May 5, 2009

What to Buy…or Not Buy

By Marc Faber

From the tidal wave of e-mails and comments I have received from numerous different
sources I am under the impression that most investors view the recent rally in the world’s
stock markets as a bear market rally. I suppose we would need to define a bear market
rally as a rally that fails to make a new all-time high (for the S&P 500, above the 1576
reached in October 2007) and is also followed by a new low for this cycle (below 666 for
the S&P 500 reached in early March 2009).

The problem I have with this dogmatic definition of a bear market rally is the following:
Assuming (and this isn’t a forecast, since I really haven’t the foggiest idea where stock
markets will be in six or 12 months’ time) the S&P 500 moved up to 1350 and then
declined to 500, as an investor should you care if the move to 1350 — a 100% gain! —
was a bear market rally?

My impression is that investors’ fixation on the recent rally being a bear market rally has
actually kept most investors on the sidelines and hoarding cash. Now, put yourself in the
shoes of a fund manager who, in the last 18 months, has lost 50% of his clients’ money
and missed the recent rally (34% for the S&P 500). What is he likely to do? I would think
that he would be inclined to purchase equities as they correct the sharp advance since
early March, especially as the economic news in the near term becomes less negative.

Based on our conversations with numerous managers in recent weeks, we believe that
most quantitative managers’ portfolios were not positioned in expectation of a rally. Of
the nearly 80 managers we have talked to, only one manager said they were up since
March 9th and the clear majority admitted to being notably down or stopped out on their
positions. These managers were both long-only and long- short quant managers using
market neutral and non-market neutral strategies, sector neutral and non-sector neutral
strategies, longer term and intermediate-term holding periods. It is fair to say that just
about everyone is bewildered and trying to understand when this rally will end.

Another factor to consider is that there has been a significant improvement in the
technical position of world stock markets. In the US the largest number of new 12-month
lows was reached in October. At the November 21 low at 741 for the S&P 500, the
number of new lows had already contracted, and even more so at the index’s March 6
low at 666. Also, market breadth and the number of stocks moving above their 200-day
moving averages have taken a decisive turn for the better, indicating that the stock market
advance is broadening and that the number of stocks that have bottomed out (at least in
the intermediate turn) is expanding.

I have explained repeatedly in the past that if a government is really determined to try and
postpone an inevitable collapse by “printing money” in order to lift or support asset
prices, it can be done. However, the result of such a monetary policy is to lower the
purchasing power of its paper currency, with catastrophic long-term consequences for its
economic and financial volatility.

It forces individuals and institutions with cash to buy something…anything. So, this cash
is channeled into gold and/or different paper currencies, commodities, equities, bonds,
real estate, and consumer goods and services, but obviously with different intensities and
at different times. For instance, at some times, such as in 2008, more money will be
allocated to gold; while at other times, such as since early March, more money will flow
into equities and industrial commodities. It is well understood that these money flows are
driven largely by speculative activity (and more than a little dose of manipulation). The
result in all asset markets is very high volatility and price fluctuations that don’t appear to
make any sense to most market participants and observers who don’t understand the new
rules of the investment game that were brought about by “money printing”.

This is where we are today, irrespective of whether or not you and I like policies of
“quantitative easing, massive bailouts, and frightening fiscal deficits” and their long-term
consequences! Another positive factor for stock markets is that a large number of Asian
stock markets and individual stocks in the region had already bottomed out in October
and November of 2008 and didn’t confirm the new low in the S&P in early March.

In Asia, the Taiwan and Shanghai indexes, and Korea’s Kospi Index, are all up by more
than 50% from their late October 2008 lows. (The Shenzhen Index is up 90%.) But it is
not only the Asian equity markets that have outperformed the US and Western European
markets over the last few months; since late January 2009, the RTS Russian Index is up
66% and the MSCI Emerging Market ETF is up by 55% from its early November 2008
low.

This is not to say that the global economy is about to embark on a strong and sustainable
growth phase. It also doesn’t mean that a new bull market in global equities à la 1982–
2000 has begun. But I think that, at least in nominal terms (inflation-adjusted), the global
printing presses being run by the world’s central banks and fiscal deficits have begun to
impact asset prices positively. Therefore, in the case of resource and mining stocks, as
well as Asian equities (and, for that matter, most emerging and other stock markets
around the globe), the lows thatwere reached between October and March of this year are
likely to hold — that is, for now.

The markets that have the highest probability of having made major longer-term lows are
resource-related equities, emerging markets, and Japan. Conversely, the asset market that
has the highest probability of having made a secular high (such as Japan in 1989, or the
Nasdaq in March 2000) is the US long-term government bond market.

Despite a still-weakening economy and massive quantitative easing, long-term bond

yields appear to be on the verge of breaking out on the upside. I have listed again below
all the equity recommendations I have made since December 2008. Some of these
equities have already moved up substantially (resource and mining companies, in
particular) and, therefore, I would only buy most of these recommendations on a
correction.
In addition, a number of BRIC and other (mostly emerging market) closed-end country
funds and ETS were recommended, such as Brazil ETF (EWZ), the Templeton Russia
Fund (TRF), the Greater China Fund (GCH), the Asia Pacific Fund (APB), Taiwan
iShares (EWT), the Japanese ETF (EWJ), the Japan Smaller Capitalization Fund (JOF),
the Morgan Stanley India Fund (IIF), the Turkish Fund (TKF), and the MSCI Emerging
Market ETF (EEM).

In the US, late last year we recommended buying the iShares iBox Investment Grade
Corporate Bond (LQD) and Nicholas Applegate Convertible & Income Fund (NCV),
while earlier this year we recommended the accumulation of stocks of high-tech
companies such as Cisco (CSCO), Intel (INTL), Oracle (ORCL), and Yahoo (YHOO).
More recently, we recommended beaten-down insurance companies and financials as
rebound candidates, including Leucadia National (LUK) and CNA Financial (CNA),
Citigroup (C), the BKX, the Financial Bull 3x Shares (FAS), and the Financials Select
Sector SPDR.

The market’s advance had been broadening and that more and more groups such as
airlines (AMR), homebuilders (TOL, CTX, HOV), and cyclicals such as Dow Chemical
(DOW), International Paper (IP), and Alcoa (AA) are showing signs of having bottomed
out. Among commodities, I am particularly intrigued by natural gas. There are natural gas
ETFs (UNG, GAZ), but costs are high. A better way is probably just to buy future
contracts, or Pioneer Natural Resources (PXD) or the First Trust ISE Revere Natural Gas
Index Fund (FCG).