Let’s just check at the end of this year to see how it went. That is only one year, which is a short period of time, but we are still confident in a continued recovery over the next year or 2 – just like it has from all previous declines.

All the stats you mentioned are irrelevant, unless you can estimate to what extent they are already priced into today’s market prices. Since those are all well-known, I doubt any of them will affect the markets.

The US still dominates in most sectors – retail, distribution, marketing, technology, telecom, health care & finance, and locally in utilities and real estate.

A sector does not have to perform well to outperform – just better than expectations. For the US, expectations are so low, it is hard to imaging not beating them. For example, among the best-performing stocks last year were Ford (456%), Bank of America (124%), & Citibank (77%). These companies did not have awesome performance. They just survived and didn’t lose money – which was infinitely higher than was expected of them.

Ed

All I’m seeing so far is a statistical recovery. GDP numbers came in at 5.7 % recently. Sounds impressive right? I think we need to look a little deeper into those numbers though. First, over 60% of this growth came from inventory rebuilding. Digging deeper, you can see that inventories had dropped below sales, so a replenishment was required. Increasing inventories add to GDP, while sales from inventories decrease GDP. I’m not suggesting that businesses building inventories is a bad thing, however that growth will only continue if sales grow. To this point, if you examine the consumer spending data, you’ll see that it actually declined in the 4th quarter both annually and from the previous quarter. US domestic demand also declined from 2.3% in the third quarter to just 1.7% in the fourth quarter. That does not bode well for signs of economic strength.

Imports also fell over the 4th quarter which is strange considering that in a heavy inventory rebuilding cycle, a portion of the goods that businesses need to build their products come from overseas. These falling imports have the effect thought of an increase in the statistical GDP number based on how GDP is calculated.

Finally, the impact of stimulus spending in the US accounted for 90% of the growth in the third quarter. In addition, there was a major decline in labour input in the fourth quarter(contracted by .50%). Such a decline has never coincided with a GDP this good.

Unemployment rose (hundreds of thousands of jobs were lost) in the fourth quarter. Sales taxes and income tax receipts are still falling. It’s hard to be serious in believing in a real recovery with unemployment still rising!

The US has tried to borrow it’s way out of debt to “stimulate” economic growth. As a nation that’s transformed over the years from manufacturing to a service based economy, they no longer create tangible products on a large scale to the degree of other nations do. As a result, all the stimulus money has done is buy them a little time creating even higher debt levels that will be even more difficult to reign in.

Let’s look at the US Debt figures a little deeper. In the 1940’s when debt was at all time highs as percentage of GDP, the US ended a world war and all of the “baby” boomers, went back to work. The US at that time was the world’s major manufacturer and surpassed the UK in economic might. Because they had a huge domestic manufacturing base and the population to work in those (at the time) very well paying jobs, their economy took off and they were quickly able to pay down the debts. Flash forward to the last decade, and the US economy has turned from production to hyper consumption. In the eighties, they were still a creditor nation. Now, they are the world’s largest debtor nation. The debt numbers also do not include all of their unfunded liabilities like social security and medical care for the elderly. If you add in these numbers, the real debt number is close to $50 TRILLION!!!! Certainly much higher than anytime in the past, and it’s growing far more quickly than any real economic growth.

I’ll tell a story to explain why the trade deficit is a far greater problem than many realize and why the US dollar will eventually experience a total collapse.
Imagine 4 people stranded on an island, three chinese workers and one millionaire American. They come to an agreement that they’ll each assign tasks to one another to sustain themselves. They agree that three of them will hunt, harvest and prepare the food while the fourth, the American millionaire will eat all of the food, leaving them just enough scraps left over to sustain themselves after he dines. In addition, the American agreed to issue each of them IOU’s for every meal that will entitle them to a portion of his wealth at some future date when they eventually get off the island. This goes on for some time and the American spends his days lounging and eating on the beach while the other three toil and labour to prepare food for him. One day though, the American has a heart attack and dies. At first, the other three panic, realizing that their IOU’s could now be worthless as the payee is no longer able to make good on his promise! But in the mean while, they’re still stuck on the island and life must go on. They agree to alternate between each other to share the work load so that all of them get a little recreation time and the opportunity to relax on the beach. They also now have more food, that they equally distribute among one another and enjoy better nutrition and a better quality of life. Years pass, and they eventually forget all about the American. His paper IOU’s were used to start campfires and have long been burned. They no longer need him, and realized that their life on the island was actually far more rewarding without him anyway!

