With or Without US - 2007 - Yr End, Yr Fwd Note on Markets & Economy

What a fascinating mix of conflicting data and behavior in the world economy and world markets! Commodities remain in a long-term bull trend. This is inflationary. Bond yields on US Treasuries have been falling. This asserts deflation and recession. Then, after 18 months of rebellious behavior, the US dollar has resumed its long-term bearish trend, in light of an abundance of economic and market driven factors. Finally, add in a low yield environment in the bond market. For, while it is true that 4.4% on the 10yr treasury is better than yields from several years ago ('03 in particular), and yields on shorter treasuries are much better (around 5% from recent 1-2% levels), nevertheless, investors at home and abroad need more yield. Interestingly, they need more yield for diverging reasons.

Even so, amid all these zigs and zags of data and slices of insight into Darkness & Light, the Equity markets have performed very nicely in 2006. But with 2% US GDP growth likely in the coming year: what is an investor to do?

In the summer we at Butler Financial ignored “the heavens” (the swirling macro-economic views) and upped our exposure to the equity markets, stock by stock, sector by sector: where—to our delight and surprise--we kept finding quality companies at excellent prices (as in “cheap” relative to fair value and charts). Examples of this include Dell, New York Times, Peabody Energy, and the ETF for the Canadian Bourse (ticker: EWC). Of the companies mentioned, we primarily bought them based on price, not a deep rooted love of Dell PC’s or publishing, for example. Price, naturally, is one of the best managers of risk.

So now we look ahead, to 2007 and 2008, and believe several things:

1) stocks remain the place to be – albeit in a global stock market

2) over-weightings to International and Hard Assets remain

3) the US bond market is to be avoided

4) past three years of low to no volatility in equity markets ends

5) it’s all about the dollar

6) keep an eye on alternative investments impacting markets

Stocks remain the place to be & US bonds are generally to be avoided: this is based on two factors, one market driven and one macro-economic driven. The market-driven force, as mentioned above, is that bonds offer neither American nor International investors sufficient yield. The American investor needs yield to retire and to supplement his/her income. 4.4% doesn’t do it for all except the mega-wealthy (starting at 10M networth). For the International investor, there is the matter of a weakening dollar, which will impact overall total return. As well, foreign bankers continue to hold large quantities of dollars; even if they don’t sell them, it would appear that they will be disinclined to buy more...

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