A Fatprophets article I read today shows promise for the year ahead:

Fish and chip wrapper

Waking up to headlines such as “world bank cuts growth outlook” is hardly constructive when it comes to positive sentiment. But in a bear market it is nutritious food for the bears, fortifying their argument that another financial calamity is just around the corner.

In the past 24 hours we have had to listen to the World Bank and leading economists, amongst others, remind us that global economic growth forecasts are being cut, the risks of “GFC2” are increasing sharply, Europe is heading into recession, and high income nations have sharply lower growth prospects – just to name but a few bear points.

During times like this, it is rewarding to stand back from the throng (and the consensus trade), and gain perspective. Playing devil’s advocate for a moment, one has to wonder when it comes to the World Bank, as to where were they in 2000 when the NASDAQ hit 5000, not to mention the Nikkei at 39,000 in 1990, and Dow 14,000 in 2007. There were no warnings. The point is it is very easy for leading experts, cornerstone financial institutions and government bodies, not to mention taxi drivers and the general public at large, to join the bearish consensus at the bottom or remain silent (and thus joining) the bullish consensus at the top during times of euphoria.

The elephant sitting in the corner of the room that the World Bank, leading economists and other acknowledged experts don’t seem to want to discuss these days is the huge bubble brewing in the global bond market, and US treasuries in particular. Never before has the consensus trade flocked to the fixed income market in such numbers, squeezing valuations to levels not seen in 50 years.

Most of the headlines we see today, and that includes a default by Greece, are already “fish & chip wrapper” with respect to the global economy and euro crisis. Much of the bad news has already been priced into the stock markets, and hence how else do you explain the Dow and S&P500 and other leading sock markets rising sharply in recent months on the back of such adversity?

In our view, anyone seeking a safe haven and buying 10 and 30 year US Government debt and accepting yields of less than 2 and 3 percent respectively is taking an extreme bet and paying a very high price that is right up there with the dotcom valuations of 2000 and other times of bullish extremity..

So where is the World Bank’s warning on this one?

When bearish sentiment is widely pervasive, going against the grain of extreme sentiment and swapping to the other side (and approaching cheap valuations logically) is an inherently difficult task. But a task nevertheless that reaps rewards for the disciplined value investor over time as history has shown time and again.

Now whilst we are not seeking to downplay the above risks of the European debt crisis (amongst others), seldom have we witnessed markets going in the direction that the consensus trade would have you believe is all but inevitable. Mainstream media climbing aboard this band wagon only galvanises and entrenches our view. It is worth remembering that there will always be risks to the financial markets that investors have to face, just by varying degrees. The old saying ‘markets climb a wall of worry’ has been around for hundreds of years for good reason.

If we turn to the charts of the Dow Jones and S&P500, the indices are not that far away from their all time highs. Whilst overhead resistance is significant and likely to check any further rallies’ in the near term, at some point this year we believe the Dow and S&P will break upwards into a new trading range. The catalyst for this scenario to occur will be the world becoming more comfortable with Europe, and the US economy beginning to gain traction, and this day could not be too far away.

So the question is how does one deal with the negative sentiment that is consuming the world presently and take advantage of the cheapest valuations in years.

We are not saying that equity markets are about to soar to new highs next week, but it is important to emphasise the point that downside risk is now significantly mitigated by equity valuations being the cheapest in decades, and relative to some government bonds, the cheapest perhaps in history.

Fish n Chips - anyone hungry lets bring it on :) Cheers