Do you think my story’s a little far fetched? Maybe a little, but isn’t this exactly what China and the rest of the world have been doing for some time now? Trading their real goods that they’ve worked hard to produce for IOU’s in the form of treasuries (keeping their own currency and thus global purchasing power artificially low)? to say that the world can’t function without the US consumer is like saying farming can’t continue without locust infestations! Consumption of scarce resources in return for paper IOU’s does not bode well for long term productivity.

I end with a question. Can you please explain what sectors of the US economy will fuel a future sustained recovery? And what durable advantage to they have over other nations moving forward? Innovation and education are certainly two huge strengths I can think of, but the amount of regulation and red tape that exists in the US will likely force the best and brightest to export their knowledge to other nations where such barriers don’t exist. The way I see it is that US assets (real estate etc). will eventually go up in price after the dollar collapses, but it will be foreigners buying it up not Americans.

Duncan

Definitely let’s talk later this year. Our view is that the markets a year ago were in “Irrational Pessimism” (see article on this site), so why would we go back to that?

Every loss of 30% or more in the history of the S&P500 had a gain of more than 30% within 1-2 years, except the 2009 was only +27% after 2008’s -37%. The stock market has always been resilient.

If you noticed my recent articles on “Stock Market Risks” on this site, the general view of investors is that the stock market is far more risky than it actually is. In actual fact, other than in the 1930s, the S&P500 has fully recovered from every calendar year decline within 4 years and 88% of declines were fully recovered in 1-2 years.

So far, we have seen a large recovery that we expected that was a realization that we are not going off a cliff, but the real recovery has not really started yet. The economic news is mostly good, with GDP back to positive and most companies showing good earnings and beating expectations.

Do you remember the market 10 years ago? The US was a world-beater with large surpluses, at the centre of a technology boom, and DOW was going to 35,000 (book). Those exaggerated expectations were to high and built into the market at the time, which lead to the only decade (other than the 1930s) ever with not growth in the US market.

Now the expectations are the opposite. The US is widely expected to collapse, the dollar will crash, the twin deficits will result in hyper-inflation, China will pass it soon and the US will lose its place as the main world currency. Now the expectations are so low that if the US merely survives, it will shock everyone.

Oil prices were about $10/barrel and gold was about $250/oz. with no prospects of rising.

Ten years ago, the bar of success was 20 feet high for the US and inches high for commodities. Today it is 6 inches off the ground and almost impossible not to outperform for the US, while the expectations are 20-feet high for commodities.

You saw the US debt figures on Wikipedia. The US debt is about the same as 15 years ago and about half of what it was in the 1940s. Both times they paid it down with a few years of surpluses. You can’t add debt of government-controlled organizations like Freddie Mac & Fanny Mae without including their assets. Actual debt is manageable so far.

The only issue with the trade deficit is the currency. Since everyone already knows about it and the US dollar has already fallen, is this not already built into today’s price for th US dollar?

I can’t see how inflation can happen. If we have pressures, the Fed will raise rates to keep inflation low. So our view is that inflation will definitely remain low. The only question is whether the will have to raise rates to keep it low. If they do raise rates, that will tend to push the US dollar up – not down.

The fear of inflation seems to discount the facts that the US continues to import tons of goods at very cheap prices, has continually new and cheaper technology and demographics supporting lower and lower inflation.

The supply of commodities will eventually catch up. No matter how much demand increases, commodity prices should fall back to normal, unless there is a real permanent shortage. Higher demand leads to higher supply which means the longer term price of commodities should remain low. This is in sharp contrast to the current expectations that commodity prices will continue to rise into the stratosphere.

Chasing the out-performers of the recent past is not good investing. We made a killing in the last year by going much more aggressive at the bottom of the market, when the huge recovery was obvious to anyone with faith in the economy and humans.

Today, the global and US markets are only a bit over half recovered. The low-quality stocks have recovered a lot, but the high quality stocks have hardly moved. The main recovery is still to come.

Remember, what actually happens does not affect the market. What affects the market is what actually happens COMPARED TO EXPECTATIONS. The US will almost definitely beat expectations, while it is hard to see how commodities can possibly match the expectations of continued double-digit growth.

