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Despite Record Rally in U.S. Stocks, Oil, Commodities and China Will be the Long-Term Winners

Stock-Markets / Financial Markets 2010 Mar 25, 2010 - 06:47 AM GMT

By: Money_Morning


Diamond Rated - Best Financial Markets Analysis ArticleWilliam Patalon III writes: Although U.S. stocks have made a fairly smooth transition into Year Two of what's so far been a near-record bull market, there are still many traps that can quickly ensnare a less-than-cautious investor.

Moving forward, investors need to focus on quality, take the time to understand what's really happening in Washington, and turn to such once-unconventional investments as oil, commodities and China stocks, says Money Morning Chief Investment Strategist Keith Fitz-Gerald.

"I expect the markets to remain very fragmented. Volatility will almost certainly increase, leaving investors both psychologically scarred and totally confused," Fitz-Gerald said, underscoring the need for investors to embrace a truly global view. "Fully 75% of the economic activity on the planet now takes place outside U.S. borders. So it only makes sense that investors embrace new ways of thinking in order to avoid getting left behind. At the same time, energy and commodities still have a long way to run - meaning there's substantial profit potential available."

In a wide-ranging interview, the former professional trade advisor, best-selling author and noted Asia-investing expert:
  • Predicted that oil and commodity prices are headed higher, making them "must-invest" asset classes for investors who don't want to be left behind.
  • Stated that ongoing miscues in Washington coupled with higher growth abroad make it imperative that U.S. investors embrace a truly global view when planning their investing strategies.
  • And predicted that many blue-chip U.S. companies will go for dual-listings, listing their shares on China's Shanghai Stock Exchange (SSE), providing those U.S.-based firms with access to the plentiful capital and robust growth available in that Asian giant's marketplace.

William Patalon III (Q): Now that we're one year removed from the March 9, 2009 market bottom, a lot has been made of how well U.S. stocks performed during that stretch. You correctly called the short-term correction and recovery that we saw just after the New Year. But as you've pointed out, the real question is where the market - as well as the U.S. recovery - goes from here.

Keith Fitz-Gerald: Thanks for noting that market call, Bill. Obviously, the big question is whether or not things can continue from here. On one hand, the U.S. Federal Reserve's low-interest-rate policies are designed to encourage us to remain "long" and to reinflate the stock markets. So, generally speaking, investors have one heck of an incentive to stay "long".... until the bill comes due. On the other hand, travelling around the world as much as I do, I have the distinct impression that global traders are losing patience, so investors clearly need to keep their "stop losses" tight, and remain conservatively invested.

(Q): Keith, what do you see going out six months, nine months and a year from now - not necessarily in terms of predicted performance, but perhaps the opportunities and threats you see to a continuation of this bull-market move into Year Two?

Fitz-Gerald: In the stock market right now, one characteristic separates the winners from losers - quality. Investors who want to maximize profits and minimize risk need to buy the best-quality stocks - and best-quality companies - they can find. No exceptions.

The best choices are going to be investments that not only tap into the tremendous growth taking place overseas, but that also have higher-than-average free cash flow (FCF), strong balance sheets and seasoned management that can compensate for the hopelessly inept central bankers toiling away around the world. Infrastructure, water, power and diversified-equipment makers are good examples of the categories of companies investors should be looking at right now. Energy, metals and inflation hedges also figure to be solidly opportunistic profit plays during the next 24 months .

On the other hand, I don't see consumers gathering strength anytime soon, meaning that luxury brands and cyclical consumer goods are off the table - with one exception: China. Retail-spending growth in China is expected to top the growth in retail spending in the United States, Japan and Eurozone combined.

(Q): What should investors be doing to capitalize on those opportunities, while also protecting themselves against the risks you've outlined?

Fitz-Gerald: For investors right now, the first order of business is to replumb their minds and focus on cleaning up their investment house, so to speak. Wall Street won't and Washington can't. So more than any other time in history, the average investor must take responsibility for his or her own future. The objective is to position yourself for a solid upside, while at the same time cutting risk to razor-thin levels. To do this, rely on such tools as the 50-40-10 portfolio-allocation strategy that we espouse. Of course, trailing stops are a big part of this, too, and that's something we talk about all the time.

