Annual Asset Class Review January 5, 2009 Featured Trades: (VIX), ($BVSP), (RSX), ($BSE), (FXI), ($KOSPI), (TBT), (JNK), (PHB), (HYG), (COPPER),(FCX), (CHK), ($XEU) After the annus horriblus of 2008, I thought it would be a good time to review the major asset classes and suggest reallocations. Equities: UP The collapse of the volatility index (VIX) is telling us that the horrific, gut churning, 10% daily moves are over. But equities are no longer a US play. Extracting the insane leverage of the last decade means chopping the US growth rate down from a booming 5% to an anemic 2%. This is not a strong argument to buy American companies, which is why most analysts only see the indexes recovering 10%-20% this year. You might just get tedious range trading after the late 2008 dead cat bounce. The real action will be in the BRIC countries, which will see upside returns double what you will get with the S&P 500. Buy Brazil's Bovespa ($BVSP), Russia's RSX (RSX), India's Bombay Sensex ($BSE), and China's FXI (FXI) or Hang Seng. And it may be time to spell BRIC with a 'K' by throwing in the Korean Kospi ($KOSPI) as a sweetener.

Bonds: Treasuries Down, Private Debt Up. As I have been vociferously arguing in these pages for months, US Treasury bonds are witnessing the final stages of an overinflated bubble, and you don't want to be anywhere near this asset class when it bursts. Take out the flight to quality and year end balance sheet window dressing bid from this market, and you have an accident begging to happen. Take in the long term inflationary impact of Obama's plans, and you have a 30 year contract which peaked at 142 last week that is really only worth 70. It's just a matter of time before massive government issuance buries largely foreign buyers. Throw in the 50:1 leverage offered by a long bond futures contract, and the profit potential of a short position is so enormous, there are not enough zeros on my calculator to total it up. Buy the Lehman 20 year plus ultrashort bond ETF (TBT). Unfreezing of the debt markets will move the prices for every other type of debt off of their current throw away levels. Buy corporates of every grade with a heavy weighting in junk, or fixed income securities backed by REIT's, emerging markets, credit cards, student loans, or subprime loans. A convenient way to do this is to buy the ETF's for the Lehman High Yield Bond Fund (JNK), the PS Corporate High Yield Bond Fund (PHB), and the iShares iBoxx Fund (HYG).

Commodities: UP

After giving up almost all of their 21st century gains, virtually all commodities, including grains, softs, energies, and metals, are due for a recovery. A good part of the sell off resulted from the disappearance of financing, which is now slowly working its way back into the market. Now that newbie investors who never should have been involved, like pension funds, have bailed on this asset class, conditions are set for some serious base building. Commodities will be the principal beneficiaries of an epochal trend away from paper assets towards hard assets that will be the dominant investment theme for the next decade. Chinese and Indians still want to raise their standard of living faster than these substances can be grown or ripped or pumped out of the ground. Now Obama is adding America to the infrastructure build out story. A safe way to play this is through beaten down, dividend yielding, producing equities like Freeport McMoran (FCX) for copper, Chesapeake Energy (CHK) for natural gas, and US Steel (X) for steel and iron ore.?? But don't expect huge gains until we see signs of a global economic recovery by the middle of the year. Then watch out.

Currencies: Dollar and Yen Down, Everything Else Up

Since we are smack dab in the middle of a six year trading range, I don't really have a handle on what the buck is going to do short term. Could we see $1.20 or $1.00 for the greenback in an event driven overshoot short term? You betcha! But longer term, the trend is still down. Obama's highly inflationary reflationary policies will eventually lead to an utter collapse in the dollar. If they are successful, the economy will recover, bringing Americans back to their old low saving, high consumption, high importing ways, adding fuel to the fire. Don't bet against the 45 year trend. Expect to pay $2.00 for a Euro in the years ahead. Take that European vacation now!

Real Estate: Down

With markets still deleveraging, and the son of subprime, the Alt-A loans, on our doorstep, real estate is dead money at best. Although the cost of carry for home ownership is rapidly approaching equivalent rental costs on an after tax basis, fewer and fewer buyers are qualifying for loans. Add 1.2 million unsold homes from builders to three million existing homes already on the market and you have a staggering 4.2 million homes for sale in the US. This is 7% of the total American housing stock. Probably 20% of US homeowners are underwater on their mortgages, and they're not buying anything anytime soon. We also have an impending crisis in commercial real estate generating lots of mall bankruptcies and empty retail space to deal with. Remember, 'debt' is a four letter word. I don't see a meaningful recovery in residential real estate for five years, and then it will be a slow claw back at best.

Global Market Comments for December 30, 2008
Featured trades: (MS), (GS), (WM), (BS), (FNM), (FRE), (AIG), ($GOLD), (WTIC)

I thought I would resend you the market forecasts I sent a year ago, in case you missed them.

1) A young black guy you never hear of, whose middle name is Hussein, will be elected President in a landslide, trouncing Hillary Clinton.

2) The Dow will crater 6,000 from the current level of 13,500 to 7,500. Economic growth will decline from a current 5% rate to minus -10% next year. After a hugely success summer Olympics, China's growth rate will collapse from 12% to zero.

