Best Investments For 2011

Commodities, “BEE” markets; “BEEs” stands for “Big Emerging Economies.” and Multinational Stocks Are Best Investments For 2011

[Editor’s Note: This is the first installment of a two-part interview with Money Morning Chief Investment Strategist Keith Fitz-Gerald, during which the investing veteran explores the state of the U.S. economy, stock market and commodities prices. The second part appears tomorrow (Friday).]

The U.S. recovery will continue this year, and U.S. stocks will continue to advance, though investors can expect whipsaw trading patterns and must beware of the point when the U.S. Federal Reserve ends the cheap-money mindset that’s fueling the advances, says Money Morning Chief Investment Strategist Keith Fitz-Gerald.

But uncertainty also brings opportunity, and Fitz-Gerald sees tremendous profit potential for those who are willing to remain invested – and who have the courage to make opportune choices. Commodities of all types, so-called “BEE” (Big Emerging Economy) markets and the stocks of companies that derive a major portion of their sales from these fast-growing overseas economies should be on everyone’s investment menu.

And don’t ignore multinational stocks from your own backyard: While it might surprise many investors to discover this, many U.S.-based companies are major players abroad, Fitz-Gerald says.

“I see the markets generally rising until mid-2011, which is when the reality of stimulus spending, the looming budget battle and fiscal follies set in. I believe that 15% is not out of the question, though not all in a straight line and not all at once,” says Fitz-Gerald, a former professional trade advisor and best-selling author who is a regular contributor to Money Morning.

In a wide-ranging interview with Money Morning Executive Editor William Patalon III, Fitz-Gerald assessed the health of the U.S. and global economies, provided his outlook for the U.S. stock market, and for commodity prices, and even offered a fix-it plan that Washington would do well to take note of.

Here are the highlights of that two-part interview. Part II – which includes Fitz-Gerald’s fix-it plan for the U.S. economy – appears tomorrow (Friday).

Money Morning (Q): There’s that old adage: “May you live in interesting times.” 2010 was certainly interesting – and surprising. What’s been the biggest surprise for you over the past year?

Keith Fitz-Gerald: Interesting choice of words Bill. Few people understand that they were actually meant as a curse in ancient China. And while we’ve managed as a country to avoid paying for our excesses so far, the bill could come due for payment at any time.

I remain completely stunned by the hubris I see all around me. The notion that the government (and our leaders) can artificially manage our economy is completely preposterous. And I find the notion that our government somehow knew how to spend $14.1 trillion of our money better than we do absurd.

Yet, that is the reality we are dealing with right now, so we – as investors – would do well to profit from it.

If you look back to late last year, U.S. stocks have been on a torrid winning streak. Do you see that continuing? If so, why? If not, obviously, why not? What are the key factors here? What are the wild cards that investors need to be aware of?

Fitz-Gerald: I see the markets generally rising until mid-2011, which is when the reality of stimulus spending, the looming budget battle and fiscal follies set in. I believe that 15% is not out of the question, though not all in a straight line and not all at once.

Having said that, I’m a little concerned that “everybody” is waiting for a pullback that hasn’t happened. But the bottom line is that, for right now, I don’t think it’s wise to “fight the tape.”

As for wildcards, there are a few, with the three chief ones being:

* Potential policy changes in the U.S. government that potentially end the “all gain/no pain” philosophy we’ve seen to date.

* The ongoing European Union (EU) banking crisis that even now is a long way from over.

* And China – it’s imperative that we learn to dance with the dragon, rather than risk being eaten for dinner.

How does the U.S. economy look to you? Where is it strong? What are its weaknesses? Where are we six months from now? Twelve months? Three years?

Fitz-Gerald: I think the U.S. economy remains fundamentally flawed, despite the fact that we are several years into a “recovery.” If the government’s spending multiplier really worked, we should be screaming along at 8% or more.

Instead, the bulk of companies are still reporting strong earnings and gains that are based on a combination of cost-cutting and bottom-line growth, while our real estate markets remain mired in a historic funk, with our lenders paralyzed and our consumers shell-shocked. Many remain out of work on top of all that.

I think it’s very telling that the sales growth that has occurred, interestingly enough, remains largely concentrated in overseas markets. And that speaks to something I talk about incessantly – namely that our own recovery and that gains that we are seeing here are, in reality, being driven by economies and economic events taking place thousands of miles from our own shores.

Just look at Detroit. U.S. carmakers are not doing anything brilliant, yet everybody thinks they’re in fine form. That’s great when you consider that most of their sales are coming from overseas, and from China in particular. The newly public General Motors Co. (NYSE: GM) sells more cars there than here. McDonald’s Corp. (NYSE: MCD) fits the same profile, and derives 70% of its sales from overseas markets. The same is true for Caterpillar Inc. (NYSE: CAT).

I could go on, but you no doubt get my point: You need to hold multinational stocks. And here’s an interesting thought to consider – with some of these U.S. multinational companies, their U.S. operations may actually be holding them back!

