By Robert Fitzwilson of The Portola Group

October 20 (King World News) - “The Shocking Reality Of The World Today”

The charade of the debt ceiling debate and clash between political factions last week should demonstrate for all thinking investors that there will be no resolution to the operating and accumulated deficits and obligations in the foreseeable future.  For those of us that are aware of the financial peril that swirls around us, it is difficult but crucial to comprehend that this is a battle between factions that embrace the concepts of sound money, hard work, thrift and savings and those that completely reject those beliefs....

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There has developed a nearly complete disconnect between the concepts of output funding savings, investment and government spending.  It used to be that the individuals and corporations would generate salaries and revenues.  Savings and capital for reinvestment came from the net remaining after paying taxes.  Taxes were allocated using a budget process.  Borrowed funds could be used, but the assumption was that the debt would also be repaid out of taxes.

We have no budget process in the United States.  Collected taxes are just a component of overall spending.  Printing makes up the rest.  Budgets at the state and local level are mandated by law, but most budgets rely upon accounting trickery, raiding of reserves or borrowing money that cannot be repaid.  Tax increases are also a favorite budget balancer, but that continues to restrain economic growth and employment.

Investors need to separate their beliefs about how economics should work and accept the reality of the situation.  That reality can be broken down into those who have the capability to spend and those who have the ability to spend.  Through massive savings, China has the capability to spend.  The West and the Japanese have the ability to spend through printing.  Allocating funds based upon the continuation of these two realities is the proper way to approach investing in the world in which we find ourselves.

Wishing that governments and markets will return to functioning as we know they should based upon history and human experience is causing potential returns to be lost.  Reversing the current trends is not going to happen any time soon.  We should anticipate more of the same.  The scramble for resources will continue.  Markets will continue to be managed and manipulated.  Aggregate debt will continue on an upward, exponential trajectory.  The debt cannot and will not be repaid.  Some combination of inflation and outright default are the only resolutions possible at this point.

China will continue to acquire oil, iron ore, copper, precious metals and assets that will address the key issues of food and water.  Solar energy is a prominent agenda item for them as Stephen Leeb has discussed.  That is extremely bullish for silver in particular.

The stock market has also been a conundrum for investors.  There are those that say that stocks are extremely overpriced.  For the large-cap names, there is truth to that.  Most of the gains in this calendar year have been due to multiple expansion, not growth in earnings.  However, in a world untethered from the realities outlined above, stocks could go from being overvalued to grotesquely overvalued. 

Bonds, “trophy” real estate, antique cars and collectibles are priced in the stratosphere, so why shouldn't stocks also rise to such levels?  It is the printing press that is driving the multiples to date.  Given that the printing press is back in high gear with the debt ceiling increase, one needs to consider that the multiples could expand much further.    Revenues could also resume an upward path along with multiples as inflation generates higher nominal top-line growth.  We could have rising stock prices driven by further printing before we see a Weimar-type collapse.

The large-cap stocks might have hit a ceiling of some kind, but many of the mid-cap and small-cap companies found in indexes such as the Russell 2000 have been on quite a roll.  In many instances, the rise in prices has been based upon accelerating sales and earnings, not on the wings of Federal Reserve policies.  Broad asset allocation does not work in our current world.  Investors need to seek out the companies taking advantage of emerging opportunities or benefitting from the expansion of debt and government spending.

While we remain convinced that the global financial system will implode at some point, the charts for the stock market indexes as well as many individual companies are telling us we could very well move higher.  This could easily reverse if the underlying economic indicators continue to deteriorate, but what we see at the moment looks constructive.  Even though many savvy people believe that stocks are in a bubble, this type of madness can continue on the back of more money printing.  What investors should do in this type of environment is not get caught up in the frenzy of particular equities, but rather seek out value in the form of precious metals, other real assets, and rapidly growing companies.

Financial crises do not mean the end of the world.  The world moves on.  What does happen is that the ownership of assets changes from those with paper to those who have prepared for it by exchanging fiat currency for real/productive assets.  Investors need to not only follow the lead of the Chinese and continue to acquire precious metals, but also remain open to traditional opportunities such as the historic renaissance of energy exploration and production in the United States.

Energy, technology, food and water are but a few of the powerful themes that will generate long-term returns for investors willing to spend the effort and time to find companies providing solutions.  Those looking for income should look for companies not with the highest dividend payouts, but those with the ability to growth the dividends even if the payout rate stays the same.  Complementing portfolios in this fashion while maintaining core holdings in precious metals makes the most sense to us in the current environment.

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