Hot sectors happen when a policy or technology event materially raises after-tax returns on capital there relative to other assets. Investors move money from low to high return assets which creates capital gains for the guy who got there first. This is precisely the same thermodynamic process as a storm system (a gap between high and low pressures or temperatures) in physics. People can best understand it by looking at a weather map of these storms. (See the weather map on my website for several of these storms.) The reason I like the weather map metaphor is everyone already understandds it, and everyone also knows that a storm is TEMPORARY. The same is true for hot investments, i.e., you also have to know when to SELL them when the party is over.
Last year’s storms were:
1. Oil and commodity prices, both implications of China strong growth;
2. Small cap U.S. stocks caused by the gusher of liquidity for small companies that happened when the banks opened their doors to business loans again 18 months ago; and
3. The turnaround of Japan caused by the end of their 13 year deflation.
In 2006, the most interesting storms will be:
1. Communications technology. Congress will pass a new telecom law next year that will dramatically increase capital spending on new high-speed networks. At the same time, China, Korea, India and others are making massive investments in IT as a strategy for growing their economies without using more oil and gas. This is great for capital owners altogether, but it’s especially great for telecom equipment makers and software writers. Best way to play that is EWY,the Korean ETF. (Korea is an important R&D provider for China.) Another is IWZ (the US technology sector).
2. The inflation monster will pull its scary head back into its cave next year and the Fed will back away from tightening (especially if we have a bad event at GM or Ford to prod them into providing liquidity). Investors will realize that inflation and interest rates will stay low so it is safe to buy the companies whose profits are growing more than 10% per year. The market will boom, especially for the small companies who rely on bank liquidity for working capital. Best way to play this is the Microcap stocks (IWC; the Russell microcap ETF) or the small cap ETFs (IWM and IJR).
3. We will get an extension on the dividend and cap gains tax cuts in January. Great for the overall market, but especially great for companies paying dividends (you can use DVY for this), or companies with big cash positions and huge free cash flow (maturing tech stocks like MSFT who can initiate dividends or pay special dividends.)
4. I also have sizable bets still in place on the China Growth stom system (EWY (Korea), EPP (Australia, New Zealand, Singapore, Hong Kong), on coal (BTU), and on Japan (EWJ).
As always, I own all of the stocks I mentioned above. (How could I tell readers I like a stock if I don’t put my own money into it?)