Monday, August 04, 2008

2008 Quarter 1 Update

May 2, 2008

“If we are correct in our opinion that global growth will remain strong over the coming year then it stands to reason that many good values are being created as many babies are being thrown out with the bathwater so to speak.” Much has transpired in the financial markets since we made that statement in our January update letter to clients. The markets continued their treacherous and volatile path which ultimately led to the death of Bear Stearns as an independent company in mid-March. This announcement precipitated what could turn out to be a bottom for the domestic stock market as a crescendo of selling overwhelmed the indices. The domestic economy has continued to deteriorate while global growth has remained strong, a fact that has benefited our client portfolios to a large degree. And to that point, our thesis hasn’t changed. We believe growth in emerging countries around the world will remain strong and that is why we have continued to add to positions in companies that will benefit from this growth. While U.S. growth has come to a virtual standstill, China saw their first quarter GDP grow over 10% and India has experienced similarly large growth in its economy. A continuation of this growth will ultimately lead to elevated commodity prices and more and more demand for infrastructure build-out, all positives for our current positioning.

It’s important to note that while we are currently negative on the domestic economy, we do not believe that the U.S. is doomed to fail. As asset managers it is our job to continually look for what we believe to be the best opportunities for our clients, regardless of the current market situation. Today that opportunity clearly lies overseas and as we’ve stated before, it’s not necessary to buy foreign stocks alone in order to capitalize on this reality. So what are some of the areas we have been adding to recently? Energy is clearly at the top of that list as we believe that current prices for natural gas and oil will continue to remain high for the foreseeable future. Is it possible that oil and even natural gas prices are higher than they should be at this time? Of course it is, however with the continuing rise in emerging economies and their appetite for all things energy we believe that demand will outpace supply for a very long time. Consider the forecast recently made by Bradley George, head of global commodities and resources for Investec:

Global energy demand is expected to rise 50% over the next 25 years. In the next 10 years, China is expected to account for more than a third of growth in oil demand and the Middle East for 15%. Vehicle sales in China grew about 25% in the past year. On the supply side, there has been a drop in the number of new oilfields and yields from existing oilfields are falling.

This is excellent news for natural gas companies such as XTO Energy (XTO) and PetroHawk (HK) as well as oilfield services companies like Schlumberger (SLB). And at the risk of repeating ourselves, the demand for other commodities such as base metals will only increase as China, India and others swallow supply, making it very difficult for miners to bring enough out of the ground to sate this appetite. This will continue to boost the outlook for companies such as Freeport-McMoran (FCX), U.S. Steel (X), and Cleveland Cliffs (CLF), all of which mine and produce commodities such as copper, nickel and iron ore as well as gold.

If we sound exuberant with respect to overseas growth it’s because we are. It is extremely exciting to be able to identify and capitalize on such a profitable and emerging trend for our clients, and for that reason we are elated. We have every intention of “making hay while the sun shines” so to speak, and we believe that the sun will be shining on this complex for a long time to come. That being said, we have not neglected finding opportunities closer to home as well. Technology continues to be an attractive sector due to continued growth both in the U.S. and abroad. Companies like Research In Motion (RIMM) and Apple (AAPL) continue to post excellent results as do Microsoft (MSFT) and Google (GOOG). Healthcare also remains an attractive domestic sector and we hold positions in companies like Zimmer Holdings (ZMH) and Medco Health (MHS) for that very reason.

And just as it is important to build positions in sectors that we believe have the wind at their back, it is equally important to avoid sectors that might underperform during this difficult period in the markets. We have largely avoided sectors such as financials, real estate and retail given the poor prognosis for the U.S. consumer and the difficulties involving the ongoing credit crisis here at home. That being said, we have managed to find what we believe to be bargains in “best of breed” companies such as Goldman Sachs (GS) and Mastercard (MA). As market dynamics continue to unfold we will be watching very closely some of the aforementioned beaten down sectors for opportunity when the domestic climate begins to improve.

So what’s in store for the second quarter of 2008? While we believe that it is very likely we have seen a near term bottom in the equity markets, it is our opinion that we will experience continued volatility in the months ahead. We also believe that the spotlight will remain focused on global growth, and this bodes well for us. The cross currents here at home will continue to swirl as we debate the likelihood of a U.S. recession and it’s potential depth, the ongoing difficulty in the real estate market and the upcoming national election. It’s important to keep in mind however that the stock market is a forward looking discounting mechanism which is typically more concerned with the future than the present state of affairs. If one believes that the U.S. will slowly work its way past these overriding issues in the not too distant future then it stands to reason that the markets will begin looking past them even sooner. Barring any further shocks to the system, we believe that the financial markets are already setting themselves up to have a decent second half in 2008. While we believe that there still remains the possibility of the market stepping on a land mine or two in the coming months, it is our opinion that much of the negatives, real and potential, have made their presence known thereby increasing market participant confidence going forward. In short, we feel very good about our current position in the market and are looking forward to further success in 2008.

As always, we appreciate your continued support and welcome the opportunity to assist anyone that you may feel is in need of our help. We appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager and we look forward to working with you in the future.


Post a Comment

<< Home