Prepare your portfolio for a wild ride

Significant challenges facing the world capital markets in the years to come will necessitate an active management style to avoid the potential disaster should investors one day come to the conclusion that many governments of the world are bankrupt. Gold and other hard assets will likely perform well for years and our new natural resources portfolio will serve to capture that upside potential for investors. But, as we saw in the second quarter, there will be periods where despite the longer-term trends in these sectors being bullish, we will see cyclical periods of weakness.

On the positive side, earnings growth is still good in most sectors of the economy. In a large part because interest rates are so low and companies are cutting costs at a break-neck pace. That is one reason why unemployment levels are stubbornly higher than in past economic downturns.

Every company that might miss earnings in the second quarter is likely to blame the Japanese tsunami tragedy and for the most part, investors will likely buy it. It might take a few more months of soft retail sales and manufacturing data along with weak employment from the U.S. to convince investors it is more than temporary.  

On an earnings basis, global stock markets have reasonable upside from here (fair value based on 5 year regression 13x $110 =$1430), but that is, of course, tempered by the persistent risks to the global economy.

We are not bearish on the world like some, as we generally feel we’ll get through it, but a few scars can be expected. Over the next 5-10 years, there will likely be many shifts and shocks to the World economy that will occur within the context of increased volatility. This period will be more similar to 1960s and 1970s than the 80’s or 90’s, but make no mistake there are decent returns to be made in actively trading the cycles.

 The key is staying on top of the changes, allocating assets to the right places, and in the shorter term (day-to-day and month-to-month) managing risk and volatility. The market environment necessitates that investors be increasingly nimble and avoid at least some of the most adverse risks to come.

We can envision a period at some point in the next few years where people realize that government debt is not as safe as the low, risk-free rates are telling us. What is happening in Europe right now is only a small taste. If the US policy makers make some mistakes, which is highly probable, then emerging markets growth will not be enough to save us from another Lehman like credit shock where banks stop trusting one another and interbank lending freezes up.