With A Great Year Behind, I Am Cautiously Optimistic About 2007

The past year has been a booming year for investors all over the world. Of the major markets that are under my watch, the Asian markets led the pack and the US market was a laggard, which was only up about 13.6%, or 15% including dividend. Interestingly the return is close to its historical average for the last few decades. Considering the relatively low expectations held by most of the Wall Street analysts at the beginning of 2006, the sustaining high oil price and the uncertain housing market, last year's return can be viewed nothing short of being remarkable.

There are many reasons behind the bull markets. In my opinion the most important are

1. Emerging markets are so strong that all boats are being lifted.
1. Providing markets for US products.
   
2. The globalization is working in full swing and US is benefiting the most from it:
1. Almost unlimited supply of cheap labor is keeping the prices down and inflation low, offsetting the high oil price.
2. US is becoming the provider of choice for technology and finance, both carrying very high-margin.
   
3. Asset bubble: I think the US is experiencing a bubble of financial assets. Too much money is available to chase limited real assets in the world. The low interest rates are not attractive enough for asset managers. This is good for stocks as long as the bubble lasts.
   
4. No catastrophic events (war, flood, etc.) in 2006.
   

These factors are causing record-breaking profits for US corporations. In fact the P/E ratio for the S&P 500 ratio is lower than 15 on average, which hasn't been seen since 1994. In other words, stocks are cheap even with four years of consecutive gain in the market indices. Investors are feeling comfortable about the market: the volatility level is at the lowest in more than 10 years. This kind of optimism and the abundance of cash available in corporates and private equity funds are also driving M&A and MBO deals at record-breaking level.

Baring sudden events, I am seeing the same strong market forces in action in 2007 and am cautiously positive about the US market. After all the stock prices are cheap.

On the other hand, certain events could make the market tumble. Among them are:

1. Political instability in emerging markets such as China and India.
2. A escalation of war in middle east.
   
3. A free fall in dollar.
4. A housing market collapse in US.

Of course there is always something that could go terribly wrong but nobody can predict. Managing a portfolio in this kind of uncertain environment can be a very challenging task. What's the probability for one or a combination of the things to happen? I would probably put it at about 50%, in other words a pretty high number. But again that was true also at the beginning of 2006. Of the most important things that I've learned during the last couple of years is to stay positive. Below are things that I would do,

1. stay in the market;
   
2. hedge the bets;
3. do the homework: sound practice of stock analysis is still the key; and
   
4. pray for the good luck (not!).

In other words, do the usual things that I am supposed to have been doing already. Without major negative events, I see S&P 500 break a new record during the earlier months of 2007. The index is only 8% from its previous high set in 2001. How much weight does this "prediction" carry for my own decision making? Exactly Zero! Why? This is what I believe:

You Don't Predict What's To Happen. You Manage Based On What's Happened.

My number one goal should be to guard against a big loss, while trying to achieve my usual objective: to outperform the benchmark index. Is it possible to match the super performance of the past year? Very unlikely as the plate is getting fuller but I really shouldn't care about it either: it wasn't my objective to be up over 50% to start in 2006 and it shouldn't be an objective either now that we are in 2007!

Happy Investing.