Vector Money Management

August 19, 2010

Mid-August Outlook and Portfolio Design

Filed under: Market Comments,Outlook — vector @ 2:29 pm

The financial markets continue to struggle with what we consider to be irregular conditions – record low interest rates, record high gold prices, record government borrowing, record government spending and a 9.5% unemployment rate.  At times like these, it is crucial to understand, as best you can, the real situation and not default to a standard plan developed for more normal conditions.  The real situation, as we see it, is that the U.S. economy is slowly recovering from the financial crisis of 2007-08, a crisis caused by a gross misallocation of capital into residential and commercial real estate.  The reaction of government policy makers from both parties has been to focus on minimizing failure – from the largest organization to the individual home owner.  The unintended consequence of their (often ad hoc) actions has been to create an unusual and unproductive policy mix (monetary, fiscal and regulatory) that is severely limiting the expansion of the economy during this recovery period.  With little foreseeable change in the current predicament, we have focused our “portfolio design” process on sectors, industries and companies that stand to benefit from opportunities outside the U.S. where economic growth is much more robust.

 On the Defensive Side:  This is the most challenging period we can recall when it comes to preserving capital while also generating a reasonable return.  There is a growing debate over whether Inflation or Deflation is a bigger risk.  Both can wreak havoc on investment portfolios, so the issue is a crucial one for investors.  We have focused on and studied the issue for a long time and it is our considered opinion that Inflation is the much more likely outcome of the current policy mix and, thus, rates as the more serious risk for investors.  The U.S. Treasury Department and the Federal Reserve have run a weak dollar policy for almost ten years and there is no indication that they will adopt a strong dollar policy any time soon.  It is no coincidence that during this weak dollar decade the Periodic Table of Elements (metal commodities) has easily outperformed the S&P 500 Index.  For these reasons, our portfolio design continues to include a significant weighting in natural resource related companies.  A weak dollar is a tail wind for the businesses of these companies, so they provide some hedge against the risk of rising inflation in the months and years ahead.

   Continuous Assessment: The upcoming election on November 2nd could very well shake up the policy mix coming from Washington, especially in the fiscal and regulatory arenas.  More certainty on the issue of future tax rates could be an important catalyst to putting some of the $2 trillion on corporate balance sheets to work in the U.S. economy.  The latent potential of the American entrepreneur should not be underestimated.

 If you have any questions or feedback please let us know. 

 Ashby Foote