How Much Higher Can The Bull Go? - The AIA Advocate Newsletter

In This Issue:

How Much Higher Can The Bull Go?

Predictions About The Economy Are All Over The Map

Several Threats To Growth Are Worrisome

Food And Energy Are Good Bets Now

The Bottom Line

Since our last newsletter in February, the stock market continued to rise. During the first part of the month it looked as if the rally was stalling because stocks remained fairly flat. Then on March 13, the market found its second wind and got back on the escalator. By the time the clock ran out for the period, the Dow and the Nasdaq were up 1.6% and 5.5% respectively.

The latest spurt added to a rally that had already delivered impressive gains. From its beginning on October 3, 2011, the two indices rose 23.9% and 33.6%. The current leg up that began on December 20, accounted for 9.0% and 19.8% of the move.

How Much Higher Can The Bull Go?

The big question now, of course, is how much life does the bull have left? The short answer is, nobody can know for sure. However, stock fundamentals suggest that the market could rise another 10%.

After such a long advance, we think stocks are overdue for a correction. After any run-up, many investors will usually decide to take some of their profits off the table. Once the decline begins, other investors who were thinking about doing the same thing will join the crowd, and the correction will feed on itself.

In addition, if anything happens that makes investors think they were too optimistic about the economy and corporate earnings, stocks will move back down until their prices reflect the revised outlook. Unlike the more sedate move up, a corrective decline can be quite rapid.

Predictions About The Economy Are All Over The Map

Right now, the outlook for the economy and earnings is mixed. Mr. Bernanke at the Fed has been warning that growth may slow down in the coming months. He believes the spurt that we are seeing now is due to companies rebuilding their inventories, and is not the result of a significant increase in consumer spending. The Fed chief is worried enough about the economy that he said he would start another round of monetary easing if it seems necessary.

Many corporations are also flashing caution lights. Earnings have been strong in recent months, but company spokesmen are projecting lower returns as the year progresses. They point to the impact of the recession in Europe, slowing growth in China, and some weakness in the global economy. Higher energy prices are also a concern.

On the other side of the picture we have former U.S. Treasury secretary, Lawrence Summers. In a March 26 op-ed article in the Financial Times, he argued that job growth is now staying ahead of population growth, which means the unemployment rate should ease down. He also noted that consumers are starting to buy the cars and durable goods that they put off during the recession.

In addition, Mr. Summers pointed to strong growth in mobile information technology, social networking, and the domestic oil and natural gas industries. He also believes (as we do) that the housing market seems to be stabilizing.

From our perspective, we think Mr. Summers is more likely than Mr. Bernanke to be correct about the economy. In our travels around the country we are finding an improving mood among most Americans. People are not buying many homes but they are renovating and expanding the houses they already own. Most people are also dressing better, which indicates they must be spending more at the mall than the Fed's numbers (that are always about 3 months behind) indicate. All in all, we think the US economy will do better this year than many people expect.

Several Threats To Growth Are Worrisome

Nevertheless, there are some serious problems in the world that could end the economic upturn.

The biggest threat is higher oil prices. As you may painfully recall, in 2007-2008 when oil rose from about $100 a barrel to $147, it sucked so much money out of the economy that the economic downturn turned into the Great Recession. To be sure, there were other factors that contributed to the severe decline, but expensive energy was the trigger.

Today, oil is already $125 a barrel so it would not take a very big shock to push the price into the danger zone. An attack on Iran would almost certainly do the trick. If Iran retaliates by shutting the Strait of Hormuz where 20% of the world’s oil supply travels, the price could go to $200, and perhaps a lot more.

The sovereign debt crisis in Europe could also spin out of control. If Greece can’t be saved, most analysts think that Portugal, and perhaps Spain, could be next. In that case, the European economy would almost certainly plummet. Since Europe buys about 20% of America's exports, our economy would also suffer a blow.

Fortunately, the Europeans have been building financial firewalls around Greece, so the risk of a domino effect is lower than it was a few months ago.

On the positive side, if the threats to growth can be eliminated, or at least reduced, stock prices will probably shoot up. A diplomatic solution to the Iranian nuclear controversy, or encouraging news about the sovereign crisis in Europe, could easily fuel another strong upturn for the bull.

Food And Energy Are Good Bets Now

Whenever the outlook is uncertain, smart investors look for stocks that can do well even if the economy doesn’t. Two sectors that fit the bill are food and energy.

Bunge Ltd. (BG) looks especially attractive to us. The company is a global food processor with a particular emphasis on soybeans, for which the company has become the world’s largest dealer. The company also deals in grains, sugar, bioenergy, and fertilizer. The mix of businesses owned by Bunge is an excellent match for the rising agricultural and energy demands we expect to see over the next few years.

We think the company’s soybean business is especially promising. Soy is a high protein product used to raise meat and poultry for people in developing countries who can afford better diets. Soy is also the main ingredient in many food products that provide protein more directly to the table. In addition, soybeans provide oils for commercial customers in dozens of industries.

Soy oil is also the main ingredient of the most efficient biofuel. In fact, Rudolf Diesel developed his namesake engine in 1893 to run on soy oil that farmers could produce themselves. Bunge is also the third largest producer of fuel-grade ethanol in Brazil. As petroleum products become more expensive, the demand for biofuels should increase significantly.

Not surprisingly, the world’s most populous nations are becoming major soybean users. China now relies on imports for 80% of its soy products and expects to increase its purchases by more than 50% by 2020. India is also starting to use more soy products.

The demand for soybeans is expanding so rapidly, last year Bunge joined forces with SEACOR Holdings (CKH) to construct a large export terminal on the Mississippi River in Illinois. The new terminal will give Bunge low-cost access to the largest soybean customers in the world.

Bunge appears to be a timely acquisition. Rising costs cut into fourth quarter earnings but the company’s profit topped forecasts, and revenue soared on strong grain and other volume. Although the stock is up from its recent lows, we think it has further to go.

Sasol (SSL) also appears very attractive to us now. The company is the world's largest and most advanced producer of synthetic gasoline, diesel, and jet fuel that it produces from low grade coal and natural gas.

Sasol’s natural gas-to-liquids business is especially promising. Because large new shale gas deposits have been made recently, the resource is very cheap. At the same time, oil is becoming more expensive.

At current prices, one unit of energy from natural gas costs 38% less than the same amount of energy from oil. Even with the cost of converting natural gas to a liquid fuel, there is still a big margin for Sasol. Natural gas prices could go up considerably, or oil prices could drop sharply, and Sasol should still see attractive profits.

As it turns out, Sasol has a hedge against a rise in natural gas prices: the company is buying its own suppliers. Sasol invested $2 billion in two major shale gas fields in Canada, and is investigating similar opportunities elsewhere in the world.

Sasol announced excellent fourth quarter results. Operating profit rose 70% from the same period last year. Despite its success, we think the stock is still very attractive for long-term accounts.

The Bottom Line

There is a lot of uncertainty about which way the economy will go this year. Good arguments exist for both outlooks. However, we think the optimists are more likely to be correct.

Since the amount of economic growth is in question, we think the safest strategy for investors is to emphasize food and energy stocks. Bunge looks very good for its soybean, grain, and biofuels business. Sasol seems to be in the right place at the right time with its synthetic fuel operations.

Until Next Time

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time...


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Posted 04-03-2012 9:38 PM by Research & Editorial Staff