Ed

No, I’m not really a contrarian.We research and invest with the world’s top investors.

If you take the top investors that beat their indexes over long periods of time, most are value investors. Value investors rarely buy what is currently popular, since there is usually little value there.

We get to hear the opinions of these All-Star Fund Managers regularly. They are very different from the average fund manager working for a big institution and usually very different from currently popular opinions or those in the media.

What I hear makes me a big optimist. I have faith in free enterprise, free trade, human ingenuity and the stock market. I don’t foresee anything dire for the U.S.

The issue with commodities is that, by definition, a commodity is an item without unique characteristics. Oil or gold or wheat from one supplier is the same as from the next, so the only way to compete is on price. Unless there is a permanent shortage of supply. commodities will have low prices long term.

Your comments about corporations are true, but don’t really apply to the stock market. I would suggest you read the recent article on MDJ about the Risks of the Stock Market.

Ed

I fully agree that the States biggest asset is their ability to innovate. Unfortunately though, due to increased regulations and an increasingly litigious society it’s becoming harder for those innovations to be brought into fruition. But who knows, policy can quickly change and they could still come out on top. My point is that whether the US economy picks up or not, it doesn’t matter if you’re in commodities. They will rise with or without the US! One thing is for certain though, that the long term trend for the dollar is down. Commodities will never be worthless, can you say the same for shares of a corporation?

Ed, I hope you are right but I doubt it and I think the ‘recovery’ we are seeing is just the bailout money working its way through the system. If the money supply “printing press” gets turned off things will quickly grind to a halt. If they keep spinning then look out for hyper inflation in the US.

My point is that anything that is widely known will not move markets.

For example, you and millions of other investors believe that commodities will rise because of demand from China. Are you waiting to buy commodities until then or do you already own commodities exposure? So, if growth happens as most people expect, that supports TODAY’S price, not a future rise.

Commodities may not be at their highs, but most are still up a lot this decade. Commodities are not like equities that usually rise in the long term. Rising demand alone does not increase commodity prices, only if supply cannot keep up. Demand is expected to rise, but so is supply. There were some large gains initially because supply was behind, but huge increase in demand may or may not lead to higher commodity prices.

The question is: will the future turn out to be even better for commodities than your rosy forecast or will it be somewhat lower? Today’s price reflects all widely-known information. If the future is great, but slightly less than expectations, then commodities may well fall.

Another example is farm land, which you mentioned. Again, I have heard this from quite a few people. I recently talked with a guy that bought farm land 3 years ago for $1,000/acre and just sold it for $1,500. That’s a 50% rise in 3 years. It would normally take 15 years for that much of a rise. The farm land boom has already happened as well.

The biggest gains will be in a sector where the future turns out to be quite a bit better than today’s expectations. If you focus on that and try to find information that is not widely known, you can find bigger opportunities.

The US economy still has many areas to grow. Most of the cost of a product is marketing. When I used to work in the mattress business 20 years ago, a high-end mattress set cost $250. We sold it to stores for $500 and the stores sold it for $1,000 (sometimes more). So 75% or more of the money is in marketing, packaging, distribution, retail, etc. From my experience, less than 25% of the money for manufactured products goes to manufacturers. The US dominates in most of the other areas.

They still dominate the world in financials, health care, retail (staples & discretionary), technology & telecom and real estate and utilities are usually local in each area. So, they can still dominate the world in 8 of 14 sectors.

The advantage the US has is their innovation. Whatever the next big thing is, they will probably be there.

The US may or may not be successful the next decade, but the expectations are low. We are investing there because the belief in the fall of the US is rampant and we believe vastly overdone.

I use the same US debt figures from Wikipedia. Look at the 2nd graph showing debt as a % of GDP. The red line is public debt. You will see it is still lower than 15 years ago and about half of where it was in the 1940s. Both those times, they came out of it with little problem.

I think the massive number of articles predicting a debt crisis in the US and the collapse of the US dollar are extrapolations of recent trends, but the stimulus programs will stop. I think the articles are also political pressure to try to encourage Obama to cut spending.

Anyway, the panic about the US that is rampant seems to us to be hugely over-exaggerated.

