate problems could still knock the wind out of us, or in the best case, we could muddle through without too much damage. Still, I don’t see a scenario where real estate rises in any meaningful way. Furthermore, if you believe inflation is coming, as I do, then that means interest rates will rise, making things even more difficult for real estate related investments.

The inflation play will be a major consideration this year. Generally, this is for more aggressive or more nimble investors. Also, this play has many different forms, including shorting Treasuries, shorting bonds and at some point, buying gold and commodities. But be forewarned, playing inflation could require some patience and a stomach for volatility. We could have several inflation “scares” before inflation actually hits, leading to high volatility, and we still don’t know how severe inflation will be. So some flexibility and attention is required.

While you may not choose to short bonds, I would recommend exiting longer- term bonds or longer-term bond fund investments if you have them. Many money managers have placed a significant portion of clients’ funds into bond funds over the last year. As interest rates rise, bond prices fall. The only scenario I can think of where longe-r term rates stay low is if there is a severe double dip, and I think that’s unlikely.
In the short-term, I remain cautious on commodities in general. The consumer remains weak, which puts a ceiling on commodities such as oil. Basically, if oil goes too high, consumers will drive less, bringing down the price of oil. In addition, continued buying from China, which has driven much of the commodities trade in the last year, is now in question. China’s buying was caused by stimulus spending and the desire to stockpile; there is no evidence that these factors will drive China in 2010. In the medium- to longer-term, the picture changes: inflation and world demand will favor commodities.

Investing Ideas for 2010

So how does an investor play these themes? Here are a few ideas. Just a note, these are ideas, not fully researched suggestions. I advise you to do your own research and to consult your own investment advisor, especially to determine if any of these are suitable for your portfolio. And of course, this list is not meant to be exhaustive by any means.

The Product Cycle Trades

Smartphones – long Apple; long Motorola (which may turn from nothing into something); short RIMM (because competition is increasing. This is risky and is for advanced traders only that can manage the risk). I am long Apple.

The Tech Trades – Microsoft, HP, Dell and Intel for the PC refresh cycle; HP and Dell for servers; EMC for storage; Cisco and Akamai for the desire for bandwidth. Oracle for software to manage data. For the record, Dell is in turnaround mode and has been playing catch-up; for this reason, I consider it the weakest of the investments listed. I am long Microsoft, Dell, Intel, EMC and Akamai.

The Airplane Replacement Cycle – airlines will have to buy new airplanes, because the ones in service are getting old, and newer models are promising greater fuel efficiency in a world with expensive oil. Boeing makes the promising 787 Dreamliner, and Titanium Metals supplies the titanium that is a major component of the Dreamliner.

The Television LED Cycle – televisions are shifting from LCDs to LEDs. As this occurs, Corning, the maker of glass, will benefit.

Advertising Recovery and Transition to the Internet. Advertising is recovering and shifting more and more to the internet, and in future years, to mobile devices. We all know the winner in this case, Google.

The Second Stage Financial Recovery – financials may take a hit in the short-term, but after a 2-3 quarters, we may be able to say that much of the bad assets are off the banks’ books. If that’s the case, we could see normalized earnings – that is, earnings without the significant real estate write-downs of the last couple years – anywhere from 2-4 years from now. When we can see losses beginning to decline, it will be time to buy banks such as JP Morgan, Wells Fargo, Bank of America, US Bancorp, and Citi again. Another set of plays in this category is the credit card companies, especially a high-quality name such as American Express. Like the banks, they are buys when it’s clear that losses are declining. Mastercard and Visa are earlier buys because they are transactions processors and do not extend credit like Amex and Capital One. I am long Bank of America, US Bancorp and Citi.

The Investment Banks – Goldman Sachs has taken a hit recently, mostly because of seasonal weakness in trading. Goldman is the best shop on the street, and is the beneficiary of the disappearance of Bear Stearns and Lehman Bros. Going into 2010, trading should pick up again. Later in the year, we may see trading decline as the Fed withdraws financing from the economy. I like Goldman Sachs here, as well as Morgan Stanley as a lighter, more conservative version of Goldman. I am long Goldman Sachs and Morgan Stanley.

