Market Forecast: The Rest of 2005 And Beyond

The Ten Year Treasury Bond's yield backed down to 4.43%, from recent highs above 4.6%. However, the easy money of low interest rates will continue to fade. I am forecasting that this benchmark yield rises above the 5% level this year. It does matter to you--even if you've never touched a T-bond. Home mortgage rates move up nearly in tandem, and WILL continue to do so as we move to year end 2005. Watch for the 30 year fixed rate (currently just under 6%, up from 5.2% in early February) to cross through the 6.5% threshold and finish the year just shy of 7%. How does this effect the entire economy? Deeply. Just ask the British. Their central bank has been set on nearly double our benchmark rate, as they attempt to fight off inflation. However, most British mortgages are variable (they go up and down with the market), not fixed...so it's starting to chill the housing market as well as broader economic growth. Rising rates are particularly known for cooling consumer spending for lower-income folks (also most impacted by rising gas prices) and therefore GDP and stock market growth. As the refinancing boom spawned by 45 year lows in interest rates during 2002-2004 ends, we approach the mid-years of the interest rate cycle in the U.S. History tells us that there's always a bull market somewhere--and always a bear market somewhere. While I don't see a recession in 2005, we almost certainly will have a slowdown of some significance before Mr. Bush's successor (Hillary vs. Condi or Hillary vs. McCain) takes office in January 2009. U.S. Equities have started 2005 slowly, as they did 2004, but look about fairly valued right now, and should finish the year with a total return in the 10 to 20% range. The Morgan Stanley World Index (the two dozen developed countries) should fare even better than the U.S. as it did in both 2003 and 2004, so make sure your portfolio is not U.S. only. Countries with steep yield curves and favorable trade prospects stand to significantly outperform the U.S. and world averages. Last year, China cooled and Brazil roared. This year, watch Latin America and India to outperform the U.S. and world stock market indexes. Try one of the various ETF country index funds to diversify your portfolio. Foreign stocks can have higher dividend payments and move in ways less correlated with your U.S. stocks, so it will have a smoothing effect on your portfolio year after year. Often times, you can buy this non-U.S. exposure right here on our markets--without changing currencies. Observations: Oil is NOT in short supply. $58 a barrel, at least $15 of that is pure fluff that will not last. It's refining capacity that is in short supply, and that will take years to fix. We literally have hundreds of millions of barrels in excess crude sitting around unrefined. The Saudis are cutting crude prices, forcing others to follow, as you would expect in conjunction with a visit to President Bush's ranch in Crawford, Texas. Oddly enough, we should see persistently high gas prices all year, and declining oil prices. Recommendations: Equally weight the U.S. to the world index (just over 50% of world value). Underweight Europe, Australia and especially Japan. Go with a light overweight on indexed emerging markets in South Asia (India, Thailand) and Latin American regional indexes. Don't miss out on Brazil, Chile, and Mexico, Colombia, Thailand, and India. Stay away from Venezuela (property rights and Cuba-esque dictatorship forming) and China (the world's greatest rights violator has a long way to go in terms of openness and investor protections...good growth but still too much risk) Be prepared for yawn after yawn of boring returns in the U.K. and Western Europe as they continue to stagnate, stagnate, stagnate. The growth and excitement is NOT Germany/France/Italy/Spain, which I place among the 3 most troubled markets in the world over the next few years. I call their anti-business governments the "Marxist Quartet." Poland, Hungary, Romania, Denmark and the Nordic countries are a little more interesting... but just a little. The world's second largest economy is Japan. You can't ignore it, but it's pretty much dead money. Japan's highly touted recovery is overhyped. You should not zero weight it (far too much deviation from the world index), but you can underweight Japan significantly for next year. It has a shrinking population, 100% dependence on imported commodities, which are rising in cost, and an awful financial system. Koizumi has done a good job of starting to heal the most screwed up banking system in the world, but he is too little too late (like the Governator in California.) EWJ is the ticker, but Japan overall will not likely perform as well as the World Indexes. India, Brazil, Russia and China are the 4 most important emerging markets in terms of GDP and GDP growth. I'm overweight on all but China, where communist dictatorships trounce investor rights all the time. Watch for Colombia (President Uribe's finally brought security after decades of chaos and civil war) and India (the regime of Prime Minister Singh is really committed to privatizing and growing the economy) to be the surprise gems of the developing world this year. Among the rich countries (where your benchmark ETFs will allocate most of your funds), watch for Europe to fall short of a slightly above average U.S. economy. Don't try picking individual stocks in India or Latin America--just stick with the index Exchange Traded Fund.