Ten Thoughts for 2011
Here are my ten thoughts on investing going into 2011:
(1) The Eurozone is a scary place to be. The basic problem is that there are huge economic distortions that have resulted from the Euro. What needs to happen is "price convergence"; prices are too high in the PIIGS and too low in the "Northern Block" of Germany, Netherlands, Finland, and Austria. Unless Eurozone officials begin to recognize that the issue has absolutely nothing to do with sovereign debt (which is merely a symptom of the "price convergence" issue), then it's almost inevitable that there will eventually be a national bankruptcy. As "cheap" as things look in the Eurozone, I'm still hesitant to invest there.
(2) China is about to see its bubble burst sometime in the next two to three years. Official have no control over the "shadow banking" system, which will continue to pump money into the economy, in spite of economic signals that suggest there needs to be less money there. All of this goes back to the Dollar peg, which has eroded purchasing power and has squeezed consumers, which is driving inflation. It's also driving the asset bubbles there; it makes sense from a logical perspective if you are a consumer to buy hard assets so that your money does not lose value. Yet, the Chinese economy does not need more real estate or gold. Nor does it need more manufacturing capacity. There is massive oversupply to external economies and undersupply to the consumer space. I don't know how long it will take, but eventually, the house of cards will crumble.
(3) The United States is slowly recovering. It is held back by the currency distortions in Asia and the Eurozone crisis; however, things in the domestic sphere are starting to look better. Only problem is that aggregate demand is lagging behind everything else. Businesses are now sitting on s@#$loads of cash, but won't invest that money, because they see nowhere to invest it. Until aggregate demand rises, this pattern could continue. So my guess is that we continue to see recovery at slow pace, but the economy will recover all the same.
(4) Latin America and South America are the two best "emerging market" areas to invest. Latin American economies have actually been held back by the currency wars in East Asia. The currency manipulations of the East Asian nation are starting to backfire and this benefits Latin America more in the future.
(5) US homebuilders are very cheap right now. Who knows how long before we see "normalized" production again, but at the current prices, I see no reason not to sit around and wait on it.
(6) Small and regional banks will eventually prove to be a great investment, but it may take awhile, and one must be very careful about which banks they are buying. But even if you want to play it safe, you can find well capitalized banks that are selling at or below tangible common equity and will probably benefit from higher interest rates in the future.
(7) Public REITs with lots of cash and liquid assets could potentially benefit from some of the distressed debt coming due in the next few years. The private RE companies' suffering will be the public REITs' gain.
(8) Pain in Asia has the potential to filter out quite a ways. Think Australia. And maybe Canada.
(9) If China's economy dramatically slows, gold, silver, and copper could all see negative price action. China's gold buying in 2010 has increased five-fold from gold buying in 2009. If this demand collapses, gold prices could drop considerably. While this might only mean a 10% - 30% drop in the price of gold, it could be much more harsh on vulnerable gold miners, particularly the major gold miners who have been purchasing new resources at inflated prices. Silver miners are also a very scary bet right now and extraction costs are nowhere near the spot price. Of course, the bubble could continue to move on for another 6-24 months; but I think the risks are definitely starting to get higher and investors need to be more concerned about the downside.
(10) Don't forgot the rule of abnormal earnings. "Abnormal earnings" is an economic term that implies that a "normal profit" exists and that if a firm is earning above that, it achieves "abnormal earnings." Abnormal earnings entice new competitors to enter into an industry. Unless there are significant barriers to entry, a firm will have difficulty maintaining those abnormal earnings for an extended period of time. Investors might not be understanding the concept of "abnormal earnings" when applied to Netflix (NFLX). NFLX has a competitive moat around the DVD-by-mail market; so it can protect its abnormal earnings in that sphere. Unfortunately, that sphere is dying and it's now competiting in a sphere (streaming content) that theoretically has fewer barriers to entry.
Those are my thoughts. Feel free to love them, hate them, or be indifferent to them. ;)
Disclosure: I am investing in long, short, and option position in regards to most of these themes. I own long-dated puts on NFLX.