Long-term Outlook

Hello,

I had told some of you that I wouldn't buy equities long-term at these levels. Firstly, I want to explain the limitations of my experience and predictive ability. This equity bull-market is remarkably resilient and may keep going for a while. If Ben Bernanke and the Fed keep short-term rates low for another year or so, as is possible, then markets could keep rising and make new all-time highs by late 2011. We could conceivably keep going up to bubble valuations. This would not be good.

Most smart people I know (and even some not-so-smart ones like me) have been wrong about this bull market. While I have a good record of predicting short-term movements in the market, I have not thus far been good at predicting the longer-term. (I am zero for two so far -- on the extent of the 2007-08 crash and the subsequent recovery). These are just my thoughts. I could be all wrong.

Secondly, I want to point you to Jeremy Grantham's letter, not because he knows what will happen, but because he is very intelligent, experienced, honest and moral, and, unlike me, he is right more often than not. Link: http://www.gmo.com/websitecontent/JGLetter_ALL_1Q10.pdf

Thirdly, I want to clarify what long-term means for me -- it means, for me, a time-frame more than 2 years. I think that the United States faces significant debt servicing problems in the future, and that there is no good way for it to service its massive debt obligations other than to cut spending and raise taxes. If debt stays high (or becomes higher, as is happening), then interest rates should rise. If interest rates rise, this will stifle the recovery. So the government will want to cut spending, so as to prevent interest rates from rising. Whenever this happens, and this must happen within the next 2-5 years (and probably sooner to avoid losing its credit rating), whenever the U.S. government spending cuts spending, equity markets will struggle.

In the current political climate, we will not be able to cut spending or significantly raise taxes, which means that the Federal reserve will be under pressure to keep short-term interest rates low. (If interest rates are low, it is easier for the government to service its debt.) While this will be good for equities in the short-term (next 6 months or less; which is why I'm short-term bullish), I think it will also be inflationary in the long-run. The current short-term bank-to-bank interest rate in the United States is 0.25 percent. Extraordinarily low short-term rates over time beget asset price inflation. When bonds are not a good alternative, money goes into commodities. As those of you that live in developing countries know, food inflation is real and it is here. We in the United States haven't seen it recently, partly because of the strong dollar.

The dollar is strong because of the crisis in Greece (the Euro is the biggest alternative and sovereign defaults are increasingly likely in the Euro zone). This instability elsewhere brings about a demand for short-term U.S. debt, because the U.S. dollar is a funding currency as well as a safe haven. This demand for the dollar helps keep interest rates down in the short-term. Right now the attention is on Europe. However, sooner or later the world will catch on to the debt crisis in the United States, either through the ratings agencies putting out warnings, or otherwise. The way I see it, one after another debt crises will start surfacing in the second half of 2010 and 2011. When this happens, the gold boom will start in earnest. Thus, for the next 5-10 years, I am a gold and commodities bug.

Finally, in the very long-run (beyond the next 5 years), I am very bullish on all asset classes. For the last 6 months, I have been telling my friends that we began an 80-year bull market on March 9, 2009.

All the best!