Ed

This is totally incorrect (where do you get your statistics please?)
The real numbers can be found here:

http://en.wikipedia.org/wiki/United_States_public_debt

http://youtube.com/watch?v=2I0QN-FYkpw

There’s no doubt that gold has risen very quickly and has all of the aspects of a bubble. I personally would not buy gold at these levels, but am holding on to the gold that I do own and am not selling. If there are significant pull backs in the short term, I’d buy more. But I’d first look to other more attractive assets like natural gas, silver, and uranium that are still way below their highs. Uranium is a no brainer as Europe alone has plans for 8 reactors over the next several years which will only increase demand of this finite resource. Another fantastic inflation hedge that’s grossly undervalued is Canadian farmland. You can still by an acre of fertile farmland in Saskatchewan for around $400.00! They can’t make more land, and as the world population grows and inflation continues to erode purchasing power, that land and the food grown on it will only rise in value. It’s the farmers who’ll drive the Rolls Royce’s in the next decades, not the investment bankers, especially as the baby boomers retire and the next wave of investors with far less in net worth create a major “trimming” of jobs in the financial sector.

You mention this “growth” in the US economy, yet I don’t see where it’s going to come from? For years, container loads of ships have sailed into port to America and unloaded their cargo. They then return to their country empty! The US outsourced most of it’s manufacturing years ago, so they would have to start building factory’s and training people to before they can begin hiring people and producing output. This would take time and they’d be competing with Asia where the infrastructure, people and output are already in place. Maybe the IT sector can pulls them out of the recession? It’s doubtful, as India has more qualified IT professionals than all of North America combined and they work for a fraction of what a US firm would have to charge. Finally, with the US involved in two expensive “endless” wars and spending incredible amounts on Health Care reform, pension benefits (as the majority of their working population is approaching retirement) and every expanding Government programs, they only have two options; raise taxes or continue quantitive easing and monetize the debt. Raising taxes doesn’t win votes, so my guess is they’ll continue down the path of least resistance and open up the flood gates until they’re further afloat in excess liquidity.

If you follow the padded numbers of GDP and the CPI, then you’ve been hoodwinked into believing that inflation has been low and can be contained under a central banking system. Considering consumer spending accounts for about 70% of US GDP, I’d be very cautious of numbers showing “growth” in the economy when all that growth really amounts to nothing but consumption. The US trade gap with China is incredibly wide, and for all of the bashing of China for keeping the Yuan artificially low, their worst fear would be if China actually did strengthen their currency as it would raise prices on almost all goods imported into the US and have a rapid inflationary effect. The US has been able to play a very good shell game for many years with their reserve currency status. But foreign nations are finally waking up to the fact that they’re trading their widgets for IOU’s. As “sovereign” nations start to default on their obligations, I believe many will turn inward and reduce their US dollar reserves.

I’ll get you the numbers on the US debt situation when I have a bit more time tomorrow, but I know with 100% certainty that it’s far, far higher as a % of their economy. And if you take out CONSUMPTION, which accounts for nearly 70% of what the governement numbers report as their “economy” the numbers are absolutely staggering. I’ll also touch on your statement that inflation has been kept in check after past bailouts. First of all, let me ask you something very simple that anyone can answer. Did $100,000 in the US buy you more or less goods in 1987 than in 2010? Certainly some items such as computers and electronics have evolved and come down in price, but what about groceries? Housing costs? Schooling? Health care (if you’re in the US)? I bet if you average out the numbers, you’ll see that “real” inflation is far higher than what was reported in the numbers year over year?

Your last point makes no sense at all “…the best growth opportunities are in areas that our out of favour…” So we should have invested in US textile companies, betamax, large video rental store chains, and print only newspaper companies? Buy low sell high right? Problem is, often when you buy low, it goes even lower. The trend is often your friend, yet you must see further than the trend and stay the course when it reverses. Look to where the fundamentals haven’t changed and invest your money there. The real next bubble forming is the US Carry trade and treasuries. I don’t see how anyone can say that commodities are in a bubble when they’re still WAY off of their all time highs?!

My point is that your view is the trendy view. I have literally heard your viewpoint probably 100 times in the last year – almost word for word. That means your viewpoint is built into current prices.

For example, my personal opinion is that the price of gold already discounts double-digit inflation – which is extremely unlikely. If inflation rises but to less than double-digit, then gold will likely fall.

