Strategic and Tactical Allocation for 2011

We all know that in financial Investments :  “The rear view window is much clearer than the front view”  and

“Hindsight is always 20/20 (perfect)”

Moreover, we would like to state emphatically that  :

"Strategy (not Tactics) will determine long- lasting success", and

"Investments should be approached with the planning involved in a marathon race and not as sprint event".

Year 2010 ended on a very positive note. December provided an excellent Santa Claus rally of about 8%.  Since the July lows the US market appreciated by about 28 %. Moreover, since the March 2009 lows the recovery in the US indices has now surpassed 85%. Patient strategic investors were happy to enjoy the spectacular rallies!

At the start of year 2011, Emerging Markets continue as  the world’s engine of  growth and the US consumer has again  assumed a leadership role in aggregate demand. Europe is fighting its most serious existential crisis. Major problems are rippling the old continent : the level of sovereign debts, possible failures and debt  haircuts, the needed creation of a major supranational fund (EFSF) and special funds   for  national  bailouts, the possibility of fiscal federalism, the survival of the euro and  the issues of ultimate cohesion of the EU. These problems are formidable and a potential source of major disturbances. They should be seriously considered in the allocation process and in the investment strategies.

On previous reports we have dealt among other issues with the following major topics :

a) The possible end of the free market system and  the need for governments in extreme situations to engage in Stabilizing intervention.

b) The creative and dynamic aspect of business reflected in the higher long-term returns of the stock markets over fixed Income returns reserved for lenders.

c) The relative valuations of various asset classes at different points in time. Our last presentation was in the September  2010 bullish report.

Regarding the above mentioned topics, we are happy to acknowledge:

a)        The stabilization rather than the destruction of the capitalistic system ( even the TARP program proved profitable for taxpayers).

b)    The extremely strong stock market recovery (as forecasted in the end 2008 Report of the regression of stock market returns to their mean).

c)    The continuing rally following our September report on relative valuations.

Historically, we enjoy the higher relative performance of the of NR & Cie SA all Equity Model Portfolio over the indices by a wide margin for a period of twelve years. In an attempt to self evaluate our efforts we can identify some positive and negative periods,

On the one hand, we have to accept that we did not predict the 2008 catastrophe due to the real estate collapse, excessive leveraging and the tremendous policy mistakes .The latter have to include government sponsored financing of real estate (Fannie Mae ,Freddie  Mac etc), lack of regulations, a protracted period of low interest rates, the Lehman bankruptcy  and the  initial political rejection of TARP.  During this period the western financial system almost collapsed and markets moved away from the widest trading range. The professional pessimists that monopolized the media had finally their day under the sun but paid their dues during the spectacular recovery by remaining stubbornly short.

On the other hand, we remain proud of being able to predict and protect ourselves during the years following the 1999-2000 extreme valuations and internet bubble Moreover, with nationalistic sadness, we acknowledge our predictions of the Greek stock market collapse in the early part of the decade and the recent Public Debt crisis, the possibility of default and the stock and bond market disasters.

We have repeatedly stressed that Strategic Allocation is the key determinant of portfolio performance. The proper selection of asset classes,  geographical distributions, currency prospects, investment styles and even of sectors are the major concerns. Moreover, it is extremely important to follow a disciplined approach adding to stocks after serious corrections and /or improvements in fundamentals.

Our Strategic  and Tactical views for 2011  can be summarized as follows :

Overweight : Equities

Overweight : selected residential real estate

Underweight :   Bonds and cash

It is evident that the exact proportions should be determined by the specific attitudes towards risk.

Attempting to become more detailed in the specific asset classes we would make at this point the following recommendations    :

Equities : Emphasize Large cap ,emerging markets, value (over growth), dividend yield, exposure to Asia, the consumer, technology and  energy sectors

Bonds : reduce government ,maintain selected  corporate and emerging markets.

Real estate : examine buying  selected German and  US residential with high rental yields

Commodities : cautious on gold which we consider as  an evolving bubble. Look at industrial metals and on agricultural on weakness.

Currencies : Sell euro on rallies, beware of the expensive CHF, accumulate currencies of selected emerging countries and   of countries with strong performance in their Balance on current account and in their Public Finances.

The simultaneous appreciation of stocks, bonds and commodities should not continue after the initial phase of the recovery cycle. stocks and Bonds can move in tandem when interest rates fall. Gold had an amazing and surprising performance despite the fears of deflation as it was used for hedging against errors in judgment in the deflation scenario and as a protection to the possibility financial chaos. At this point,, deflation is not the major issue anymore and with our forecast of relatively mild inflation gold appears overbought due to excessive hedging. Finally, as earnings and growth rebound stocks should outperform bonds.

There is no doubt that valuations in January 2011 are somewhat stretched and that on the technical side the rally has not experienced any serious correction for at least six months. Moreover, a correction is possible as bullishness is the prevailing mood. Indeed, three years in succession of positive returns are not common in stock market history .The old questions of when, from which level and how much will the markets correct come to the surface.

However, in the medium term expansionary policies associated with the third year of the political cycle have traditionally been very positive for the stock market. Finally, on the fundamental side, strong  Earnings (above $93 for the S and P, or a P/E of 13.5 at 1290) and the low interest rates associated QE might provide one of the best opportunities to invest in leading large cap equities since WWII.

For every investor, the outcome of the long term investment success is equally important as his/her primary business . We lived the painful experience for equity returns of the worst possible decade ever and the disastrous year 2008 . However, the resumption of superior equity performance will continue after the spectacular initial return of the two preceding years. Long term success in investments will be determined by clear thinking, the decisiveness, consistency and the willingness to be exposed to risk.

Best Wishes and Best Luck to all !