The current correction in commodity stocks is instructive. Just as I cautioned in the past two issues of Perspectives, commodity stocks across the board have posted a meaningful correction, typically falling between 10% and 15% from their end of January highs. There are surprises: in some areas (most notably energy) energy, the correction lasted only as few days, while in others (like the base metals) it’s shallow and looks more like consolidation than correction. Increasingly, it’s becoming apparent that supplies of raw materials will be in a fairly chronic supply squeeze, unless global economic growth takes an unexpected and major hit. This doesn’t mean that there won’t be inventory buildups from time to time, but with supply elasticity low and demand growth escalating, such bulges will be mere squiggles on the periphery of the big trend. Which isn’t keeping some influential Wall Street figures from repeating their mantra that commodity stocks are at dangerous, near-bubble prices. Are they really? Let’s take a brief look at history. In 1980, when commodity prices reached their last peak, mining and energy shares together made up 35% of the market capitalization of the S&P500. Twenty-two years later, after a brutal bear market, they accounted for less than 5% of the index. Now, after three-and-a-half years of advancing, the mining and energy complex is back to 10% of the S&P500. There is no telling how high the peak will be this time, but it seems apparent that the bull still has a long way to go. Not only are commodity stocks very underrepresented in most portfolios, but valuations are reasonable. Many of the top quality energy and mining stocks trade at less than 10 times expected 2006 earnings. Try and find those kinds of multiples in the consumer stocks arena, one of the economy’s most tired and mature sectors! What should you do about all this? It depends on your time frame. The March to May period is typically one of weakness in the commodity stock arena, which means that the consolidation phase could still have a while to run. If less than 25% of your equity portfolio is in commodity related stocks, I suggest you use the coming days and weeks to position yourself.
China and globalization are again being vilified, as the US mid-term elections approach. And most of what’s being said is nonsense. To begin with, there is little point in debating the merits and drawbacks of globalization-the point is that outsourcing and other manifestations of globalization will not go away. The simply are. Yes, the US is losing lots of manufacturing jobs, but importantly, it still experiences net job creation. And yes, China and others are able to export huge volumes of goods and services to the developed world, totally as a result of their low labor costs. But look some of the brighter aspects. Globalization creates the formation of middle classes and advances educational opportunities in many emerging nations, which means that the world economy will in time be augmented by hundreds of millions of new consumers. Also, dramatic economic disparities have in the past been sorted out by the ravages of war; globalization gives us the hope that in the future they may more often be sorted out via trade. Finally, let’s consider what US legislators would face if it weren’t for the new riches of China and others. Who, after all, would buy all those bonds an increasingly indebted Washington needs to sell?
THE BOND BUBBLE
China and globalization are again being vilified, as the US mid-term elections approach. “There’s complacency in this market and that’s dangerous,” say the people at Bridgewater Associates and I agree. As I’ve said in Perspectives on numerous occasions, the fundamentals for the US bond market and US dollar are rapidly deteriorating, but investor sentiment does not reflect it. The result: a major setback is in the cards. It may manifest itself in a dramatic correction or in a steady, protracted decline.
Peter Cavelti’s background as a financial analyst and author spans 35 years and four continents. His grasp of global issues is extraordinary and his comments and books have been published internationally. He was president of Canada’s Guardian Trust and subsequently owned his own firm, which managed some of the best-performing natural resource mutual funds. Peter firmly believes that only an integrated understanding of geopolitical, demographic and economic events can lead to successful investing, and that is what his web service Perspectives is about. If you feel keeping on top of relevant global events takes too much time, Perspectives is for you. Whether it’s investment advice or political analysis, Peter offers his insights in concise and easy-to-read form. Best of all, Perspectives is free. Visit www.cavelti.com and sign up today!