The market's crystal ball is broken

By Jim Jubak

I can't remember a time when views on the short- and long-term direction of stocks, the financial markets and the global economy were so thoroughly at odds.

One of these views is going to turn out to be very wrong. Either the next 10 years will look much like an attenuated version of the current crisis, or they will show this crisis to have been just that, a crisis, and the major investing themes of the past 10 years will reassert themselves as the drivers of the global economy and financial system.

I'd bet the short-term view of the long-term future, which is so dominant right now, will turn out to be, well, shortsighted. If I'm correct, then long-term investors are going to see a huge pop when the crowd swings in their direction. All they have to do is survive until then. Not an easy task when the turn is so unpredictable and the day-to-day punishment is so unrelenting.

In the short term, everything is gloom and doom. You could see that pessimism recently in the march of the major market indexes to their lows of the 2000-02 bear market -- and in the case of the S&P 500 Index ($INX), through its 2002 intraday low at 768. The Dow Jones industrials ($INDU) aren't far from dropping all the way back to their 2002 bottom of 7,552. The march has been nearly relentless, even for a bear market.

Normally, bear markets are punctuated by rallies that suck investors in from the sidelines before failing and inflicting more losses. Not this bear market. It just goes down and down and down. From Oct. 1 through Nov. 24, the Dow has managed back-to-back daily gains just twice.

Polarized predictions

Long-term investors -- and not just Warren Buffett -- see the current market collapse as a buying opportunity. On Nov. 19, a day the S&P 500 dropped more than 6%, Norway's $300 billion sovereign wealth fund announced that it was increasing its allocation to stocks to 60% from 40%.

"These market circumstances suit us very well," Executive Director Yngve Slyngstad said. "We are a large buyer in a market with more sellers than buyers."

The fund, which invests Norway's oil and gas revenue for the day when the oil and gas run out, is the second-largest sovereign wealth fund next to that of the United Arab Emirates.

But the short-term money is selling, which in this case means hedge funds and their investors. Hedge fund investors pulled a record $40 billion out of the funds in October, the most since Hedge Fund Research started compiling figures in 1990. Hedge fund managers have been selling, too, and some of the industry's biggest funds are now 50% in cash.

How's that for divergence?

Of course, you could argue that that kind of divergence is exactly what you'd expect in a bear market. It's just business as usual in these unusual times.

But it's not just views of the long- and short-term direction of the stock market that so divide investors. It's everything, including the direction of prices for food commodities, the direction of oil prices, the direction of inflation and the direction of interest rates. There's a gulf between the long- and the short-term view in each of these areas that's big enough to swallow an oil tanker, a dry-bulk carrier and a deep-water drilling rig.

Commodities in the short run

Let's start with food commodities. No. 2 yellow corn that sold for $6.55 a bushel in June 2008 in central Illinois sold for just $3.90 a bushel in October, according to the U.S. Department of Agriculture. No. 1 hard red winter wheat that sold for $9.19 a bushel in Kansas City, Mo., in June, sold for $6.17 a bushel in October.

No wonder shares of companies that make farm machinery, such as Deere (DE, news, msgs), or that produce fertilizer, such as Potash of Saskatchewan (POT, news, msgs), have been hammered this year. Shares of Deere were down 68% in 2008, as of Nov. 21, and shares of Potash were down 60%.

In the short term, the logic behind that extreme sell-off is impeccable. Farm income is going to be down this year. In fact, the Department of Agriculture calculates, the average farm could well lose money in the 2008-09 season. Farmers who aren't making much, if any, money won't buy many tractors, and they'll try to cut back on expensive fertilizers. Add a credit crunch that makes it tough for farmers to get loans to buy equipment or fertilizer, and it's only logical to see revenue headed down for Deere, Potash and other farm-related stocks such as Yara International (YARIY, news, msgs) and Mosaic (MOS, news, msgs).

Commodities in the long run

In the long run, though, the picture looks very different. Here's the long-term math that Potash cited in its Oct. 23 conference call: Global grain stocks have been drawn down over the past decade as production has failed to meet demand in most years. The global percentage of annual consumption that is stockpiled has fallen to 16.6% compared with a 30-year average of 25.3%. It now takes a record crop every year just to keep pace with rising global consumption.

Any reduction in planting or yield in 2008-09 will lead to another surge in commodity prices, farm incomes and the share prices of farm commodity companies in 2009-10. The food crisis hasn't gone away despite a short-term drop in food commodity prices.

