An interesting article by Stephen Leeb...hang in there he talks about oil.
Capitalize On the Changing Times
Stephen Leeb
After five years of record market gains and exceptional economic performance, no wonder investors are complacent. They're slow to recognize the inexorable changes happening in the economy and markets.
Ironically, the most important and longest-lasting changes don't occur all at once for exactly those reasons: people are reluctant to give up on the past, especially when the past has been so rewarding and comforting. But piece by piece, the market is changing and so is the overall investment climate. The sooner you recognize these changes, the more likely it is that you'll profit in the new investment arena, one that promises to be fraught with both risk and opportunity.
Perhaps the most visible sign of change is the behavior of the most important market averages. Since July, almost all broad-based measures of market performance such as the S&P 500 and the Dow are down. Indeed, the Dow began the year with its worst setback since 1920. Similarly, January was one of the worst months in the postwar period for the S&P 500. Index funds, which have been investment darlings for most of the past decade, are beginning to lose their appeal.
The preeminence of index funds, whose performance mirrors that of the major averages, went hand in hand with the fall of small cap stocks. Until the 1990s it was almost an article of investment faith that small caps outperform big cap stocks over long periods of time. But a decade is a long time, and for almost the entire 1990s, the little tykes were also-rans. That, too, is changing.
In the first four weeks of the year small caps outperformed large caps by nearly 10 percentage points, one of the largest differentials on record. This wasn't a start-of-the-year fluke, an exaggerated January Effect. Rather, small stocks actually have been outperforming since April of last year, chalking up a better-than 20 percentage-point advantage over the big guys. You have to go all the way back to the 1970s to find comparable relative performance.
The 1990s were characterized by strong economic growth and low and declining inflation. Do the still largely unrecognized changes in the market environment go hand in hand with changes in the economy? You bet they do. Slowly but surely, the economy has become more inflationary. Yes, growth is still strong. But no longer is growth completely painless. Though the reported numbers are still tame, inflation across the board has been picking up.
Oil: Still a Make-or-Break Cog In Our Economy
Some compare the current environment to the 1994-95 period. Through a series of small but steady rate hikes, the Federal Reserve in 1994 engineered 1995?s soft landing; the economy slowed just enough to assuage inflationary pressures.
But this isn't 1994-95. Then, we had help from weakening emerging economies, particularly Mexico, Brazil and other Latin American economies. That took the heat off commodity prices, a crucial factor in the soft landing.
Today, emerging economies are strong almost across the board. China deserves special mention. About six months ago it was accepted wisdom that the Chinese economy was in crisis and that a currency devaluation was inevitable. It was a question of when, not whether, the Chinese devalued. Guess what? Today if the Chinese currency were allowed to float it would rise, not fall. Indeed, the argument against floating the yuan is in fact based on fear of a sudden rise.
India also deserves special mention. As the largest democracy in the world and the second-largest country, it has one of the strongest stock markets and seems nearly certain to be firing on all cylinders for the foreseeable future.
Strength in China, India and most other emerging economies suggests that pressures on critical natural resources stemming from rising demand won?t abate as they did in 1995.
But, of course, we?re really dealing with the obvious as oil recently touched a nine-year high above $30 a barrel. As I?ve argued before in this space, OPEC only has so much control over energy pricing. My calculations suggest that by year-end 2001 if the world economy continues to grow, most of OPEC's spare capacity will be used up.
I have no doubt that OPEC will shortly increase production, which will keep the uptrend in energy somewhat in check, but only for a relatively short period of time.
The complacency about energy is amazing. I keep seeing articles arguing that new technologies will make oil easier to find, that oil today is a much smaller chunk of the U.S. economy than when we had our last crisis, and so on. These arguments are shallow enough to be dismissed with just a few sentences.
The U.S. is the most technologically sophisticated country in the world. Despite this, oil production has been declining for 30 years. The only time within the past 30 years that we managed to increase production was when Alaska?s North Slope came on stream. Even then, production rose for only a few years before beginning to decline again. (The North Slope and other giant fields such as the North Sea are noteworthy because they reached peak production within about a decade. No technology has managed to reverse this.)
The second less-than-brilliant observation about oil is that we don't have to worry because it accounts for far less of our economy than a generation ago. This is true, but it stems largely from the fact that oil today in real terms is much less expensive than a generation ago.
The critical point is that oil still remains an essential cog in our economy and there are no meaningful alternatives on the horizon. Whatever the price, we'll have to pay it. And as its price rises it will become ever more important. The same goes for other vital commodities such as food and water. They're less important today only because in real terms their prices have been declining. But as long as any commodity remains essential, its importance to the economy will be defined solely in terms of its relative price. And at least for the near term, the relative price of most essential commodities will have an upward bias.
The Economic Winds Shift
The upshot is that as long as the economy continues to grow--and grow it must--inflationary pressures will build. The markets have started to catch on, but just barely. The relative strength in small-cap stocks is a direct consequence of inflationary growth.
However, there are still a lot of signs that investors won't accept the reality of the new economic environment.
One time-tested relationship is between inflation and price-to-earnings ratios (P/Es). When inflation rises and is high, P/Es fall. Yet P/Es and other measures of value of the major market averages remain at historic highs. Moreover, the stocks that continue to grab the headlines are the wildly overvalued tech stocks. But even in this area there are signs that complacency may be waning. AOL, Dell, Amazon and even Microsoft, all former leaders, appear to have made tops. While the over-the-counter market continues to move higher, ever more it's characterized by frantic changes in leadership. Frantic and chaotic action is often a prelude to a market top.
On the other side of the coin are selected energy stocks, particularly natural gas stocks. They remain at historic lows despite the surge in energy prices.
It's as if investors just won't accept that the very comfortable world of the past few years has changed. But it has, and the sooner you recognize this the less you'll risk in the overvalued areas, and the more you'll stand to make in the slew of undervalued stocks. |
