The big macroeconomic picture

Sometimes when you step back, get away from the computer for a couple days, and then step forward again, you take a different perspective on things. Such as what to sort through first in an inbox that has 60 unread emails.

I have typically experienced that a hands-off approach works better than a hands-on approach to portfolio – every time you touch your portfolio, you have to be making a correct decision compared to the person on the other end of the trade.

This time when I returned, I noticed that practically all resource and commodity-based equities, in addition to the broad indexes were up. My portfolio received a minor increase, so it is always emotionally difficult to look at everything else go up, but I am buffering that against the fact that I have a risk-adverse portfolio with a significant amount of cash.

The two obvious factors that went on this week was:

1. US Congressional Elections – Republicans take the House, Democrats keep the Senate. My projection here is that the state of the fiscal situation in the US government will not change to a significant degree – there will be massive fiscal deficits for years to come. It will be unlikely that this new congress will be able to restore some sort of fiscal balance. In fact, the decision might be whether to bail out certain states or not, which have accrued liabilities that is far beyond their ability to pay. What is interesting is that the market predicted this result in advance, but there was no significant market reaction.

2. Federal Reserve engaging in potential quantitative easing – they announced a number less than what the market was expecting, but announced it nonetheless.

The big macro issue is that in order to stimulate exports, countries are reducing the value of their currency by pumping more of it into the economy, which you see in the form of government deficits. Since every country that has an export base is doing the same thing, you do not see much of a shift in relative valuation, but you do see a shift in valuations with hard assets, such as commodities and to a lesser degree, equity and debt. This creates a rather volatile situation in the marketplace.

I don’t know how this will resolve itself – my instinct has always been to purchase commodity-linked equities, but it feels like a crowded trade. Cash feels like it is depreciating by the day. Fixed income has valuation and risk/reward issues, especially if/when long term rates increase. Shorting long-term bonds is something to be considered, but doesn’t alleviate the problem of what to do with cash. Income-related securities have also been bidded to the roof, and barring any price corrections between now and year end, one of my 2011 predictions will be that income-related securities will underperform.

The least of what seems to be all ugly options is cash, specifically Canadian currency cash. There are a few reasons for this:

a. You can get a 2% yield on it (retail) or slightly less in institutional amounts (1-year treasuries are about 1.2% right now in Canada).
b. The Bank of Canada is not engaging in quantitative easing. In fact, by smartly increasing short term rates to 1%, they have probably done the whole country a favour.
c. Being a Canadian resident, I am intimately familiar with the country and the Bank of Canada, although I should point out there are three provinces that I have yet to visit.
d. Cash is very liquid and can be deployed at a button click’s notice into something better that appears on the radar.

Ultimately, investing in what you know will be in demand, at a good price is the generic fallback, macroeconomics be damned. But the macro situation is becoming something an investor has to pay very close attention to even with their microeconomic investments. A couple weeks ago I mentioned that some of my research lead me to place orders in two (US-denominated) securities. One of them went above my order price and has not gone back down. The other has been hovering in a range, and I have established a 6% position in.

Besides for this, I continue to watch, although I know my US cash holdings feel vulnerable to depreciation of purchasing power.