Long-term investors -- I mean really long-term -- agree. Daewoo Logistics of South Korea may have a 99-year lease (I told you this was really long term) on 1.3 million hectares of farmland in Madagascar. (A hectare is roughly 2.5 acres.)

Why "may have"? Because faced with the possibility of huge protests, Madagascar's government is saying that it's only facilitating a "land search." The Daewoo plan is to plant corn on 1 million hectares (the rest would go to palm oil production) and then ship the bulk of the harvest back to South Korea. The goal to provide long-term food security to South Korea, the world's fourth-largest importer of corn.

Continued: Inflation in the 'short run'

And South Korea isn't the only long-term investor forecasting a return to a global food supply squeeze. Kuwait and Qatar, for example, are both in discussions to invest as much as $3 billion in Cambodia, one of the few countries in Asia with a big supply of underutilized arable land.

Long-term investors aren't limiting their investments in locking up supplies against future shortages to food commodities. On Nov. 20, the government-run Export-Import Bank of Korea announced it would lend $1 billion to Brazil's Vale (RIO, news, msgs), the world's largest producer of iron ore. South Korea imports 23% of its iron ore from Brazil. China and India are attempting to tie up future supplies of iron (and oil and other commodities) with similar deals. These investors see the current plunge in steel production as a short-term event and seem to be preparing for a rebound in 2010 or so.

Inflation in the short run

I guess that puts these investors on the inflation side in the current inflation-deflation divergence. Short-term investors believe inflation is dead. On Nov. 20, 90-day Treasury bills were priced to yield just 0.12%. Some actually traded at an interest rate of 0%.

Treasurys with longer maturities also pay almost nothing at the moment. The two-year note traded with a yield as low as 0.96% on Nov. 20. The 30-year bond traded to yield just 3.71% -- that's a record since the bond was first issued in the 1970s.

Part of that is simply a reflection of how much fear there is in the financial markets. Investors looking for safety will buy short-term Treasury bills even if they don't yield anything. All they want is a safe place to park cash for a few months.

But if you're buying a two-year note or, even more certainly, a 30-year bond, you're only buying safety if inflation is dead. And that's exactly what the bond and bond futures markets are predicting. These prices imply deflation -- an expected drop in prices of 0.7% annually -- for the next five years. Inflation, according to the bond market, will average just 1.3% a year over the following five years.

Inflation in the short run

Minutes from the Federal Reserve's October meeting make it clear that most Fed officials are still looking for inflation, rather than deflation, over the next five years. Inflation, now running at an annual rate of 2.3%, will fall, the Fed projects, to between 1.4% and 1.7% by 2011.

As you'd expect in this market, there's a group of investors who disagree strongly with either of those projections. Diverging from the deflation and low-inflation camps, they focus not on the current recession in the developed economies and the slowdown in the world's developing economies, but on the huge amounts of money the world's central banks have pumped into the global financial system. We have $700 billion for the Treasury's bailout plan, $144 billion for American International Group (AIG, news, msgs), $70 billion for Bank of America (BAC, news, msgs), JPMorgan Chase (JPM, news, msgs), Citigroup (C, news, msgs) and other big banks, and that's just in the United States.

That doesn't begin to add up the money pumped out by the European Central Bank, the People's Bank of China, the Bank of England, the Bank of Japan and others. All that extra cash chasing a limited supply of goods, services and financial assets is likely to set inflation soaring as soon as a receding tide of fear releases this money from the vaults of banks now too fearful to lend.

An eventual acceleration of inflation -- within the five-year time period where the bond market is currently predicting deflation -- would send bond prices plunging until yields climbed high enough to get ahead of inflation again. It would push up commodity prices as investors sought shelter, again, in those inflation hedges. Nothing like that is now priced into the financial markets.

More divergence

I could add other instances of major short-term and long-term divergence. In the short term, the U.S. dollar looks like it will hold steady or maybe even climb against the euro. In the long term, the dollar is likely to steadily fall against a basket of world currencies. In the short term, oil prices could test $40 a barrel. In the long term, a run back toward the last high and then beyond to $200 within five years is extremely likely.

You can boil all these divergences down to one very simple difference of opinion: The short-term view argues that the situation we now see before us -- fear everywhere, a global recession, a crippled financial system -- has ushered in a new age and that the next 10 years will look very much like the present. The long-term view holds that the next 10 years won't resemble this crisis in key particulars because, well, this is a crisis -- and that many of the long-term trends that shaped the last 10 years, such as the rise of the developing world and the consequent supply shortages of oil, base metals, food and energy, will shape the next 10.