That’s why research from Bespoke Investment Group (BIG) and other shops like them shows something startling – stocks of diversified U.S. companies with overseas sales outperformed those that rely solely on U.S. operations.

People often ask me how this is possible. Here’s the answer: As much as 40% of the earnings posted by Standard & Poor’s 500 Index come from overseas markets. The consumer discretionary spending, which everybody is screaming about and which accounts for 70% of our economic growth, actually only comprises about 15% of the S&P 500’s earnings. And that’s the disconnect.

The moral of the story is this: The activity we’re seeing in the U.S. stock market is being largely driven by two things: a) the Fed’s actions and b) overseas growth.

And that will remain true for some time to come.

(Q): Europe continues to grab the headlines: What’s your outlook for Europe? For the euro currency? How could this outlook affect the rest of the global economy?

Fitz-Gerald: I think the EU’s banking situation is a lot worse than is being let on and may, in fact, be the single biggest risk to the world’s financial system today. Don’t forget that the euro is the result of a political union not an economic one which is why the economic realities now testing it are so harsh. That having been said, China has stepped in to stabilize the EU but how long they’ll play ball or how much it’ll cost remains to be seen. I said early on in this crisis that we may be witnessing the end of the euro and I see nothing now that would cause me to rethink that even though it may take awhile to materialize.

(Q): What’s your outlook for inflation? How will that affect U.S. Federal Reserve policy, and interest rates?

Fitz-Gerald: Officially, inflation is a non-issue at least if you believe the Fed. However, if you eat, drive, buy medicine, pay for insurance or do anything remotely resembling the rest of us, you know this is complete poppycock. Not only is inflation already here, but the inflation rate is running at 9% or more a year, according to my back-of-the-envelope calculations.

As for Fed policy … well, as long as the central bank wants cheap money, it’s going to do everything it can to keep rates low, because this is how it’s subsidizing things – with low payments at low interest rates. If the Fed suddenly raised rates, inflation would “officially” jump, and that would kick up cost-of-living increases while re-chambering everything from credit card rates to mortgage payments.

The Fed’s in a real pickle. Even though this is exactly what needs to happen. Team Bernanke can’t avoid reality forever.

(Q): Following that question about inflation, what do you see for commodities? Which ones do you like? What should investors avoid? How about gold and silver? As you know, those continue to be the-most-asked-about investments/informational topics here at Money Morning.

Fitz-Gerald: History suggests that we are still a long way from the end of a commodity run. There will be pullbacks for sure, but against the context of a failed fiat currency system worldwide – and the inflationary concerns associated with the immense pile of debt we’re accumulating worldwide – the trend for commodity prices is much higher.

I see gold, for example, at $2,500 an ounce, and most metals doubling within a few years. Part of that is going to be because the world views commodities as a hedge. Part of that is going to be because individuals love metals and always have for personal reasons – weddings, rings, etc.

But the lion’s share of that is going to be because entire nations, such as China and India, and many of the major trading houses, are hedging their bets with something they perceive as an alternative currency, not a commodity.

Here’s the thing. Despite what you see on the late-night TV commercials, gold has never been an inflation hedge. But it has been a great crisis hedge. And that’s really what’s at stake here. Add in the fact that much of the world now views gold as a “proxy currency,” and you can easily understand why prices will head higher.

The other thing to consider is that commodities are a twofold play. First, if things go to hell in a hand basket, chances are commodities will hold their value better than other choices. Second, if things work out okay, history shows demand will pick up and prices will escalate many times over, as well.

Either way, you absolutely want to have commodities as part of your portfolio.

(Q): I’d also like to ask – separately – about your expectations for oil prices. I don’t think Money Morning readers will soon forget the “call” you made three years ago, predicting mid-$100 oil prices at a point when crude was trendless and trading in the $90-a-barrel range.

Fitz-Gerald: Thanks for remembering. I believe that we’re going to see oil at $100 a barrel a lot sooner than we’re going to see it at $70, for example. And I’m expecting $5-a-gallon gasoline by 2012, which implies a per-barrel price of at least $175.

Like other resources that are in hot demand worldwide, this is not rocket science at this point. Nobody, for instance, in their right minds debates “peak oil” anymore, as they did only a few years ago. The question now is “when” – not “if.” We’re still burning more oil than we’re finding and alternative energy, despite huge progress on a variety of fronts, remains a long way off, practically speaking. I think most investors want to own – for lack of a better term – a “continuum” of energy investments … which stretches from the oil-and-coal fossil fuels, reaches all the way to solar power, and includes everything in between.

(Q): Let’s move onto a topic for which you’re known to be virtually without peer: China. What’s your six-month-to-12-month outlook for China – not just in terms of actual growth projections or predictions for stocks, but also in terms of what you expect to see develop … or what news you expect to come out of … that key global giant.

Fitz-Gerald: Again Bill, thanks for the kind words. I’ve been closely involved with Asian markets for more than 20 years, so at this point I ought to know at least a little about what goes on there.

