First Quarter 2011

As I write this, investors are digesting the news that our economy went backwards in the first quarter of 2011. Although this was no surprise, with the floods and cyclones ravaging domestic primary and mining production, the negative 1.2% figure for the quarter was worse than most expected. On the global scene, bad weather and the Japanese earthquake have seen a general slowdown in the global recovery. This  has lead to skittish markets "shooting first and asking questions later", as stock markets generally react with an immediate risk-off approach that is typical of the low conviction  and short terms we've seen over the last few months.

While no one really knows the future, for what it's worth, from communicating daily with our 41 investment professionals at this firm and other market participants (all with different views), I can't say it's time to head for the exits.

This month, an investor talking to me about hoarding gold bullion and staying clear of growth assets asked me why I currently have a more positive view. Essentially asking if I am simply a blind optimist? 

Economies, countries and indeed, companies and investments, will only grow in the future if the pre-conditions for that growth actually appear in the future. I use the term "pre-conditions" because, from an investor’s point of view, if you want to buy undervalued assets, you need to proactively spot these conditions before they are a commonly held belief.  While this sounds quite self evident, it's an important concept. Houses prices and stock markets don't just go up "because they always do". US house prices, which are weak and falling; and, the Japanese share market, still not back to it's 1986 high; are key examples that markets can, and will, overshoot. Did US house prices in 2006 have the "pre-conditions" to keep growing at historically ridiculous growth rates? In this case, no one was willing to ask the question in the greed feeds on greed money go round that developed. 

To make a judgement on the pre-conditions, you have to think like an investor and look at the underlying forces in your current portfolios to make an intelligent assessment.

The US still has some powerful tailwinds with low interest rates; the QE2 liquidity; a low dollar; and, as we've also seen over the last six weeks, a defacto further easing with US two year treasuries falling 35 basis points to 0.45% and 10 year treasuries falling 60 basis points to 3%. Equity market valuations don't look stretched, with overall strong and re-built balance sheets and high dividend yields. Locally our economy looks like bouncing strongly, with many stocks priced for a much more negative outcome. In the REITs sector, balance sheets are now strong and yields also look attractive.  

I don't know whether my long winded answer altered the emotional fear in that particular investor’s eyes, but at least he said he would think more like an investor rather than a media consumer.