Quarterly Commentary: April 2011

The first quarter in review

The markets were in a shallow correction for most of the quarter, improving only by the end of March. The markets largely shrugged off the Libyan war, the Japanese earthquake, and any other bad news. The action, extended though it is, has been in oil and silver. I made a little money in VXX before the market rally, and for several accounts, reloaded into royalty trusts during the late February/early March sell-off. But mostly, it was a range-bound, low-volume bore in which I held mostly cash.

Perspective for the Second Quarter

Quantitative Easing II that the Federal Reserve implemented last August is scheduled to end in June. The political facade of fiscal responsibility should last until perhaps first quarter, 2012, when neither party will want to be blamed for a double dip recession during the presidential election. The bulls have had the run of the place since September 2010. Asset classes that prospered from the $600 billion infusion, like stocks, commodities, precious metals, and oil, should suffer the most from its demise. Asset classes that suffered from the rapid expansion of the monetary base this encouraged, like the US dollar, should soon see a rebound. As such, I have an instinctive bias to the short side, or to cash.

The markets have ignored mounting economic headwinds. Other than a falling dollar, very little has rallied on fundamentals. Oil, copper, and most commodities have growing inventories. Many of the best performing stocks have little or no earnings. There is a widespread bullish consensus, which is often a contrary market indicator.

As such, I suspect the markets may exhibit considerable volatility throughout most of the second and third quarter; i.e. a replay similar to last year.

Tactics for the Second Quarter

The quarter is off to a poor start. Most breakouts are failing almost immediately. Energy and natural resources earnings have been largely discounted. Unless a new sector pops up with surprising earnings in April, it may be an unpleasant quarter. Cash and the inverse exchange traded funds are at the top of my watch list.

Sector Thoughts

• Bonds may do better this quarter if there is a flight to safety. “Better” is a relatively term, since even in a bull market move there has been very little capacity for capital
  gains, while bond yields are still pathetic. I continue to avoid this entire asset class.
• Gold and silver are overbought and bear substantial risk of a severe correction. However, these are clearly bubble assets that I believe will attract attention as long as
  central banks print money. Silver may be a trade sometime later in the year. I have been using the ETF AGQ
• Industrial commodities have had a good run as well. Surplus inventories are starting to take effect; and any strength in the dollar will precipitate a substantial correction. This sector may once again be a trade later this year.
• Oil is a wildcard. It has risen in spite of surplus inventory, but not so much that it cannot keep running. Higher (sustained) oil is considered bearish, as it will put the brakes on any economic recovery. My only planned oil holdings are BPT, the royalty trust. If oil slides, or becomes range-bound, at least we can collect the dividend.
• Emerging markets popped within general market conditions over the last month, but now seem to be settling back down into a trading range. There seems to be little
  compelling reason to buy or sell. At present, I have no positions in these securities.
• Agricultural commodities have very promising fundamentals, but the most successful investment opportunities have been in the futures market. A number of ETFs and ETNs have been created to track agricultural commodities, but timing is particularly important in these instruments. I’m watching JO, BAL, BG, SGG, DBA, MOO, JJG, CORN.
• Technology stocks have been sliding, or at least range-bound, as many of the leading stocks have begun to fall back. The sector looks weak, and I may at some point short it through the SQQQ exchange traded fund.