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Aftershock Monthly Investment Outlook

Ra tes Ra i s i ng Soon
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February 28, 2013


The big item in the news right now is the budget sequester (budget cuts of about $85 billion), which looks bound to happen. However, there could be some agreement reached in the next few weeks when the effect of the cuts begins to truly bother politicians in Washington. Other than that, the economic news is not too dramatic. The economic indicators around the US have been very mixed. The Philadelphia Feds index of business conditions in the Mid-Atlantic region fell to its lowest level in 8 months, while manufacturing activity this month in the Chicago area reportedly grew at its fastest rate in 11 months. Reports on durable goods sales have been mixed. Figures on new home sales in January were very positive, but with a catch: the figures are seasonally adjusted, and the adjustments made were very favorable, whereas adjustments in the previous five Januarys were negative. So it remains to be seen how much credence should be given to those figures, since they are dependent upon an unusual adjustment. With these mixed messages in mind, lets take a look at the different asset classes. Stocks We were a little mistrustful of the rising market last month, and while it might seem like the market has gone higher, the fact is that the S&P 500 has basically been

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flat for the month due to recent sell-offs. Most of the gains for the month were erased in the course of three days. Meanwhile, many European stocks that began the year with gains similar to the S&P 500 are now flat or down for the year. This confirms what weve said in the past, that yes the market can climb higher for various reasons, but it doesnt take much for investors to be reminded of the fundamental instability in the global economy, thus sending asset prices back down. The theme here is fragility. When there is no fundamental basis for growth, any growth we do see is going to be on shaky ground. So we want to reemphasize what we wrote last month: the stock market can still go up. But beware. Volatility like what were seeing now is often a red flag. There may be some limited upside in the stock market now, but we are concerned about the downside risk as time goes by. Over the next month, news on the budget sequester will likely have an effect on the market. But in general were not expecting a major movement up or down over the next month. Bonds Just as we suspected, the so-called Great Rotation of people moving from bonds into stocks didnt last very long. Over the last few weeks, bonds have been outperforming stocks. We expect this trend toward higher bond problems to continue and even gather strength if global stock markets continue to have problems and/or if sequestration becomes a bigger problem down the road. These developments would lead people to turn to bonds and away from stocks for safety. Of course, any positive developments that drive up the stock market would tend to drive down bond prices. However, were at the point now where any increase in interest rates, which would drive down bond prices, is going to draw a reaction from the Fed to push rates back
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down. This is why it was easy for us to predict that rising interest rates wouldnt go on much longer. It doesnt take a genius to see that a country as debt-laden as the US cannot afford higher interest rates, and the Fed will do what it can to prevent rates from going too high in the short term. This limits the downside risk of bonds for the time being. Commodities We wrote last month about upward pressure on gasoline prices, and they have gone up. There is some limit to that pressure though as the price of crude oil has fallen, though gasoline prices will likely remain elevated especially as we head into driving season. Our prediction about the short-lived rise in copper and other metals turned out to be correct, as the prices have dropped 5 to 10 percent in the last month. We dont see much change here going forward. And our warning on agricultural commodities only becomes more relevant as we head into spring: Well see what the weather has in store. As of now, much of the West and Midwest remains in drought or near-drought conditions, even after the recent snow and rain there. Gold and Silver The bottom line with gold: As the price gets worse, the reasons to own it get better. The fundamentals are certainly not getting worse. Instability in Europe continues to increase, the US faces issues with sequestration, while Ben Bernanke has indicated in his recent testimony that the Fed has no intention of reigning in QE money printing. And yet, gold prices are down 4 percent for the month. As weve always said, gold can be volatile from day to day or month to month. In fact, the recent drop reminds us of the period from March to May of last year when gold went down about 13 percent in spite of news that
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would typically be good for gold. It still finished up over 6 percent for the year. When the price goes down in spite of increasingly solid fundamentals, it just becomes more of a value buy. We see this in the stock market all the time, when the market takes a while to notice the rising fundamental value of a company. Apple provided a good example of this in the spring of 2005 when its share price dropped nearly 25 percent down to a mere $33, in just one month, even though it was continually developing excellent products and building value. Clearly the share price wasnt reflecting the true value of the Company, and eventually the stock market took notice. By the end of the year Apples stock had more than doubled in price. There are quite a few people today who would have loved to be the ones who bought Apple at $33 per share. And we think in the end, those who own gold now are going to be glad they did. Currencies Last month we wrote that the UK might be headed toward limitless money printing. That only looks more likely now that the UKs sovereign debt was downgraded from its previous AAA rating, and more and more members of the Bank of England appear to be open to money printing as a potential remedy for its economic troubles. The yen has been very volatile lately, and we expect that to continue as there is some uncertainty as to exactly how much money the Japanese government will be printing and over what time period. Meanwhile, the euro which we said last month wed be keeping an eye on has begun to turn downward, and that will likely continue due to continued economic weakness and as well as the big win for opponents of austerity in the recent Italian election.
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