There is a good chance that when we look back at November 6th
to November 14th,
2012, the period that includes the US election and the Communist Party
Congress in China, we will recognize an important secular inflection
point.
The key was to sell
There are three time scale references that are useful in
looking to the future. The first is that the media and other pundits focus
primarily on the tactical or temporary time slots; e.g., when in last week’s
post I recommended selling on the day after Election Day. I was wrong that
there might have been a relief rally on the basis that one unknown was now
known. The key to the recommendation was to sell because of the large number of
remaining unknowns which were not likely to be decided until the spring of
2013. On a short-term basis the decision to sell last week was correct. Several
astute investors have informed me that they reduced their 60% equity allotment
to 30% on Wednesday. Another smart investor decided not to take advantage of
the drop in stock prices as there were too many unknowns.
Cyclical periods
The second time frame (and the one most used by institutional
investors and members of investment committees) are cyclical periods which go
on for a few years. Election cycles, crop cycles, fashion cycles, economic
cycles and market cycles are examples of outside forces that somewhat
predictably influence market prices and portfolio returns. To participate in
these cyclical periods, consultants like three years, older CEOs prefer five
years and younger CEOs favor ten years as calendar periods to capture most of
the other cyclical behaviors.
Always is a long time
For those of us who are managing money for succeeding
multiple generations and/or institutions who believe in their eternal lives,
secular time periods are more appropriate. The demographic trends, the technological
changes and long-term medical developments are some of the factors that impact
secular growth rates and the attractiveness of various investments. I have
always been more focused on secular changes than shorter term phenomena,
particularly today. I am writing the first draft of this post Saturday night,
the 10th of November, the 237th anniversary of the
US Marines Corps. Marines believe in lots of practical virtues, but our motto
is Semper Fidelis, which is Latin for
‘always faithful.’ Always is a long time and it is from this background that I
look to our future, including our financial future.
November Elections
In a
period of under 10 days the US and China, the two largest economies of the world conducted
elections (albeit differently) that may be viewed as inflection points to the
future. The practice of analysis rests heavily on an
examination of past actions. There is a well-documented history of the rise and
fall of empires, or if you prefer, dynasties. The characteristics of large
empires that go into declines over many years, and in some cases centuries,
start with public displays of moral decay, demographic changes that create
distrust between elements of the population, excessive spending by central
governments, inflation leading to the practical devaluation of the currency and
weak political leadership which translates into too cautious military and naval
deployments. While empires fall because of their internal problems, they are
finally subdued by new empires that are led by hard-working populations that
want more. Often the rising empire is to the east of the falling one.
The
victors in the US election and the California Proposition 30 referendum ran on the platform of raising taxes on
others, temporarily defined as wealthy income generators. Few of those who
supported these policies stopped to think that in the long run these impacts will
be self-defeating. Ultimately, if the wealthy do not physically move, as from
France to Belgium, California to Nevada, US to Singapore, or change their cost
structure (employing fewer people), they will raise the prices for their goods
and services. Some of the price increases will be disguised as reduced services
and support, as well as less quality. This phenomenon is called inflation.
We know that the impact of inflation tends to be retrogressive. The poor will
suffer more than the wealthy. Central bankers around the world desire inflation
which will lead to the practical devaluation of our fiat currency compared with
hard assets. We are setting up a weak dollar, which will be dangerous if combined
with a less capable US military/naval force.
To the East of the US is China, beginning the installation of
the fifth generation of its collective leadership this week. The composition of
the Politburo
Standing Committee (expected to be seven) was determined by the retiring
fourth generation leadership, and to some extent the third generation leaders. On
November 9th, China Daily published
an advertisement in the Financial Times
as to the progress that has been made under the fourth generation. The results compare
2011 data with that of 2002, which can
be summarized as follows:
·
Percentage
of Urban Population: 51%
vs. 39%
·
Private
Vehicles: 79
million vs. 10 million
·
Foreign
Students: 293 thousand vs. 86 thousand
·
Fortune
500 Chinese Companies: 69 vs. 11
·
Refrigerators
per every 100 rural families: 62 vs. 20
·
Cell
Phones per every 100 rural families: 180 vs.15
and many other measures of physical and financial progress.
The expected fifth generation leaders have prepared detailed
plans which have apparently been approved.
Investment Implications
Near-term (tactical) events move markets; thus volatility
will pivot on news from both Washington and Europe. While stock market volume will
probably remain relatively mild, there will be an increase in selling by
taxable investors trying to avoid higher capital gains taxes. It is possible
that the number of insistent sellers could create some bargain prices.
Cyclical investors should recognize that the odds are that an
economic cyclical recovery has already started; led by housing, replacement/replenishment
cycles, Sandy-induced repair and rebuild needs and perhaps some longer-term
attention to prevent severe damage from future natural disasters. Casualty
insurance stocks will get a boost when they announce their premium increases.
The secular investor needs to recognize that the next
generation is going to hinge on the opportunities and problems emanating from
China. Successful investing in China is problematic for us who are used to
Western accounting and contract law. However, there are three other
alternatives. There are some mutual funds and other institutional investors who
may well be able to be successful investors in China. A second alternative
would be a handful of US, UK, and European companies that expect a large part
of their future growth will come from China. The third alternative would be to invest in those areas
that can be critical to Chinese growth, such as Africa, Australia, Brazil and Mexico.
One secular trend identified by Sir John Templeton years ago is the
shortage of high quality shares to buy. The combination of cash acquisitions
and stock buybacks is reducing the pool of available shares for purchase. To a
similar degree, the credit problems facing many bond issuers have reduced the
amount of the highest quality paper that is available. As these needs become
apparent, I have no doubt that the investment and commercial bankers of the world
will try to fill the void; the question will be the quality of the new paper.
Under these conditions, and I speak with bias as an owner of shares in a number
of investment bankers, I would rather own them than the paper they sell.
It’s your turn
What portion of your investments do you assign to your tactical, cyclical
and secular buckets?
__________________________________________________________
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