|
Portfolio strategy update
David Gottstein
Editor’s Note: The following portfolio update is from David Gottstein’s monthly Dynamic Research Group’s newsletter. It was compiled in early July. CURRENT MARKET NEWS Interest rates and the market
Usually it holds true that the longer the term to maturity of a debt instrument, the higher the interest rate. In a rational world where one deserves more when one gives up more, giving up the right to spend oneís own money as one sees fit until a debt is paid off has a value. Longer maturity securities add value not only through time value, but also through credit risk.
So why is it that 10-year note rates have been hovering at or above the 30-year treasury bond rate?
We think there are two factors at work here. First, the government is limiting supply of the long bond. This has created an imbalance due to distortions in institutionally driven demand and the continuation of decades of investment psychology momentum.
Eventually the market will need to reward itself for time and credit, and the 30-year bond, even though not as plentiful, should trade at rational levels.
Second, and more important for stock investors, is that we think the market is telling us that higher short-term interest rates will slow the economy enough to curb the prospects for inflation. We think the Fed will now take a wait-and-see attitude as to economic growth and employment levels.
The harder question for investors will be to determine how it will impact earnings. Of course, it will be different sector by sector. Housing has slowed, and so has the enthusiasm for retail.
Certain technology issues continue to shine, albeit selectively. The bottom line is that we still have high expectations priced into the market. With interest rates in the clear for the time being, it is earnings that will rule the day. The new world oil order Saudi Arabia is a patient oil master. With control of the faucet that can either flood or starve the world of oil, it is keenly aware of its need to maximize revenue over the next 100 years.
Maintenance of the monarchy depends on this. It pumped enough oil to drop West Texas crude to near $10 a barrel several years ago, forcing discipline on other OPEC members and maintaining the world’s addiction to oil.
Meanwhile, with some exceptions, the world economies have grown. From Southeast Asia to North America and Europe, we are all consuming more oil.
We can thank all those sport utility vehicles we Americans have grown to love for increased consumption. The result is that there is a renewal of growing demand that continues to outstrip supply. Only if the world economies, and especially the U.S., go into a recession does OPEC run the risk of losing its supply discipline.
We believe that because these high oil prices are a blessing to money-starved OPEC members, more order will be maintained this time, and oil will likely trade between $25-$32 for the next year or so. In an odd way, this may even help the Fed by causing the economy to slow down, perhaps with the cost of some temporary inflation. As long as oil prices don’t continue to rise, a new trans-global economic balance and order will be in place.
The world according to DCM: As we have said previously, Alan Greenspan won’t stop until he tones down the party. Ultimately, that means slower corporate earnings growth for most companies and possibly more negative earnings surprises.
We think the market will experience significant volatility, trading within a range through the end of the year, but will not make significant progress on a broad basis.
The economy continues to be strong, but money supply is down, as are fund flows and consumer confidence. These, factored in with higher short-term rates and robust valuations, augur for a challenging time for the indexes.
We are maintaining a 10 percent cash position and will look for more oil-sector issues when we can get them at a value.
Good luck this month.
| 