I wouldn't stake every dollar on the long-term view being correct. Nothing is ever certain in investing, and it doesn't pay to take all-or-nothing bets. But it will pay over time to put some money into the sectors and themes that the short-term view so thoroughly scorns today.

The toughest question to answer is when. In my view, it's still too early. The short-term view may be wrong in the long term, but right now it rules the markets, and this bear is set to punish anyone who gets too far ahead of the current crisis. As I've said so often recently, investors who have managed to put and keep some cash on the sidelines will get their chance to invest it -- for the long term -- sometime in the last half of 2009 or in early 2010. Patience remains the key.

Continued: Developments on past columns

Developments on past columns

"10 financials you'll want to buy": Some "toxic" financial assets are turning out not to be so toxic after all. A $30 billion portfolio of mortgage-backed securities that BlackRock (BLK, news, msgs) is managing for the U.S. government is delivering almost exactly the cash flows that BlackRock had anticipated, the investment bank told the Reuters Financial Summit. That's significant because the portfolio is composed of assets the government guaranteed when Bear Stearns went under in March. It was market pressure from investors who doubted the value of the assets on Bear Stearns' balance sheet that led to the company's collapse.

A number of the financial companies that have followed the trail that Bear Stearns blazed -- Lehman Bros. (LEHMQ, news, msgs) and American International Group (AIG, news, msgs) perhaps most prominently -- have argued that the market was undervaluing the assets in their portfolios. With time, they said, the market would come to realize that these impaired assets were worth 90 cents or more on the dollar and not 40 cents or so.

Of course, time was exactly what the markets wouldn't give these companies. It's certainly too early to tell, and the sample is very small, but it does make me ask, "Could Lehman and AIG have been right?" When investors panic, markets can deliver totally misleading prices, the BlackRock portfolio certainly suggests.

"Make money off China's nightmare": Australian iron ore startup Fortescue Metals (FSUMF, news, msgs) has decided to fight a tumbling stock price with information. The company released far more details than usual as part of its September quarterly report. The company's loss for the quarter came to $55 million, excluding the effects of currency fluctuations on its long-term debt and a revaluation of a subordinated note held by Leucadia National (LUK, news, msgs).

Fortescue reported that it has used recent weakness in the financial markets to buy back debt with a face value of $65 million for just $45 million. The company also announced that it had amended a contract with a top-five steel mill in China to increase its deliveries to 5.5 million metric tons from 2 million metric tons next year.

Since Fortescue had sold out its projected production for next year, the company's ability to increase sales to that customer implies that some other customer had cut its order for 2009. The amended contract, Fortescue added, was priced in line with the annual benchmark price for iron ore. The company, in fact, said it has not sold any ore at spot market prices, which are about 45% below the benchmark price set in annual negotiations between iron ore miners and the Chinese and Japanese steel industries.

Meet Jubak at The World Money Show

MSN Money's Jim Jubak will be among more than 100 investment and finance experts sharing their advice on what to buy and sell in 2009 at The World Money Show in Orlando, Fla., Feb. 4-7. Invest four days dedicated to planning and refining your portfolio by attending some of the event's more than 300 workshops and panel presentations.

Admission is free for MSN Money readers. To sign up, call 1-800-970-4355 and mention priority code No. 012659, or register online.

You also have a chance to get to know Jubak and several other money experts next June on a cruise to seven European ports of call on the Crystal Symphony cruise ship. From the gilded cathedrals and extravagant palaces of Russia's czars to the trend-setting boulevards of London and Helsinki, this voyage is for both history buffs and market enthusiasts. Cabins start at $9,610 per couple. For more information, visit the InvestorPlace Media Investment Cruise Web site, or call 1-800-435-4534.Editor's note: Jim Jubak, the Web's most-read investing writer, posts a new Jubak's Journal every Tuesday and Friday. For the duration of the financial crisis, he will publish a third column whenever he gets really, really angry. Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. For suggestions on helping navigate the treacherous interest-rate environment, see Jubak's portfolio of Dividend Stocks for Income Investors. For picks with a truly long-term perspective, see Jubak's 50 Best Stocks in the World or Future Fantastic 50 Portfolio. E-mail Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares in the following companies mentioned in this column: Deere, Fortescue Metals, Potash of Saskatchewan and Yara International. He did not own or control short positions in any company mentioned.