By Michael Lewitt, Editor, The HCM Market Letter

It is fair to say that 2010 was an extremely difficult year in which to handicap the financial markets. Despite an extremely disappointing economic recovery, the equity and fixed income markets have performed extremely well and have correlated very strongly

The correlation is starting to break down a bit, although the schizophrenic nature of the equity market sometimes makes it difficult to determine where it is going to trade on a particular day. In general, stocks remain more attractive than bonds, but that reminds us of the adage that “in the kingdom of the blind, the one-eyed man is king.”

Despite the fact that such respected observers as ISI Group (from 2.0 percent to 3.0 percent) and Goldman Sachs (from 2.0 percent to 2.7 percent) are increasing their U.S. GDP projections for 2011, their expected growth rates remain far below what one would normally expect in the wake of a recession as steep as the one that we experienced. The reason for this is that the detritus of debt still hangs around the neck of the U.S. economy and acts as an enormous counterweight to growth.

HCM does not like to make short-term recommendations, but we understand that we are in a short-term oriented world and that readers like actionable ideas. Accordingly, we will provide some short-term guidance before outlining some longer-term suggestions.*

Short-Term Investment Recommendations

  • In the near-term, we continue to believe that corporate bank loans remain a very attractive asset class for investors looking for reasonable returns and relatively low risk. Bank loans offer a return in the high single digits and are floating rate instruments that protect investors from interest rate volatility. Our two favorite ways to play the bank loan market are not bank loan mutual funds (known as “Prime Funds”) but two stocks: KKR Financial Holdings LLC (KFN) and Tetragon Financial Group Ltd. (TFG1).
  • While HCM always prefers investments that provide a current yield, there is a reason why so many fixed income investments do not provide a current yield today – the wrong-headed policies of the world’s central banks. That is why dividend-paying stocks that offer appreciation potential are far more attractive than corporate bonds, which are trading at increasingly tight spreads. Mutual funds or ETFs that focus on large cap dividend paying stocks are a good investment today.
  • BP plc (BP) stock is very cheap (and will likely resume paying a dividend in the first quarter of 2011), and Chesapeake Energy Corporation (CHK) is significantly undervalued at its current price of about $22.00/share.
  • On the short-term macro front, I recommend that investors short the Euro against the dollar and even more against Asian currencies such as the Singapore dollar. The Euro should suffer continued weakness as the European sovereign debt crisis unfolds. The Euro can be shorted against the dollar through two leveraged ETFs, EUO and DRR.

Long-Term Investment Recommendations
 

  • Everyone should keep buying gold because central banks and governments keep debauching their currencies. Investments should be in the form of physical gold but the gold ETF (GLD) is also an easy way to gain exposure. Gold mining stocks are a far less effective way to gain exposure to gold since the investment is diluted by all of the issues involved in the company.
  • The dollar is a long-term short, particularly against Asian currencies (my favorite remains the Singapore dollar) and the Swiss franc. As noted above, the dollar is a long against the Euro as the Federal Reserve and the European Central Bank compete for the title of Chief Currency Debaucher.
  • Treasuries (and investment grade bonds and other fixed income instruments that track Treasuries) remain a long-term short because global investors will sooner or later demand a higher return for lending to the U.S. government as long as it refuses to get its fiscal house in order. Treasuries can move either way in the short-term, which is why I am not making any short-term recommendation regarding them.
  • At some point – and that point is a few years off, but not infinity – there will be massive inflation as a result of the unprecedented monetization exercises being undertaken by the world’s central banks. For that reason, hard assets such as real estate, art, agricultural land, and precious gems are attractive for wealthy investors looking to protect their long-term wealth.

* (Readers should assume that Michael Lewitt and accounts managed by Harch Capital Management, LLC have positions in these securities that are consistent with these recommendations.)

(Reprinted with permission from the HCM Market Letter)