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By Liu-Yue (Louie) Lam, Co-Founder, Chief Investment Strategist, Oxstone Capital Management,

The first few months of 2011 started off incredibly well.  Companies were reporting strong profit growth and increasing dividends.  A few trends played heavily in the markets favor.  Monetary policy continues to grease the market with extremely low interest rates and asset purchases.  Fiscal stimulus also played a significant role.  Both political parties compromised and agreed to roll-over low tax rates for everyone.  In addition, it was also seasonally the best time to be in the markets, the 3^rd year of the Presidential cycle is usually the most profitable time for stock trading.

Even one of my all-time investing heroes – Warren Buffett, got into the act.  He was extremely positive on comments regarding the future of this country during his annual meeting.  Mr. Buffett also was in an acquisitive mood lately, putting his elephant gun to work.  That’s usually a good sign as any that there were great values to be found, and it was time to be in the markets too.  In addition, M&A activity were raging all over the place.  Companies were flushed with cash and putting it to good use.  Credit was flowing again and private equity firms were able to borrow at low rates to do deals.

The U.S. markets marched continuously higher even though the rest of the world was selling off.  All around us, the world was burning red with revolution.  Across the Gulf region, nations were caught in a domino effect of revolt and chaos.  Oil rose dramatically higher due to potential supply disruptions and gas prices here in the U.S. climbed higher too.  Even as geopolitical risks dominated headlines, it did not dominate the U.S. markets.  It appeared fundamental stock picking were taking the baton away from macro headlines.  The U.S. market appeared unshakable as we shrugged off each and every macro threat until now.  No one could have foreseen an earth quake near Japan that would set off the tragic tsunami that claimed 10,000+ lives.  The untold human loss as well as economic loss is still climbing ever higher.  I quickly made my donation to the Red Cross in support of the victims of the earthquake/tsunami in Japan.  I didn’t expect my modest donation to appease the stock market gods so I waited in anticipation for its next reaction; fully expecting the tsunami which started on the other side of the world to quickly arrive on our shores too.  However, what I missed was the nuclear Godzilla now crashing the party.  The new black swan in the form of a nuclear meltdown is now melting away the rest of the global markets.

Volatility is spiking again.  The risk off trade is back on as risk appetite wanes in the face of so much uncertainty from this unfolding nuclear disaster.  Macro investing and geopolitics reign supreme once again.  BOJ quickly pumped $180+ billion into the financial system, setting off another round of quant easing to support the financial markets.  Although, historically there was a strong correlation between global financial market boom and BOJ liquidity, I wonder if it would be enough in the short run.  It is always difficult to assess the markets with any degree of accuracy when central bankers were doing their best to distort market fundamentals.

How should you invest during a time like this?

In the short run, oil will be hit because taking the 3^rd largest economic power out of play in the global economy will reduce global gdp.  Natural gas will rise as an alternative to nuclear energy.  The Yen will strengthen due to repatriation of capital back home for the rebuilding effort.  This will also reverse the carry trade causing a sell-off in commodities.  In the long run, base metals should rise due to the huge demand for materials required for the rebuilding effort.  I expect demand for base metal commodities will be strong (steel, copper, aluminum).  Natural gas will also be in high demand again as the nuclear accident refocus people’s worst fears on the safety of using nuclear as an alternative energy source.  While natural gas is clean and less costly to build the infrastructure and transportation pipelines for use.  Precious metals like gold and silver are still a perfect hedge to black swan events such as the current nuclear Godzilla raging in Japan.

I also see a great buying opportunity in Japanese blue chips like Sony, Nintendo, Toyota, and Canon for the long run.  There is also a tremendous opportunity to buy nuclear companies like Cameco Corp. and USEC Inc. that have sold off heavily during this market panic.  Nuclear energy is not going away even after Japan’s meltdown.  The world population will still be growing and demand for electricity will outstrip available fossil fuels especially in emerging market countries.  Countries like China and India will continue to support their ambitious nuclear programs because it is the only way for them to achieve some manner of energy sufficiency as part of their national security needs.

 

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