I expect growth of 9% to 10% in 2011. Factor in the 10 trillion yuan cash buffer outside official statistics alluded to by the recent UBS AG (NYSE: UBS) report and we could easily see another 30% in growth tacked onto my estimates.

I expect further maturation on a variety of fronts, including the sophistication of Chinese stock markets, the protection of intellectual property, and an increase in the global capital that flows there.

People – and by that, I’m mostly referring to Westerners – are fearful of Chinese inflation and that’s not to be ignored. But let’s keep this in perspective: 3% inflation in a 9% economy is hardly the problem it is here. And don’t forget that the Chinese are tapping on the brakes, while we’re stimulating growth. Those are very different scenarios.

Washington is in for a very rude awakening when as it begins to cope with the stark reality that China, with $2.8 trillion in reserves, is increasingly calling its own shots.

On the other hand, major international companies, including many in the S&P 500, already understand this new reality, which is why they’re spending huge amounts of money to stake their claim in China. Those companies understand that the Red Dragon is arguably the last untapped bastion of consumer wealth on the planet.

One final thought: I expect one or more Western companies to take the plunge this year and list on either the Shanghai or Shenzhen stock exchanges as a means of tapping into the fast-growing pool of Chinese capital fueled by a middle class that’s some 330 million strong.

(Q): Understanding that this is a short Q&A, and that we’re only providing an overview of your thoughts, I know investors will still appreciate a bit of “what’s the bottom line here” with regards to your current outlook and strategies. What advice would you give to investors right here ? What sectors do you like, or types of stocks do you like?

You always put interesting – and useful – wrinkles into your strategies … for instance, before the market collapsed two years ago you spotted the risks and put investors in our affiliated trading services into “inverse funds,” which offset losses and actually preserved profits when those indices fell. What advice of that type would you provide investors with right now? What else should investors be looking to include?

Fitz-Gerald: Again, thanks for remembering that. I work very hard to stay ahead of the game with both my thinking and my recommendations. Here’s my current view from 30,000 feet :
• The U.S. economic recovery is real, even if the means used to stimulate it are foolish beyond imagination. It will not be smooth and there will be fits and starts around the world, but the overall trend is up, to the tune of 2.75% growth here in the United States, and 4.0% globally.
• The best choices, bar none, are multinational stocks – the shares of large, multinational companies with real businesses, real cash flow and real exposure to overseas markets – particularly those in Asia, with an emphasis on China. It may surprise you to discover that many of these companies are actually listed on the Big Board (NYSE). This insight should actually provide U.S. investors with some comfort if they’re not yet ready to brave the wilds in markets they haven’t visited, or invest in companies whose names they can’t pronounce.
• The risks associated with not being “overweighted” in these stocks is very real and will determine the difference between enjoying your golden years, or spending those golden years working under the Golden Arches . Yes, the United States and EU will recover eventually, but the question is how much money you’re going to leave on the table. Few people realize just how staggering an “opportunity cost” this will be … but they will find out. And not the hard way if I have anything to say about it.
• The best markets are the “BEE” markets; “BEEs” stands for “Big Emerging Economies.” Forget the BRICs and the PIGS. Obviously there are overlaps – China being one that’s especially worthy of note – but the financial characteristics associated with the concentration of wealth in the BEEs are directly correlated to stock market returns. Remember the old axiom … “he who has the gold makes the rules” … and right now that’s not us. As a case in point, consider this: Emerging-market economies currently sit on nearly 75% of the world’s currency reserves.
• Energy, infrastructure and the cyclical industries related to them are all solid bets, because they are demand driven. I’m leery of U.S. and European discretionary choices because they could be easy victims of changes in government policies or changes in consumer fortunes.
• You’ve got to plan on inflation sensitivity. I’m not smart enough to figure out when it will hit in earnest. But as I pointed out earlier, inflation is already here if we look at it from a practical standpoint. And there’s no excuse for not protecting your portfolio. Not now.
• Near -term, I’d like to see a pullback, if for no other reason than we’re overdue. Barring somebody deciding that the bill is due, I think that will be a buying opportunity for the right stocks connected with the right markets
• Money will continue to migrate from the “nanny states” to those that are backed by real growth and that are poised to become their own best customers – a la the BEEs.

(Q): Lastly, what do you think will be the biggest surprise to investors this year; by that, I’m talking about during the 12 months to come. What’s the biggest possible wildcard? What do investors need to be the most careful about?

Fitz-Gerald: People cannot take this bull market for granted, but I think the markets will be much stronger than people imagine and for reasons most don’t expect (as we’ve demonstrated here).

I also think that the single biggest challenge most investors will face this year is staying invested. There are bear tracks everywhere and it’s easy to get spooked.

Finally, prepare yourself for a market that’s going to remind you of a Saturday night barn dance – with one step forward … followed by two steps back.

By Fitz Gerald-

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