Worrying Top Down

Recently read a few books on investing. After a month of thinking and reflection, I’ve repositioned my family to reflect my current conviction. There are great uncertainties ahead of us. The following consideration to risks and its tradeoff has great impact on my portfolio allocation for the family and stock picks decision.

1. Inflation vs. Deflation – Over the next decade, are we entering a period of inflation or deflation

? Different asset classes behave differently under these two scenarios (e.g. long dated bonds, commodities, equities, etc).

Two different point of view is presented by two astute investors (Gary Shilling vs. Howard Marks):

a. On deflation, see Gary Shilling and his book, the http://www.forbes.com/2011/02/04/gary-shilling-deleveraging-china-treasuries-intelligent-investing-video.html

10 investments to buy (Gary Shilling – Deflation View)
• Treasury and other high-quality bonds – Shilling says he has been a 30-year Treasury bull since 1981. The “bond rally of a lifetime” is going to continue as deleveraging causes deflation.
• Income-producing securities and dividend payers – There won’t be much growth, so you might as well collect dividends.
• Food and other consumer staples – Consumer discretionary spending is getting whacked, but people still need to buy bread and socks.
• Small luxuries – People want to spend money on something. Shilling says items like snakeskin tote bags, five-blade razors and designer jeans could be the new type of conspicuous consumption, taking the place of big ticket items like sports cars.
• The US Dollar – With Europe and Japan drowning in debt and emerging markets verging on a crash, the dollar is going to start looking pretty good. Shilling says the dollar will remain the world’s currency, with no real competition from gold or the yuan. Meanwhile, America will be mired in deflation.
• Investment managers and financial planners
• Factory-built houses and rental apartments – Cheap small homes are the order of the day, as old people look for a cheap retirement spot and young people look for a small mortgage. Renting will be a more and more popular strategy.
• Health care companies – As America ages, the health care industry seems unstoppable.
• Productivity enhancers – Anything that helps juice bottom lines will do well in the new era. This includes consulting groups, computers, internet, biotech and telecom.
• North American energy – Shilling is bullish on deepwater drilling and natural gas, as well as coal and nuclear.

b. On inflation, see Howard Marks’ notes to investor (http://www.oaktreecapital.com/Memos/Tell_Me_Im_Wrong_01_22_10.pdf)

Investments to buy (Howard Marks – Inflation View)
“From today’s levels, I think rates are more likely to go up than down (there’s so little room for the latter).”
What to do about them? The list of possibilities is long:
• Buy TIPS.
• Buy floating rate debt.
• Buy gold (but only at the “right” price, and what’s that?)
• Buy real assets, such as commodities, oil and real estate (ditto).
• Buy foreign currencies.
• Make investments denominated in foreign currencies.
• Buy the securities of companies that will be able to pass on increased costs.
• Buy the securities of companies that own commodities, or that own assets denominated in foreign currencies.
• Buy the securities of companies that earn their profits outside the U.S.
• Hold cash (to invest once interest rates have risen).
• Sell long-term bonds (and possibly go short).


2. Stocks Valuation: Are stocks in general expensive or cheap? Using PE as a proxy see Robert Shiller and Jeremy Siegel debate this on cnbc.



3. SGD versus major currencies, in particular, the USD. As a balanced portfolio, I will unavoidably have exposure to USD and other major currencies. Yet there are costs to hedging, and also timing and size of hedge will have an impact on the portfolio.

4. The importance of cash

In November 2010, Jeremy Grantham commented that
“The Fed is driving the S&P [500], which is overpriced … driving it from already substantially overpriced into what I would call dangerously overpriced,” Grantham told CNBC in a lengthy interview. “It wants us to go out there and buy stocks, which are overpriced because bonds they have manipulated into being even less attractive. So, we’re being forced to choose between two overpriced assets. That is not always a terrific choice to make because there is a third choice, and that is don’t play the game and hold money in cash.”

See interview here: http://video.cnbc.com/gallery/?video=1640401359