3) The subprime crisis will explode, and incinerate all debt markets, driving Lehman Brothers into bankruptcy. Shareholders in Washington Mutual (WM), Bear Stearns (BS), Fannie Mae (FNM), Freddie Mac (FRE), and AIG Int. (AIG) will be wiped out. The US financial system will be nationalized.

4) Morgan Stanley (MS), now at $60, will plunge to $5, but CEO John Mack will keep his job. Goldman Sachs (GS) at $200, will drop below its $60 IPO price.

5) Yields on the best grade junk bonds will rocket to 25%. The Fed will lower the funds rate to zero and the ten year bond will trade at 2%.

6) Crude (WTIC), now at $80, will nearly double to $150, then fall off a cliff to $30. Gasoline will go from $5/gallon to 99 cents. Investors will go gaga over alternatives in the first half, then develop amnesia in the second half.

7) The dollar will end the year as the world's strongest currency.

8) The Japanese will emerge as the world's best managed banks.

9) The prices of all commodities will double in the first half of the year, and then drop by two thirds in the second half.

10) Despite all of this mayhem, the traditional safe haven of gold will drop like a stone.

Merry Christmas from the California State Hospital for the Hopelessly Insane

Global Market Comments for December 29, 2008
Featured trades: (TM), (GM)

1) Employment consultants Challenger, Gray & Christmas see the worst jobs market since the Great Depression in 2009. We have lost 732,000 jobs since November, and another one million are to go during the first half of next year. There are now 2.2 million workers who have been looking for jobs for more than six months. Financial services, housing, construction, automotive, and retail have taken the biggest hits. The bright spots are to be found in health care, education, food, and agriculture. Your next male nurse may be a retrained GM worker with calluses on his hands and a big hairy back.

2) There are 100 million cows in the US, and each one emits 4 tons of methane gas a year, from both ends. Environmentalists want to impose a carbon tax of $175 per dairy cow to slow down the global warming this is causing. If they want to charge a carbon tax on my methane output I am in big trouble.

3) I thought you would like to have the specs on your next car. The current generation of hybrid cars uses a heavy nickel metal hydride battery to get them up to 20 mph, where the gasoline engine takes over, doubling gas mileage to the 40-50 miles/gallon range. The next generation plug in hybrids will use lighter, more powerful lithium ion batteries to power the car full time for the first 40 miles, where a small gasoline engine then takes over. Cars will obtain most of their power from an overnight plug in to a standard wall outlet, which will only cost $100-$200/year in extra electricity bills. Toyota (TM) estimates that 90% of drivers won't use gasoline at all! Notoriously secretive Toyota was supposed to bring out its plug in Prius in January, but that has no doubt been delayed by the economic crisis and the cheap price of gas. And General Motors (GM) has a pipedream of launching the Volt, using similar technology, in two years.

4) Investment banks saw a record 1,309 mergers and acquisitions transactions worth $911 billion cancelled in 2008, as financing became as rare as a Mc Cain bumper sticker on a Toyota Prius. This used to be a major profit center for the industry, but is expected to make a big comeback next year.

5) The volatility index (VIX) is at last climbing off its historic, lofty levels, down from 89% to 41% since November. In case you forgot your integral calculus, take the current VIX level, divide by 16, and that gives you're the anticipated move in the index for the next 30days. So a 41% VIX presages a 55 point move up or down in the S&P 500 in January. The big question in traders' minds is: will the slow bleed in volatility continue through the holidays, until the Obama inauguration, or through all of 2009? Nuclear winter anyone?

6) San Francisco is now the third largest banking center in the US, thanks to Wells Fargo's (WFC) acquisition of Wachovia Bank. Charlotte, North Carolina is number two, thanks to the strength of Bank of America (BAC), originally another San Francisco bank. New York is still number one, but is fading fast.

7) The S&P 500 index has brought in a zero return for the past 12 years. Very bad for index funds, like Vanguard, as investors get discouraged and give up on equities. Some $200 billion has left US equity funds this quarter.

8) With sterling at $1.48 and falling fast, and the euro at $1.38, the two are rapidly approaching 1:1 parity. His would be an ideal opportunity for the pound to enter the euro bloc seamlessly. But just as the UK may enter, Italy could leave, because it can't adhere to the debt ceilings imposed by the European Central Bank. In the meantime, Germany is still obsessed with inflation. Can you blame them, being the home of Weimar era hyperflation, where it took a wheelbarrow full of paper Reich marks to buy a loaf of bread. This is the euro's first real recession, and it may not survive.

9) Banks are trying to max out their Treasury bond holdings on their balance sheets at year end to prove to investors how conservative and well managed they are. The dam will break on January 5, when bankers rush to extend loans to better quality credits to beat the heat from Washington. I suspect the bulk of this will initially be refinancings.

10) Nine out of the last ten bull markets were lead by a sharp recovery in consumer discretionary stocks. Think Home Depot (HD), Comcast (CMCSA), Best Buy (BBY), Urban Outfitters (URBN),?? American Eagle Outfitters (AEO), or for wimps, the Consumer Discretionary Select SPDR ETF (XLY).