2010 Forecasts

February 12, 2010

The publishing schedule for my FREE update will be on a monthly basis for 2010. Most of my time is spent on the daily update and running Food on Foot, a non-profit I started in 1995. FOF provides meals, clothes and job opportunities to the poor and homeless of Los Angeles.

I will be teaching a class for those who wish to learn how to forecast economic and interest rate trends. The class will be held on Wednesday April 21st from 6-9pm in Century City and seating is limited.

2010 Forecasts

I begin every year with my three best bets and this year’s list offers much promise for those with the patience needed to realize a profit with limited risk. While much of the financial community concentrates on trading profits that usually end with losses for customers and profits for the brokers, the biggest winners each year are always those with well thought out ideas and a road map of expected events and an exit strategy. Since investing is a zero sum game where winner’s profits equal the losses of those on the wrong side of the market it is important to start with an important question. What is it about your investment idea that is not already priced into the current market? In other words why is the person on the other side of your trade going to be wrong? Most of us can’t make a decision about an investment until we have read numerous articles or heard about the idea on financial TV shows which gives us the confidence needed to pull the trigger. Unfortunately this falls right into one of my key investing rules: People would rather lose in company than win alone and that is the main reason so many lost so much money in the bear market between October 2007 and March 2009. A lack of stop losses and the fact everyone else was holding on to their positions hoping the market would turn around froze most investors and prevented them from liquidating losing positions. If the financial press had told everyone in late 2007 a historic bear market was coming and everyone should sell it might have enabled more people to liquidate but the act of taking a loss is a skill not many investors possess. Many residential real estate agents were telling customers to buy just before the peak in prices and three years later tell everyone if they had known it was a price peak they wouldn’t have been so bullish. But how would these “always bullish” agents have known? Why would they listen to anyone who was predicting lower prices since following that advice would severely impact their income? The most important advice for investors is always to ascertain if their agent, sales person, etc. can be objective with their advice. If not, is it really advice or just a sales pitch to acquire more business for them. The theme for 2010 is patience and don’t be afraid to sit in cash even though it is yielding near 0.00%.  Most investors have learned the hard way in the past three years the return OF capital is more important than the return ON capital.

Best Bet #1 – Japanese yen moves lower in value

When the fundamentals line up perfectly AND you have the backing of the Bank of Japan it often results in a very nice investment. The Japanese have suffered from DE-flation the last 20 years despite so called “experts” fear of inflation in the 1990’s. The longer deflation stays in an economy the harder it is to remove and the Bank of Japan lowered short term interest rates to zero many years ago in an effort to end their economic slide. They quickly learned zero interest rates do NOT stimulate consumer demand if retail prices are falling each year. Interest rates must be below the level of inflation and since they can’t be negative any interest cost is too high.

Unfortunately the Japanese economy is export driven and with the recent rise in the value of the yen its products and services are not competitively priced in the marketplace especially versus the Chinese Yuan. A lack of raw commodities has also hurt the economy and combined with DE-flation has prevented any economic growth for most of the last decade. The new government originally thought deflation was a plus for consumers but when it realized it came with lower wages it changed to a more expansionary plan for the economy. With interest rates at zero the normal method of stimulation is impotent so the Bank of Japan has begun to send a message to markets it is willing to support a lower value for its currency that would hopefully increase exports to countries with strong consumer demand (Australia, Canada, Brazil, etc). Currency intervention can be dangerous if allowed to go for too long especially if a country is attempting to support one that is falling because of a lack of faith from the international community. The normal tool is higher interest rates (Iceland) but that is dangerous and usually causes unintended consequences (credit contraction). It is much easier for a central bank to cap currency appreciation by increasing the rate of growth of the money supply. The downside of this strategy is runaway inflation but since Japan has no inflation and the velocity of money has been declining this result should not be feared.

The all time high value for the yen was set in 1995 and then again in 2009 at 85 to the US dollar. The yen is currently trading at 90 and unlike other countries worried about excess liquidity the Japanese model has proven the enemy is De-flation and any increase in inflation would be welcome. If the Bank of Japan follows the current plan of encouraging a lower yen it might stimulate foreign demand for their products but at a minimum couldn’t hurt a badly sagging economy. The risk is a new high in the yen below 85 but the upside potential is larger with a move to 120 this year a likely probability. As always stops must be used and hopefully this trade will have the same profitable result as our best bet in 2008 which was a lower British Pound and 2009 when we predicted a higher Australian dollar (see archives). The easiest vehicle for individual investors is a short of the FXY which is an ETF with good daily volume and excellent liquidity.

Best Bet #2 – Buy 10 year Treasury Tips if rates rise to 3.00%

Although every so called “expert” has predicted the best bet of the decade is to short Treasury Bonds because inflation must rise soon (see Japan) our best bet #2 is the purchase of Treasury Inflation Protected securities but not because of future inflation risk. These bonds offer an annual fixed rate of return but also pay investors the equivalent of the inflation rate each year. Currently the 10 year TIP yields 1.44% (+ the inflation rate) and offers little value unless inflation reverses course and heads higher this year which is the consensus view. The real rate of return (1.44%) is usually an estimate of expected economic growth over the period of the 10 year life of the bond. But it also represents a risk factor the issuer (US government) will NOT pay off the bond at the maturity. Currently the market perceives the risk of a US default as very low and any set back for the economy and or administration policies this year could easily send this premium sharply higher giving investors an excellent buying opportunity. The easiest way to accumulate profits is when market expectations don’t equal economic reality and if fears of a US default rise this year it will be a good time for investors to go against those who are betting on something that has little chance of occurring despite a huge budget deficit and continued monetary easing from the Fed.

Best Bet #3 – Long term interest rates will NOT rise this year

This might be the most controversial pick of the year as almost everyone is sure rates will rise because of a massive amount of debt being issued by the US Treasury. Over a short time period rates often move slightly to changes in demand and/or supply but over the long run inflationary expectations are the main ingredients as lenders want to protect their assets against rising inflation while borrowers attempt to borrow at rates less than inflation. But rising inflation is not always the result of monetary easing by a central bank. If the money created is NOT being lent by banks and then spent by consumers and businesses it sits in vaults as excess reserves of the banking system. Almost 99% of Fed money creation in the past year is now back at the Fed and not being used by anyone. In the 1970’s this was called “trying to push on a string” and the Fed is closely monitoring the use of its money creation wondering when it will become a desired item. The velocity of money is the key to the equation for inflation and economic growth in the country and it has been steadily declining for the past two years. Until it picks up and it may not (see Japan for the last 20 years) there is very little chance of a pick up in inflationary pressures. With an increase in inflation, long term interest rates will cause much frustration and losses for those betting on lower bond prices as they will remain close to the “key” 3.50% level (10 year Treasury) for the past year. Those real estate holders seeking to refinance mortgages should use a move to 3.50% and under to initiate new loans and stand aside when the 10 year rises to the 4.00% level. Rates will remain in a trading range for most of this year and short term movements will be caused by the release of monthly economic stats or fears of an impending Federal Reserve move to increase short term rates.

2010 promises to be an exciting and profitable year for those investors who are able to see thru the many forecasts that are generated by so called experts who only see the future from their own past experiences. Those that are able to see the future based upon the current reality and not what they “need” the future to be will profit greatly this year.

I encourage everyone to subscribe to my nightly update which is e-mailed five days a week (Sunday-Thursday) at 10pm (PST) and contains my up to the minute opinion of the economy, interest rates and various different markets.

Before entering any investment, everyone should consult with their own investment professional and discuss the risk of possible loss of capital.