2011 Investment Themes

2010 was a great year for the bulls. While many of the bulls were yelling ‘V shaped recovery’ early in the year, they shut up in the middle of the year when the Greece crisis hit, but then got saved by Mr. Helicopter with his money printing machine (uh, I mean treasury securities purchasing machine).

Moving into 2011, once again it is the federal government who laid the direction of the asset market. In the coming year, two important investment themes emerged because of the actions by the government: one from congress, and another from the Feds.

First, it is the compromised tax bill that the administration struck with the Republicans. While most people focused on the extension of tax breaks for the rich, extension of unemployment benefits, or the exemption of estate tax up to $5 million, all of which should help the economy, the most important of all, we believe, is the ability for businesses to write off capital expenses all at once in 2011, known also as bonus depreciation. While we may not condone the practice of encouraging people to spend every dime all at once, a strategy which robs future growth to create an illusion of wonderful economic activities, this is the strategy the US government has chosen to pursue, under the same principles that tax breaks are always necessary, while cautioning that borrowing trillions is not sustainable, but keeps borrowing nonetheless.

The time frame for depreciation bonus is for 100% write-off on purchases put into use between Sep 8, 2010 and Dec 31, 2011. While businesses would still be able to write-off 50% of their purchases between Jan 1, 2012 and Dec 31, 2012, the year for election again, it is a big difference from 100% and we can rest assure that most businesses would want to write them off in 2011 rather than 2012 if they can. This act is going to benefit equipment makers, ranging from automobiles, heavy equipment manufacturers, computer manufacturers, etc. tremendously. While one individual manufacturer may benefit more than another, and picking the best winners remains a difficult task, it can be quite dangerous to short the manufacturing sectors.

Timing wise, we have to remember most companies try to defer capital expenditure towards the end of the year, so Q4 of 2011 should be a particularly strong quarter for manufacturers. There are some companies which we believe will benefit more than others, but we will defer naming names in another article.

The second development came from the Feds, and it’s the proposal of lowering interchange rate for debit card processing, which may possibly spill over to credit card processing in 2011. While this act does not bode well for the banks or payment processing companies, i.e. VISA (NYSE: V) and MasterCard (NYSE: MA), this will definitely benefit retailers. If retailers do not pass this savings through to consumers, and we suspect many of them will not, they are just going to pocket the profit and increase their margins without doing anything. Of these retailers, we expect those who compete at the low-end markets most likely to pass savings to consumers, while restaurants or higher-end retailers most unlikely to do so. Coupled with the tax bills which would help the economy, we have become quite optimistic on the dining industry.

Timing wise, we have to remember that the proposal will only be finalized in April, and takes effect three months later. It also only affects debit card transactions. Therefore, margins will increase mostly for retailers that accepts debit card most often.

In the case retailers choose to pass through savings to consumers, that would be a great dampening effect on price increases, and would help to contain inflation, or god forbids, creates deflation. In that case, the Feds will likely extend the QE2 program, or institute a QE3 program, as that seems to be the only thing the feds care to do. Consequently, that’s going to prop up the asset market.

Of course, 2011 will not be without any undercurrents. A few of them are:

  • Higher long-term interests rate as people realize that the Fed has no will to institute any tight monetary policy, and that the US government has no will to really tackle the federal deficit. Of course, politicians will talk differently, but as we all know by now, they remain just like that: talks.
  • State governments continue to cut spending and increase taxes, licenses, and of course, traffic tickets to fund their deficits.
  • Rising prices of commodities dampening profits of corporations and reducing real income of consumers.

Goldman Sachs predicted that 2011 will be the year of the USA, and we believe it is indeed likely, even with the aforementioned undercurrents for the economy. There could very well be a correction because expectation has become quite high, as witnessed by the action of Nike’s (NYSE: NKE) 5% stock price drop after earnings report despite its 22% increase in profit. High expectations and over-confidence of bulls has always been a reliable recipe for market corrections, but we don’t think a severe bear market will develop in 2011. For any correction that comes, it may be an opportunity to load up on manufacturers. The day of reckoning will come some day for all the debts piled up by the federal and state governments, but unless something dramatic happens in the global political environment, we don’t think 2011 will be the year for that.

This article originally appears on benzinga.com


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