Tuesday, January 08, 2008

2008 Predictions and Investment Plan, Part II

Here's part II of my outlook for 2008. Before getting to it, I want to mention a post of mine made at the end of October Where to hide now? where I opined that utilities was a good place to be. Indeed, XLU has continued its bullish uptrend, bouncing off its rising 50 dma. It was one of the few green sectors last Friday. Just for reference, Barron's had a piece about a month ago which featured prognostications from strategists of all the big Wall St. firms. Utilities was the sector receiving the most negative votes. Amusing, isn't it?

Emerging markets
Emerging markets had a terrific 2007, gaining some 36% per the MSCI index. They have performed so consistently that for a while they were even touted as a “safe haven” play, decoupled from the slow-down in US. That thesis may be true someday. One can even argue it’s becoming truer every day, but it’s simply not the case today. To appreciate this point, one needs to look no further than the surprise contraction of Singapore’s GDP last quarter.

The ratio chart of EEM:SPY displays a prominent double top that argues for a more severe drop in EEM given its historically high beta. [Disclosure: I own some EEM puts since the end of last year.] So “decouple” may not a valid concept, but since this weakness originated from the US rather than the other way around, I expect a quick recovery in emerging markets as the global growth story is mostly intact. In short, I’m far more likely to treat the coming storm as a buying opportunity for emerging markets than domestic markets.

The one emerging market I commented most heavily on was the Shanghai market which was one of the top gainers last year at +96%. It has been in a correction since October. Early on the concerns were, in descending order, Chinese inflation and monetary tightening, the premium of A shares over H shares and the need for them to converge as China opens its currency controls, and finally a US led global slow-down. While the third reason is sure to gain prominence, historically the Shanghai market has had a low correction with the US. Technically, the $SSEC has managed to climb back above its 50 dma which is always a sign of strength. Fundamentally, I think the second half outlook is bright as inflationary pressures will abate due to the strength in the RMB and lower food price inflation (from increased pork output and easier YoY comparisons). My prediction: If the $SSEC can get above its high of 6124, it’ll reach 8000-10000 before its bubblicious nature finally catches up to it.

Russia seems to be on every pundit’s favorite list for 2008, and I won’t go against the grain here. As far as I’m concerned, the political situation is a plus as it depresses valuations. Now that Putin remains firmly in charge, there will be stability for the foreseeable future, however unpalatable that stability may seem to Western observers. I already have some exposure through TREMX, but if I were to use a fund, my preference would be the Market Vectors Russia ETF, RSX, unless there are compelling discounts in the closed-end funds TRF, RNE or CEE.

Finally, in 2008 I plan to look into the so called frontier markets – countries with young capital markets that heretofore not easily accessible. TRAMX and the Vietnam fund (VTOPF.PK) are the candidates.

Contrary to my dour look on US stocks, I see nothing but blue skies for precious metals (For a detailed projection on PM stocks, please see my earlier post). In short, 2008 may see the repeat of 2001-2002 where equities and gold went separate ways. Three years ago, a price target of $1000/oz for gold would have brought gasps, but today it’s so commonplace that repeating it here smacks of timidity. However, it’s still an important milestone and I’ll concentrate more on the timing.

From the chart above, I’m expecting the millennium mark to be reached by June which somewhat jives with my prediction for an HUI peak in May. This is all assuming the current up leg will be similar to the one from May ’05 to May ’06, even though the current wave is unfolding at a slower pace. I do expect gold to finish ’08 higher and I’ll leave that prediction till the millennium mark is actually reached. [This section was written during the last weekend, before today's ~$19 jump in gold.]

Action plan: Go after it aggressively early in the year, beware of a top in May, selling gold to buy financials then may well be the trade of the year.

2007 was a bumper year for any agricultural commodities and related equities. This theme has been featured throughout this blog, and if I have any regret, it’s that I hadn’t taken a bigger position. I continue this trend to continue. Magazine covers such as the end of cheap food from the Economist are just starting to bring this sector to the attention of the masses. Although it could temporarily be a contrarian topping sign, I predict the trend will continue much like the energy story. Their tremendous rise since November was in part due to investors’ desire to delay profit-taking until the New Year – a tendency that I took advantage of a year ago with FXI options. In addition to the agricultural commodities ETF, DBA, some names were floated in an earlier blog entry and its comments section. The Market Vectors Agbusiness ETF with the apt ticker symbol, MOO, is another conveniently way to play this sector. I’m managing some money for my mother-in-law and MOO is on the to-buy list.

So those are my plans. Wish everyone a prosperous 2008!