The Defensive Dividend Plays

PGF, a preferred stock ETF yielding in the range of 9%; Altria, yielding 6.9%; Phillip Morris, yielding 4.8%; Kraft, yielding 4.3%, just to name a few. I am long Altria, Phillip Morris and Kraft. I also manage portfolios that are long the PGF.

Alternatively, you can sell calls against stable, defensive stocks with low volatility, such as Walmart, P&G, General Mills and JNJ. I am long PG.

The Real Estate Plays

Short real estate stocks as interest rates rise.

Inflation Plays

Short longer-term Treasuries by buying instruments such as the TBT (2x short 20 year Treasuries); short-term Treasuries may actually stay stable for a little while because the Fed will keep rates low. Still, at some point, the Fed will have to raise short-term rates so eventually it will be necessary to exit short-term funds as well.

Commodities, once inflation begins to take hold, including gold, oil and agriculture plays such as Potash and Mosaic. In my opinion, inflation is more likely to appear in the medium- to longer-term. In the shorter term, low rates and a still recovering economy should keep inflation at bay.

Risks to Monitor in 2010

In any investing strategy, there are risks to watch out for, as well as things that may surprise us. Here are a few macro level things to keep an eye on:

Inflation and Interest rates have a huge impact on the economy. If inflation appears soon, rates will have to rise sooner than expected and that may threaten the fragile recovery. Higher rates mean more costly borrowing and slower growth. If we don’t see inflation any time soon, rates will remain low, which would support the recovery. But an extended period of low rates increases the probability of a severe jump in inflation at a later date.

Weakness in China. Many are saying now that China is a bubble, driven by easy money created in turn by a massive stimulus program. It’s very possible that the China bears are right about this. If they are, it means that China’s growth is illusory, and China will not be around to drive up the price of commodities.

Eurozone Problems. A month ago, alarms went through the international system as Dubai World faced a debt crises and Greece was downgraded. The cynics – or perhaps the wise – would say it’s unlikely that we’ve seen the end of the story. Further Eurozone weakness could ripple through world markets.

Tensions between Israel and Iran could send the price of oil up sharply. To be fair, “tension” is a euphemism – it’s very possible that Israel will choose to strike Iran and destroy its nuclear facilities.

Government Regulation. There’s nothing like government regulation to make markets nervous. Healthcare continues to be on Washington’s agenda, and financial regulation may very well come back to the top of Washington’s list after healthcare has had its day.

Hopefully this is all enough to keep you busy and interested in the markets. Good hunting in 2010, as they say.

Disclaimer. All trades, patterns, charts, systems, etc. discussed in this advertisement are for illustrative purposes only and are not to be construed as specific advisory recommendations. All ideas and material presented are entirely those of the author and do not necessarily reflect those of the publisher. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using the above approaches will generate profits or ensure freedom from losses. The examples used herein are not intended to represent or guarantee that anyone will achieve the same or similar results. Each individual’s success depends on his or her background, dedication, desire and motivation.

As always, I encourage you to consult your own investment advisors before making any investments. I don’t claim to be right; I can only present you my logic, and I hope you will take the time to do your own homework and decide if you agree or disagree with the arguments presented here. Also, if you really feel like spending some more time on stocks, there’s more on my blog at http://mingloinvesting.blogspot.com.

Until the next time, sleep well.

Ming Lo is an actor, director and investor. He has an A.B. from Harvard College, Cum Laude, and an MBA and an MA Political Science from Stanford University. Prior to going into entertainment, Ming worked at Goldman, Sachs & Co. in New York and at McKinsey & Co. in Los Angeles.

All material presented herein is believed to be accurate but we cannot attest to its accuracy. The writings above represent the opinions of the author, and all readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed may change without prior notice. The author may or may not have investments in the stocks or sectors mentioned.