(Q): It goes without saying that there's tremendous uncertainty surrounding the U.S. economy. Many of the concerns that you outlined to Money Morning readers as far back as 2008 proved to be the undoing of the record bull market in U.S. stocks, as well as the surging U.S. economy. In terms of the U.S. economy, what are you concerned about now? Perhaps you could provide a couple of possible scenarios that you see playing out over the next six months to a year.

Fitz-Gerald: The single-biggest challenge to our recovery is our political leadership. Time and again, when given the chance, political leaders make decisions, pass laws or reach conclusions that are ill advised, flat-out wrong or badly mistimed. I can point to two great examples in Washington right now. The first is the growing protectionist sentiment against China ... while the second is the $14 trillion fiscal hangover Washington created because or leaders insisted that we bail out Wall Street. The first example is completely misguided - not to mention about as poorly timed as humanly possible - while the second demonstrates that we can't get our own house in order.

With regard to scenarios, I see a "slow growth/no growth" outlook in the United States almost certainly for the next few years. Most of the issues that caused this mess have not been solidly addressed and the banking industry remains held together with wallpaper paste and bailing twine.

I expect the markets to remain very fragmented. Volatility will almost certainly increase, leaving investors both psychologically scarred and totally confused.

Fully 75% of the economic activity on the planet now takes place outside U.S. borders. So it only makes sense that investors embrace new ways of thinking in order to avoid getting left behind. At the same time, energy and commodities still have a long way to run - meaning there's substantial profit potential available. That's as much a function of demand growth in the emerging economies as it is the weak-dollar policies of our own government - and now the Eurozone, in terms of the impact that the escalating debt problems of Greece and other EU nations will have on the European euro.

(Q): You've talked at length about how the "rules of the game" have changed. Could you explain the difference, and perhaps give an example or two? One statement that I've heard you make, for instance (that might surprise investors who aren't regular readers) is that "buy-and-hold" investing is dead.

Fitz-Gerald: Time and again throughout history we've seen how any kind of a major change ... including a massive financial crisis ... leaves the resultant landscape permanently altered. Understandably, most investors find that fact to be disconcerting - if not downright scary. But there are actually some very good reasons to be optimistic, because history also shows us that huge sums of money are made in the transition period that immediately follows any great calamity. You can see that clearly in the days following the English Empire's expansion, after the Industrial Revolution, and after the computing revolution, to name just a few.

And that's where we are now...on the doorstep of what could easily be a Golden Age of investing for those savvy enough to recognize it. This time around, instead of a change in industrial tooling or a new age of exploration, we're seeing that the very rules of money are being rewritten - particularly as they pertain to the use of such instruments as credit default swaps.

To put it another way, the West is trying to engineer its way out of trouble with "pretend money" - the swaps - while much of the world led by China is concentrating on the management of real growth. Whether or not the data is manipulated is irrelevant...the growth is real so it makes sense to concentrate on the creation of real wealth rather than the preservation of an illusion.

(Q): Everyone's familiar with the stunning market call you made in the crude oil market several years back - calling for an escalation well into the triple digits when crude prices were sedentary and trading in the mid-$80 range. Within months, oil was trading at record highs near $150 a share. In conversations we've had, you're now warning that energy prices are headed higher. What do you see and how should investors position themselves for this eventuality?

Fitz-Gerald: Again thanks for noting that, Bill. I believe that two things are right now driving the ship, so to speak.

First, growing global demand is not only going to outrun existing supply - it's even going to outrun the development of new supply. People often point to alternative energy as a means of slowing demand growth and they're right - in the Western world, where demand has arguably dropped. But that scenario ignores such markets as China - which all by itself accounted for fully one-third of total demand growth over the last 12 months. At the current pace China is expanding its usage, that country will be using as much oil as the United States by 2018. That alone means the pricing dynamics we now take for granted are going to have to change. And there's also India, Africa and Latin America, which investors will need to factor in.

The second point to note is that while the central seemed hell bent on maintaining a weak-dollar policy, governments around the world were actively diversifying their reserves into hard assets such as oil. What they are doing is not so much a consideration of higher prices as it is a desire to safely store the "value" of their investment holdings. In effect, they are using oil as a currency, even though it's not thought about that way by most people. This, too, will create upward pressure on oil prices - as well as on other important commodities. This makes commodities, in general, an investment that investors must consider for the long haul.

