Tuesday, May 24, 2011

All the same old fears

Inflation is coming and the economic growth in the BRIC countries will stall. Europe's debt crisis is back on the front page, including a volcanic eruption in Iceland. The latter is sure to bring down the world economy if the other fears don't. We have been hearing this stuff now for some years; do you really believe that this has not been discounted in the stock market?

Ladies and gentlemen, may I re-introduce to you the Wall of Worry. Yes we had a great run from Mar 2009 until today along with some interruptions or minuscule corrections. Yes inflation is on the increase, in particular in China where it hit close to 5% - Wow!

Dow Jones and TSX over last 3 years. Sourced from GlobeinvestorGold

 Compare that to the 1970s when inflation in North America exceeded 10%. I guess everything is relative. In the meantime the Chinese and other BRIC governments have combatted the threat of inflation for nearly 2 years now and later in the year inflation is expected to peak along with decreased GDP growth. So now that we reach the point where we see some of the effects of these government efforts, we're worried that world economic growth collapses. If you believe the pundits, things always seem to be too hot or too cold and never just right!

I am not saying that one has to see the world through rose coloured glasses. But neither should we panic when we go through a period of profit taking. To some degree, as pointed out in earlier posts, all this worrying is reassuring because we are definitely not in a state of blind euphoria. After the positive earnings reports of the most recent quarter gave us enough confidence in the recovery and with no new news coming out, it is time again to worry about the Europeans, just like last year. Morgan Stanley feels we have already had enough of a correction in oil and other commodity prices and it is time for $130 oil.

Well, I don't know whether they're right and neither do I know whether the stock markets will fall no further. I do notice though that over the last number of weeks, a fair number of companies are priced at quite attractive levels and I am on the war path again. My cash levels are around 15% and it is itching as coins in the pockets of a little boy in the candy store. But itching is not the same as buying and there is still a lot of risk in the market.

Basically, I still focus on the short term parking of my cash in preferred shares which, especially on an after tax basis, pay a lot more than GICs or savings accounts. Don't buy perpetual preferreds or bonds with fixed rates – inflation is likely to pick up over the coming years and that will erode the value of those instruments. But preferred shares that expire in 2 or 3 years and that trade well below par while paying good dividend yields look yummy! Avoid companies that are not of blue chip quality. You want to be sure that they're around when their preferreds are due.

Oh, and don't invest in those European financial institutions. The risk is too high right now and Canadian Banks, although not stellar performers this year, are a lot safer. I still expect a significant upturn this coming fall, so be prepared to buy some finger licking equities when you come across it while maintaining a comfortable cash cushion (10-15%).

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