Prepare For The Coming Stock Price Invasion

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Based on the discussion in my previous article (visit my blog) on biflation for the next two years, I also see a potential drag on stock prices by margin squeeze with companies unable to pass through cost increases. In this presentation, I outlined this scenario with four investment strategies.

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Prepare For The Coming Stock Price Invasion

  1. 1. Prepare For The Coming Stock Price Invasion Dian L. Chu, June 2010 Economic Forecasts & Opinions
  2. 2. Executive Summary  Macro Environment – From Biflation to a tale of two inflations – Hyperinflation & Stagflation  Employment & Wage – Meager growth next two years  Stock Price Invasion – Expect a margin squeeze to put a drag on stock prices as companies are unable to pass through the cost increase from the raw material side  Four Investment Strategies By Dian L. Chu, June 2010 2
  3. 3. Europe Debt Crisis Deepened in 2010 Chart Source: The Economist & CFR By Dian L. Chu, June 2010 3
  4. 4. Increasing Concerns of Deflation  More pronounced in Europe as spending cuts and tax increases could weigh on economic growth and feed into deflation. Chart Source: The Economist By Dian L. Chu, June 2010 4
  5. 5. Slowing Inflation in the U.S.  Consumer Prices were up 2.2% in May year- over-year  Core CPI was up just 0.9% in May, the smallest increase since 1966. By Dian L. Chu, June 2010 5
  6. 6. Goldman Consumer Price Index  [Goldman Sachs Diffusion Index] shows clearly that the disinflation since mid-2008 has a considerable amount of breadth.”  “Consumer prices are falling across a wide cross section of the economy right now.” ~ Goldman Sachs By Dian L. Chu, June 2010 6
  7. 7. Easing Inflation Expectation  The TIPS market suggests investors' longer-term inflation expectations are rising since hitting bottom in Q4 2008.  The implied annual inflation rate over the next decade now stood at around 2.03%, rising from around 1.47% a year ago, but down from 2.41% at the end of 2009. By Dian L. Chu, June 2010 7
  8. 8. Plunging Money Supply  The M3 money supply in the U.S. is contracting at a rate matching the Great Depression, also pointing to the risk of deflation By Dian L. Chu, June 2010 8
  9. 9. Commodity Prices Shot Up  The May core PPI for crude goods shot up 60% year-over-year, the fastest rate since 1974. Including energy and food costs, crude goods prices rose 21.2%. Chart Source: U.S. BLS By Dian L. Chu, June 2010 9
  10. 10. Increasing Backlog  Backlogs are rising uniformly worldwide signaling more inflationary pressure in the pipeline ISM Manufacturing Backlogs ISM Manufacturing Backlogs 65 65 60 60 55 55 50 50 45 45 40 40 35 35 30 30 25 25 20 20 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 US Japan Eurozone China Brazil India Source: IHS/Global Insight By Dian L. Chu, June 2010 10
  11. 11. The Employment Malaise  The jobless rate rose to 9.7% in May - Slow recovery from the 26-year high of 10.1% in October 2009.  The underemployment rate was 16.6% in May, still close to October’s 17.4%, a record high.  “Wage growth in the U.S. will be meager – near 2% over next two years.” ~ IHS/Global Insight Chart Source: “World Economic Outlook”, Apr. 2010, IMF By Dian L. Chu, June 2010 11
  12. 12. Consumer Confidence  “Household confidence in advanced economies continues to lag, reflecting subdued employment.” ~ IMF Source: “World Economic Outlook”, Apr. 2010, IMF By Dian L. Chu, June 2010 12
  13. 13. Most Likely Scenario  This could result in a combination of:  Pushback from end markets are strong enough to trigger price corrections directly at some of the overheated commodity level And  Companies are forced to absorb part or all of the cost increases depending on the strength of end markets By Dian L. Chu, June 2010 13
  14. 14. Biflation Through 2012  Biflation - A state of the economy where inflation and deflation occur simultaneously  Pockets of inflation seen as money flowed into certain categories such as energy and feedstock chemicals and deflation in other “non- essential” categories  Netted to a modest headline consumer inflation By Dian L. Chu, June 2010 14
  15. 15. Bad News For Many Companies  Raw material price increases begin to move down the supply chain, pushing up companies’ costs  However, end markets are still too weak to allow a full price increase  Many companies say they are reluctant to pass price increases to consumers who are still jittery from the recession  Margin Squeeze– a drag on share Chart Source: WSJ.com prices By Dian L. Chu, June 2010 15
  16. 16. Asia Leading The Growth  Real GDP growth picked up starting in Q2 2009.  However, output in most regions of the world remains below or around pre-crisis levels  The exception is emerging Asia, which accounts for a growing share of world activity.  Commodity prices have rebounded in response to expanding activity Source: “World Economic Outlook”, Apr. 2010, IMF By Dian L. Chu, June 2010 16
  17. 17. 2013 - A Tale of Two Inflations  Stagflation in developed regions such as the U.S. and Europe, where imported higher inflation from the emerging countries will likely be met with stagnant growth.  Hyperinflation in developing and emerging economies due to robust growth.  Inflation in India already reached above 10% in May, Source: “World Economic Outlook”, Apr. 2010, IMF 2010 By Dian L. Chu, June 2010 17
  18. 18. Investment Strategy # 1  Commodities via physical ETFs or mutual funds  Natural gas, copper and agriculture products look relatively undervalued right now  Stocks and/or ETFs of commodities producers  Long term play – Crude oil, oil products, and oil producers By Dian L. Chu, June 2010 18
  19. 19. Investment Strategy # 2  Pare equity holdings with heavy exposure in the U.S. and European markets, particularly the retail and consumer goods sector.  Invest in luxury brands with good exposure to emerging markets  Drug and health care sectors should still perform relatively well regardless of regions  Investors have poured $27 billion of net new money into foreign equity funds this year, while yanking $20 billion out of U.S. equity portfolios. By Dian L. Chu, June 2010 19
  20. 20. Investment Strategy # 3  Gold shines in times of inflation as well as deflation  3-5% of portfolio should be allocated to gold and other precious metals via physical holdings and/or physical ETFs By Dian L. Chu, June 2010 20
  21. 21. Investment Strategy # 4  Cash and mixture of ETFs and/or mutual funds of short and long dated bonds and TIPS  Real estate in the U.S. looks to have another leg down in the 2nd half of this year – could be a good long term opportunity in selected markets.  Real estate market in China could have a cooling off period with Beijing trying to prevent asset bubbles – Could be good entry point in the sector for a long term play By Dian L. Chu, June 2010 21
  22. 22. Prepare For The Coming Stock Price Invasion Dian L. Chu, June 2010 Economic Forecasts & Opinions

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