Thursday, April 15, 2010

"Climbing the Wall of Worry" - Excerpt from My Quarterly Letter

We're having a few "production problems" getting my regular quarterly letter out, but hopefully it will be in the mail soon. In the meantime, I thought I would post the strategy portion of the piece that will be going out:

Climbing the Wall of Worry

After a rocky start in January, the equity markets recovered nicely, and positive returns were registered across most sectors in the first quarter of 2010.

For the fourth consecutive quarter, stocks outperformed bonds, which represents the longest "win streak" for stocks since the seven quarter winning streak in 1996-97 (according to Ned Davis Research).

Interest rates were essentially unchanged. The 10-year Treasury bond yield started the year at 3.83% and ended the quarter at 3.84%.

However, if there is a “consensus bet” in the investment community, it is that interest rates are going to rise. I am still not convinced, as deleveraging cycles in history have normally lead to deflation and lower interest rates, but clearly I am in the minority.

The emerging markets were the global stock market laggards, while the U.S., Japan and the U.K. were the market leaders, illustrating that economies and stock markets don't always move together;

Corporate bonds - especially lower quality bonds - were hugely popular. Investors apparently have put any memories of the recent credit crisis firmly behind them, and are grabbing any yield they can.

The worst performer across the asset classes? Cash. As we all know, money market rates are very low, and with the Fed essentially “on hold” for the foreseeable future, this is one area that probably doesn’t make much investment sense for anyone other than the most bearish investor.

I think that stocks could continue to rally, but at a slower pace than last year. There's too much cash on the sidelines; interest rates are too low; and there's too much pessimism for stocks to have a serious correction baring an unexpected global economic event.

Still, I do agree with the consensus in one respect: I don't know how the economy can suddenly turn robust given the high unemployment rates and huge debt burdens at the government and consumer levels.