Millions of investors throughout the world have known for several years about the growth of China & India and how that will impact commodities. That is probably already priced into current prices.

I’m also a big believer in checking facts with numbers. You say that high spending has always led to inflation. When did that happen? Not in the last 30 years. The bailouts of 1987, 1998 and 2002 did not cause inflation. In 1974, inflation was already rising for other reasons.

There are powerful forces that have kept inflation low for the last 15 years that all remain in place – globalization, free trade and technology – and the demographic effect of aging baby boomers is still coming. Plus, all the central banks are committed to keeping inflation low. Belief that inflation will rise sharply is everywhere, yet I see inflation above 3% as extremely unlikely. It would mean that all the world central banks are unable to control it.

Also, I ran a correlation analysis and the common belief that gold is correlated to inflation is false. Gold has consistently fallen during times of higher inflation and is strongly negatively correlated to inflation. Gold is a purely speculative vehicle. It has risen when inflation is low and there is speculation of high inflation, but it falls during actual inflation, since the speculation of higher inflation is not there.

US debt is not out of control. It is back up to where it was 15 years ago (% of their economy) and about 1/2 of what it was in the 1940s at the end of WWII. Our view is that the US growth will be stronger than expected (not hard because expectations are low), the debt will come under control – and the speculation of rampant inflation and commodity prices will turn out to be grossly exaggerated.

Bottom line – the best growth opportunities are always in the areas that are out of favour, where future growth is not already built into current prices. Each boom is different. The tech boom of 1995-99 was replaced by the commodities boom of 2002-7. The next boom will likely be something else?

Following the herd will not let you see the new trends or the next boom.

Ed

We have different view. Commodities was the place to be and people tend to always think trends will continue, but taking a long term view of investing and looking for value is what works.

In the short term, who knows what will happen, but the global and US markets are only just over 1/2 recovered, so there is a lot more room to recover. Investing now is still relatively cheap (especially if you look for the undervalued sectors that have not recovered much yet).

If you think long term instead of short term, investment choices become far more clear.

In general, our fund managers are seeing far more value in many areas other than commodities – health care, some financials, technology, emerging markets (other than China) and other out-of-favour sectors offer more long term growth potential.

Mostly, it is the momentum-based fund managers and amateur investors that are buying commodities now, while value managers are finding more value in other areas.

Ed

If gold was at $500 and you were arguing grounds for a rise to $600, your argument may hold some water. But virtually every argument for gold rising contains no concrete valuation methods – just arguments on why it should rise forever.

Past returns are always higher for any sector in a bubble. The recent price rise or the bubble high in 1980 don’t tell us anything about where the price will go.

Gold is only a PERCEIVED store of wealth. There is no actual tie, since it can’t be converted to actual currency, will never be currency again, and we have hundreds of years of supplies above ground today. If people stop perceiving it as a store of wealth – which will happen as soon as the price falls – then it is no longer a store of wealth.

There is huge risk in gold, since it is purely a speculative plan. Last time it rose like this, it plunged 43% in 2 months and took 30 years to recover. That is definitely a possible scenario again.

My basic point is that gold is highly speculative and is unsuitable for a leverage portfolio such as the Smith Manoeuvre. If you really believe in gold and are an extremely aggressive investor, then a 3-5% allocation should be the maximum.

Ed

Thanks for the suggestion but a comparison over the past 15 years or so of my net RSP portfolio (professionally managed) and the price of gold shows a pretty significant variation (in favor of gold).
The books I’ve been reading (”Austrian” school of economics) suggest the similarities between the current and previous US government interference in the economy and the so called ‘dirty thirties’ is very similar.
Gold has been a safe haven for value, and the basis of value in the US money supply up until 1971. Since then the government has found the printing press to be much to easy a solution to the problem of buying votes or belt tightening…they have out done themselves and all previous historical increases in the past couple of years with bailouts of various companies that are ‘too big to fail’, but should have.
These days BIG money can be created with the click of a few keys, no printing presses needed. With no ties to ‘real’ relatively rare things (i.e. gold, silver), it is too easy to take the easy road to re-election.

Unfortunately, the global currency is the US dollar held in reserve by most nations, I’m afraid they/we are going to find they have made a mistake.