(Q): China has recently become the focus of much concern. There are worries about the Asian giant's debt, about bad loans - especially at the local level - and about housing, to list just a few of the concerns. You live part of each year in Asia, and make several research trips to China each year. Those facts, as well as the fact that you're the editor of The New China Trader advisory service, means you're better-versed on China than any of the pundits right now trying to write that country's epitaph. I know you still believe the long-term story is sound. What do you see in the near- and intermediate terms, and what (good or bad) impact could that have on the world economy? In the final analysis, what do you advise investors to do?

Fitz-Gerald: Double their exposure to China. What the China bashers don't understand is that China is taking pre-emotive action to tap on the brakes. Our government, beset by a $14 trillion fiscal hangover, is staggering around after the party trying to tell people to drink less. The Chinese are taking away the punch bowl.

Let's tackle housing as an example. There are three key points to understand.

First, there will be more than 500 million people moving into China's cities by 2020, so it's only natural that housing prices are going to go up - particularly in the high-demand areas of Beijing and Shanghai that are clearly central to China's future.

Second, even as this migration accelerates, you can't buy a house without a 30% down payment. Second homes require 50% down. So the only people buying homes are those who can afford it.

Finally, housing costs - as a function of per-capita income - are still declining, which means that incomes are rising at a faster rate than housing prices.

Obviously, there are pockets of overheating - just as there are in other major markets around the world. To write off China purely on the basis of what's happening with real estate prices is a major mistake and represents some very-short-sighted thinking.

(Q): Japan's another market that you're probably as close to as any investor in the marketplace today. Many are calling for a rebirth there, reasoning that after being down for the count for so long, and having finally made some of the needed moves, that a turnabout is in the offing. But I know you've cautioned investors about being overly optimistic about Japan. Could you share some insights?

Fitz-Gerald: As you know, I'm very close to this issue, having spent the better part of 20 years traveling about in Asia and having a home in Kyoto. Japan will never regain the mantle of leadership in the Pacific region that it enjoyed from the 1950s to 1990. That's not to say that there aren't spectacular opportunities there, because there are. But the thing most people don't understand is that Japan has a declining population, so the companies that will clean up are those that have shifted their efforts away from America and the EU and toward China. Don't fall for the illusion of domestic Japanese growth because it simply doesn't exist.

(Q): What other issues ... or potential situations ... are you studying right now? What other concerns do you have?

Fitz-Gerald: I remain concerned that our leadership will fall prey to populist agendas. The biggest single factor that could derail a recovery is our own government doing something really stupid - like beating up China over the yuan or plopping another $11 trillion of debt on top of what we're already carrying.

The first miscue will virtually double the cost of anything coming from China, furthering the U.S. consumer's perception that China is a villain when the reality is that this Asian giant is the relief valve for U.S. inflationary pressures.

The second misstep is simply just additional denial that fiscal responsibility really does apply to our government the way it applies to households and individuals. You can't rob Peter to pay Paul forever...sooner or later Peter's going to leave - and that's happening already on both a corporate and personal level. Washington is treading on very thin ice.

(Q): And, lastly, knowing that you're a man who's never been afraid to make a prediction, what are the one or two prognostications that you're making right now that would most surprise investors?

Fitz-Gerald: There are two things that come to mind.

First, faced with an increasingly distrustful and skeptical public, the U.S. government will make a land grab at the $14 trillion in retirement assets it presently can't touch. But don't expect a backlash. This will be sold to a "thankful" public as a way for a benevolent government to protect our personal financial futures. In reality, it is nothing more than a way of forcing us to buy U.S. government bonds - financing the mess that Washington created.

And, second, watch for American Pie stalwarts such as - I'm merely using these as examples - General Electric Co. (NYSE: GE), The Coca-Cola Co. (NYSE: KO) and others to list their shares on the Shanghai Stock Exchange within the next five years - at most.

This will be the ultimate wakeup call for those who don't believe that Asia is the key to our economic future. The truth is, the companies that make this move the earliest are worth watching, for this will prove to be quite a shrewd move. These "reverse ADRs," for lack of a better term, give these companies access to the world's biggest potential capital markets at a time when ours are tapped out. And because they will establish foreign subsidiaries to handle this, they will build a much-closer relationship with their new-and-growing customer bases in the highly promising China market.


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