Basic materials have been the “biggest loser” of an asset class for 2012 as well as thus far in 2013. Everything tangible, from gold and copper to coal and steel, has acquired an “ick” factor that makes the asset class nearly uninvestable. Shares of companies in these categories are trading at values not seen since 2009 market lows. We are beginning to see some very important developments that might make the group more palatable. In fact, we believe that metals, mining and energy could again become Wall Street darlings.
We have been bullish on equities for some time and we continue to think they will outperform. We think higher rates are inevitable and that a good defense is what is needed for bond investors. We have never been “gold bugs,” but we do believe that adding to an allocation of resources is very prudent. It won’t make you popular at cocktail parties, but it might make you some money.
Our outlook for the U.S. economy is good and getting better.Trends in consumer confidence, employment and housing will continue, and may likely accelerate. Equity markets trading at fresh highs is a forward-looking barometer that would confirm our position that economic activity as well as profits will be up in the second half of 2013.
The Fed continues to pledge long-term, ultra-easy monetary policy.This consists of both a zero interest rate policy as well as asset purchases (quantitative easing/QE). The Fed has been resolute in their desire to spur job growth as well as create modest inflation expectations. Rising inflation expectations is generally correlated with higher interest rates. As the U.S. economy expands so will the demand for credit. We have not seen a general increase in the demand for credit, but we have heard more optimism from regional banks than at any other time in the last five years. Higher demand for credit will provide a lift for interest rates.
We would argue that the rise in interest rates since the Fed’s latest news conference (June 19, 2013) is the market sensing an end to QE. We believe this is also supportive of our thesis that the second half of 2013 will be much better for the economy than market consensus. A more sharply pitched yield curve tends to coincide with economic growth.
Global central banks also feeling emboldened to be U.S. Fed copycats are now shifting toward actively fighting deflation with asset purchases and record-low interest rates. History has shown that when these policies are pursued long enough, inflation will eventually be the result. We believe that Asian equity markets are in the process of bottoming and will respond to economic stimulus. We think this is the start of a new “leg up.” China is currently the unpopular choice, but likely the correct choice.
Equities have a lot of room to continue their move up.Markets are no longer “cheap,” but not overvalued based on historic ranges. The public is still not in the markets as risk aversion has dictated underweighting in equities. Lack of returns in the bond markets makes this avenue untenable. Recent bond market volatility caused record redemptions in June from bond funds. We believe those funds are just the beginning of the public shifting into equities.
Is it time to kick the “ick” factor in energy and resources?We tend to look for value in areas that have been overlooked by the markets. In this case, there are parts of this market that has been left for dead; these areas are energy and basic materials. Energy and basic materials have been sold off to levels not seen since the last market low in 2009. The slowing in China has decreased demand for these assets and Wall Street has disowned the entire group. Even the gold trade has gone bad after a decade of outperformance. We hesitate to agree with current valuations and find ourselves interested in more and more of these names.
Recent insider buying in companies like Freeport McMoran (FCX), Key Energy (KEG) and US Steel (X) shows us that their management believes equities are attractive and feel the future may not be as dim as the market. Even beaten down names like Walter Energy (WLT) have seen cluster buying by insiders. Insiders tend to be early, but their buying can often predict an upturn in prospects for a company, or an industry.
Easy money begets inflation. Inflation favors basic resources.We think that ultra-easy monetary policy by global central banks aimed at stimulating economic growth and raising inflation expectations will favor the demand for metals and resources. Remember, a building boom in the United States is just beginning. Expanding economies expand demand for commodities and resources. If you don’t believe in fighting the Fed, then we think you would want to allocate funds to this area even though at present you are greatly in the minority.
Conclusion –We are constructive on the U.S. economy accelerating growth in the second half of 2013. We would position ourselves for higher interest rates and believe that record stimulus will indeed produce higher inflation expectations. Higher inflation expectations and global growth should bode well for energy and basic materials. Recent, widespread insider buying across the sectors tends to validate our position. Thus, in our opinion, it is time that the “ick” should be removed and money put to work in the group.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosureswebpage for additional risk information.
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