Equities vs Bonds....Future vs Present. Common stocks, uncommon profits.

As we await eagerly our nation's birthday tomorrow, I sit here thinking of what to write about this week. The friends that know me for years will know that I have never been a fan of the lavish affair we have come to know as National Day Parade. Even though Singapore has one of the largest foreign reserves in the world, but fact of the matter is, we do not have to burn money by firing those silly fireworks into the sky. That is why I make it a point never to watch it every year. The money can be better used to help those that really need it, rather than those capitalists that benefit from our extravagance.

From my previous post on Japanese girls, I had a few phone calls from friends on where to find that particular Japanese waitress I was referring to. I would like to take this opportunity to thank them on behalf of the pub for their patronage. After last week, I am fully convinced that Singaporean men really have a fetish for Japanese women.

Ok enough about women. I have decided to write a piece on what I think of the market. Funny thing was, I asked my colleague what he was telling his clients to buy and he basically told me, "bonds". If you remember back in March, I wrote a post on how the greatest bond manager of all time, Bill Gross was predicting that the 30 year bull market for bonds was coming to an end. I do believe he is right and it was kind of worrying that an industry veteran like my colleague was selling bonds like hot cakes. Too much hot cakes may lead to a laxative effect for anyone. Too much of anything is never a good thing.

Here are the reasons why I am bearish on bonds.

1) Companies have never been so indebted before.

According to the Federal Reserve, non financial firms borrowed another $289 billion in the first quarter of 2010, taking their total domestic debts to $7.2 trillion, the highest level ever. That's up by $1.1 trillion since the first quarter of 2007; it's twice the level seen in the late 1990s.

The debt repayments made during the financial crisis were brief and minimal: tiny amounts, totaling about $100 billion, in the second and fourth quarters of 2009.

Remember that these are the debts for the non financials -- the part of the economy that's supposed to be in better shape.

Central bank and Commerce Department data reveal that gross domestic debts of non financial corporations now amount to 50% of GDP. That's a postwar record. In 1945, it was just 20%. Even at the credit-bubble peaks in the late 1980s and 2005-06, it was only around 45%.

2) Interest rates have never been so low.

SIBOR has not been this low in 17 years. Money market rates are only at 0.5%. Fed funds rate are close to zero, 3 month Libor stands at 0.44%, Euribor at 0.905% etc. Basically, what this means is that cash is not doing much for any investor. With interest rates so low, the upside for bonds are not going to be attractive enough for me to recommend to investors to buy.

3) Inflation is coming soon.

Last week, my old boss called me up and asked how he should get exposure to soft commodities like wheat, coffee and other agri products. I told him he can use stocks, funds or even structured notes. But the key here is, he is a 20 year veteran who is very astute. I do understand where he is coming from because soft commodities unlike hard commodities are less elastic in demand. Daily necessities tend to be things which we do not mind paying more for (of course we would still curse and swear) and nothing we can do about higher prices because of our consumption habits.

Wheat prices have gone on a ballistic move upwards, thanks to the fears of famine in Russia. Putin banning all wheat exports out of Russia was a radical move, but the fears of shortage is a very real one. Coffee, pork bellies etc all flying upwards, so do cherish your cappuccinos or even those free espressos which your company provides for you at the pantry because prices are all going to rise over the next few weeks. Cornflakes lovers beware, your Special K's are all going to cost more per box.

With wages in China rising, manufacturers are all scrambling to raise wages for their workers before they all start leaving for greener pastures or jumping off from the rooftops of their factories. Interest rates will be pressurised to rise as inflation starts to rear its ugly head.

So bonds are a big no no for me.

Now for equities.

Global markets look really much stronger over the past month and Europe's worries have taken a backseat as earnings season continued to impress investors. So far most of the blue chip companies have outperformed expectations and they have shown that they are still able to grow their profits in the face of the jobless recovery of the global economy.

Recent weeks, the hottest sector has been the shipping sector as earnings have rebounded and trade has picked up globally. The problem is whether it is sustainable or not. The Baltic dry index has suffered during the May and June sell down but is starting to show signs of a turnaround. If it can rebound meaningfully, we should be increasing our exposure on shipping going forward.



Technology stocks have also done very well, especially for the poor contract manufacturers that have suffered for the past 2 years. I think the market is going to continue finding more reasons to push these stocks up. Imagine, the Ipad has been sold out for the past couple of weeks. When was the last time an electronic device sold so well that there was a shortage? Who said the consumers are no longer spending?

Emerging markets continue to deliver strong growth. There is little risk of the EM countries going into a double dip scenario unless China overdoes its cooling policies but it is pretty clear that the tightening measures are more or less done and going forward, the Chinese government is going to focus on managing growth at a sustainable rate and focus on sectors that will bring about more jobs and improve the living standard of the 2nd and 3rd tier provinces.

Russia is facing food problems in the short term but oil and commodities continue to be strong thus their economy is on good stead. Brazil is in a world of its own and being the largest sugar producer and leading producer of many other soft commodities like spices and coffee beans makes it a main beneficiary of the soft commodities boom.

India is starting to look good because inflation should be tapering off. Their market has been held back by their inflationary situation but it seems like their interest rate hikes have done the job in curbing inflation and the country is back on its right track.

Singapore just announced its GDP grew 17.9% for 1H2010. We are probably going to grow faster than China and Indonesia this year and maybe only slower than Qatar out of 183 economies globally. Impressive? I think so. Sustainable? Not likely. But we do have new growth drivers in place, that is why I am a big fan of the Singapore market because I think it deserves to be re-rated. Malaysia is my favorite too, personally I am looking to start a pure Malaysian portfolio. That will probably happen soon.

USA and Europe are still going to struggle with their growth numbers. The US registered 2.6% growth for 1H2010, some may say its a reasonable number for a country as large and developed as itself. The problem is, this growth is stimulus assisted, take away the stimulus, it will probably be registering low or no growth. This is what worries the whole world, what happens when stimulus is used up. Job creation is back in negative territory for the month of July but I believe there is a silver lining to the report as the private sector showed some improvement in terms of job creation while the main drag was the public sector. In an economic situation like this, the government sector has done its job in picking up the slack, now we need to see the private sector do its part. So I believe down the road, we need to focus on the private sector over the next few months.



Europe on the other hand will be announcing GDP numbers over the next week. With Germany, France and UK expected to expand more than expected in 2Q2010, growth seems to be recovering for the major economies of Europe, while I do not expect the PIGS countries to show much improvement. As I have pointed out before, the PIGS are just peripheral countries and does not make much of a difference for the Eurozone. However, the Eurozone central bank and governments better not be over zealous in raising interest rates or impose more austerity measures across the board.

Recently, there have been many stories covering PIMCO's venture into the equities business, showing their faith in equities going into the New Normal. When the largest bond fund manager decides to go into equities, its a sign to us that bonds may be a thing of the past and equities is going to have a brighter future.

I am a firm believer of equities and the market's current momentum looks strong. Remember what I said over the past couple of months when the markets were getting hammered? It is not the end of the run for equities, its just a usual correction. Buy on dips going forward and you will be rewarded. Fortune favors the brave. That's what I always believe in.

Have a good national day ahead! But do not bother with the fireworks because burning money will never be a habit of mine. I do hope one day, we learn how to respect the poor and contribute more to their well being rather than to waste money on glorifying ourselves once a year. I have said my piece and am going to have a good rest tomorrow by studying more stocks. Have a good trading week ahead!

Best,

SVI