Don Coxe – Investment Recommendations (March 2011)

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The March edition of Donald Coxe’s Basic Points research report (subtitled “Slouching towards stagflation”) has just been published. His investment recommendations, as summarized in the document, are listed in the paragraphs below, but I do recommend you also read the full report at the bottom of the post. (Also note that Donald’s weekly webcasts can be accessed from the sidebar of the Investment Postcards site.)

1.     In global equity portfolios, cease underweighting Japan and move to above market weight, emphasizing the great global brands.

2.     The fall of the Harper-led Conservative government in Ottawa is a reason for concern for global investors if a minority Liberal government relying on a coalition with the NDP or Bloc Quebecois were to take its place. The best outcome for investors – and for Canadians – would be a majority government.

3.     The outbreak of revolutions across the south of the Mediterranean took investors’ minds off the problems on the northern shores, and the euro climbed from $1.30 to $1.42. However, the challenges facing the northern tier of the sea are far from resolved. Portugal’s Socrates drank the political hemlock, but his resignation may well make the situation worse. Greece’s situation is deteriorating rapidly, and Spain’s cajas’ finances continue to erode, weakening banks inside and outside Spain.

Italy faces the return of its historic poisonous political merry-go-round if Berlusconi’s record run ends. He is, in essence, an arresting actor with the bella figura charm that Italians love; yes, he is a laughing stock in many quarters, but he has been able to sustain for a record time the theatrical illusion of making Italy look governable. His successors will probably not provoke laughter. But the convention of commedia dell’arte is that when the laughter stops, the tears begin… and the euro will go back on the critical list.

Underweight European financial institutions and euro-denominated debt in global portfolios. Emphasize exposure to Swiss francs and Canadian dollars.

4.     Investors should prepare for the strong possibility that nearly all the good news from the Arab revolutions has already come. No one foresaw these dramatic developments. We suspect that, in the intoxicating atmosphere of the collapse of autocracies, few investors are preparing themselves for the strong possibility of a succession of disappointing – or outright tragic – outcomes. Revolutions, as history teaches, devour their children. Precious metals had been strong for a decade before the Maghreb awoke. Remarkably, they have risen only modestly since then. When the risks across a great swathe of the world turn from modest to serious, and the potential for existential risk goes from near-zero to moderate, precious metals’ basic values become more apparent. Overweight precious metals in commodity stock portfolios, and include exposure in all balanced portfolios.

5.     Agricultural stocks remain the commodities group with the best balance of risk and reward among all the possible outcomes of the current crises in the Mediterranean region and the Arabian Peninsula. Even without the possible effects of global cooling, food and fuel inflation already besets most of the world. Perhaps the only strong argument against overweighting companies oriented toward global food production is that it is so obvious.

6.     Triple-digit oil prices have returned, and pricing of oil production is becoming near-chaotic, with widening spreads in prices between sweet and sour crudes – and the day-to-day pricing of political risks. The US has been remarkably insulated from the worst of the price increases, due largely to its imports of Canadian oil sands products. The latte liberals and their friends who have sought to block US imports of “dirty Canadian oil” have suddenly become remarkably silent. Investors should overweight the oil sands companies and, for now, continue to emphasize oil and coal in North American energy portfolios. We believe that industrial clients should be hedging against the remote risk of catastrophe in the Mideast through purchase of far out-of-the money calls on crude.

7.     The US government’s Export-Import Bank is heavily invested in low-cost lending to Brazilian companies developing the deepest offshore oilfields in the Hemisphere. Obama exulted in this “cooperation” in his trip to Brazil last week. At some point, he may have to explain why he remains so obdurate against drilling deepwater off US shores, and yet is willing to let American taxpayers guarantee loans to develop Brazilian oil at much deeper depths than in the Gulf. With an election campaign now only a year away, we believe he will, within months, proclaim a cease-fire and issue licenses for big new projects. Overweight offshore companies that do not face continued litigation risk from Macondo.

8.     Cicero lamented, “The people’s memory is short” before he was garroted. The nuclear power industry wishes he were right. Memories of Three Mile Island and Chernobyl have been remarkably durable, but they were finally fading when Fukushima imploded. Continue to avoid uranium stocks.

9.     The global economic outlook which looked so promising in January has darkened. Food and fuel inflation are combining to shrink or erase consumers’ discretionary incomes. The eurozone’s internal fault lines are re-opening; big banks in Europe and the US are once again paying bonuses and dividends, but the question whether the mix of diseases gnawing at the tissues in their portfolios is merely debilitating or is potentially fatal is being questioned anew. Investors aren’t fooled: the BKX and KRE have been sharply underperforming, although financial firms accounted for nearly one-third of total US corporate profits in Q4. If the Arab revolution story turns from triumph to tragedy, much of the investor optimism that fueled strong equity markets outside Japan could fade fast.

10.  Base metals stand to benefit near-term from the rebuilding of Japan, but thereafter we expect scrap to compete with virgin metal as the recovery continues. Weakening economic prospects from emerging economies beset with food and fuel inflation and, at the margin, from the OECD, will trim previously-expected strong demand for copper and steel. Underweight base metal stocks.

11. Just because Stagflation of Seventies proportions is only a remote possibility doesn’t mean that meaningful stagflation-style damage won’t be inflicted on bond portfolios – particularly those denominated in currencies of grossly overindebted countries. We think the risk of a real stagflationary bond bear has now arrived, and have therefore reduced recommended bond durations. Unless the stagflation risk recedes, we shall be reducing those durations further in coming months. So should you.

Coxe Basic Points March 2011

Source: Scribd, March 2011.

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