The Federal Reserve Bank appears to be pushing the stock and bond markets higher.  More probably than not, this is a good time for investing.  Investors should return to their normal asset allocation by investing their excess cash reserves and monies that will not be expended within 5 years.

However, there is some danger that lies ahead – probably one year to several years from now – when the FED unwinds its actions of the last two years.  For that reason, I recommend you read the interview from Barrons Online which does a good job of outlining the present day opportunities and the risks down the road.  Click here for the Barrons Online interview.

The economy continues to give us mixed signals but most are positive.  Here is a succinct list of what happened last week:

Positives
1) Oct payrolls surprise big to the upside
2) Fed lights another fire under asset prices
3) Emerging markets continue to rally as investors seek non $ assets
4) Oct auto sales rise to best since Sept ’08 ex clunkers
5) ISM services and mfr’g indices both above forecasts
6) Both Australia and India’s central bank raise rates to cool inflation pressures
7) Fed to allow healthy banks pay dividends.

Negatives
1) Commodity inflation as measured by CRB index rises to 2 year high
2) Ireland, Portugal and Greece financial concerns continue to grow
3) German Sept factory orders fall sharply
4) Sept Pending Home Sales unexpectedly fall.

The interest rate set by the central bank of Australia, a country who is a major supplier to China, recently increased to 4.75%.  The central bank of the U.S. (the Federal Reserve) is holding the equivalent interest rate in the U.S. at .25%.

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1. Three Dimensional Moving Holograms Breakthrough Announced – A team led by University of Arizona (UA) optical sciences professor Nasser Peyghambarian has developed a new type of “holographic telepresence” that allows remote projection of a three-dimensional, moving image without the need for special eyewear such as 3D glasses or other auxiliary devices. The technology is likely to take applications ranging from telemedicine, advertising, updatable 3D maps and entertainment to a new level. Source: KurzweilAI.net

2. A Cure for the Common Cold? – Landmark research led by Dr. Leo James from the Medical Research Council Laboratory of Molecular Biology (LM in Cambridge UK has discovered that antibodies can fight viruses from within infected cells. This finding transforms the previous scientific understanding of our immunity to viral diseases like the common cold and gastroenteritis. It also gives scientists a different set of rules that pave the way to the next generation of antiviral drugs. Source:KurzweilAI.net

About 25 years ago one of my clients gave me some advice that has produced one of my biggest treasures.  At the time, my two daughters were very young.  My client suggested that I buy one of the technology marvels of the early 80’s – a video recorder and use it frequently to record family events.  In those days, the recorders weighed about 50 times more than present day recorders and carried a battery charge for only a couple of hours.  The tapes were those big ones too.  Well, both of my daughters happened to come home this weekend, and we watched some of those old tapes.  We relived some great family times.  Not all treasure is measured in dollars and cents. 

An excerpt from a Barrons On line interview with Scott Minerd, chief investment officer of Guggenheim Partners. Asset inflation—and then what?

THESE ARE TURBULENT TIMES, as evidenced by the huge gains forged by the Republicans in last week’s mid-term elections. For some perspective on a host of economic and investing matters—including suggestions on tax policy and asset allocation—Barron’s spoke with Scott Minerd, chief investment officer at Guggenheim Partners. The firm, based in New York and Chicago, has about $84 billion under management, the majority of it in fixed income for institutional and wealthy clients. Minerd, 51, a CPA who graduated from the University of Pennsylvania’s Wharton School, has a deep understanding of the fixed-income world, having been an early player in areas like structured-credit products. He’s overseen fixed-income credit trading in the U.S., Europe and Asia at Credit Suisse; he was also a managing director at Morgan Stanley. Among his related interests: financial history and macro economics.

Minerd: Mark Twain said that history doesn’t repeat itself, it just rhymes. And the events we are experiencing today look a lot like the same experiences that we had in the 1930s. There are lessons to be taken away from the 1930s that are useful in evaluating both policy and markets today. The lesson that we learned in the 1930s was not to run a restrictive monetary policy and not to allow protective barriers to go up against trade. Those have been the two things that I have kept my eye on throughout the ongoing financial crisis.

And what are you seeing?

There is no doubt that the chairman of the Federal Reserve, Ben Bernanke, is a student of history himself and is very aware of the monetary accidents of the 1930s. And as the chairman of the Federal Reserve during this period, his worst nightmare would be for the United States to fall into a debt-deflation spiral. Therefore, he is engaging in a series of policies that are creating excess liquidity in the system, relative to the mistake that was made in the 1930s. That will probably be sufficient to keep the United States from falling back into a recession. However, he is also setting the stage for events, both in the near term and the long term, that will have a dramatic impact, ultimately, on a lot of things in the United States, including asset prices and interest rates.

That sounds very ominous.

Well, in the near term, with so much liquidity available, asset prices will rise for a number of categories, particularly financial assets like stocks and bonds and commodities. That’s a bull market, which most people enjoy. But in the long run, after an extended period with low interest rates, which I believe the Fed will be able to engineer, the question becomes: How do you reverse this aggressive monetary policy without having a financial accident? And I don’t believe that the Fed will be able to pull that off successfully without some sort of a massive problem down the road. It is the problem that will occur in the next decade. And, in all likelihood, the ultimate outcome will be a paradigm shift in the way we view money. There have been five paradigm shifts in the last century on the definition of money. And it is not unusual for central banks and governments to make a shift when the problems become so big that they can’t resolve them within the financial system they created.

So you see a very tough decade ahead?

I actually think this decade is a great opportunity for investing—that is, for people who buy high-quality stocks and investments in select categories of fixed income, especially areas like high yield, and in commodities. The bull market in gold, as George Soros has said, is the mother of all bubbles, and we are still in the early stages of a bull market that will probably go on for another decade. So there are lots of opportunities for people to make money. But in most of the asset classes where people could make money, investors are afraid to get involved. That includes equities.

So while you see trouble longer term, in the meantime there are some good opportunities to make money for now?

Right. I ultimately call this the anti-currency trade. What you really don’t want to do is, at the end of the day, get stuck holding a lot of financial assets. But in the near term, because the rising tide of liquidity from the Federal Reserve is lifting all the boats—except for the boats with the holes in them, which I refer to as real estate—you can take advantage of this liquidity shift to make a lot of money over the next five to 10 years.

What is your assessment of the Federal Reserve’s decision last week to purchase $600 billion of U.S. government bonds, otherwise known as Quantitative Easing 2?

QE2 is a very blunt instrument. It is an attempt on the part of the Fed to raise asset prices in the categories where it can re-inflate. The wealth effect of increasing asset prices should help stimulate consumer demand. There’s also the incremental disposable income which can come from mortgage refinancings, if rates remain low. So in some ways the Fed essentially is handing out a subsidy or a tax cut.

Presumably financial assets worry you over the long term?

If you believe that we could ultimately end up in an inflationary spiral, any financial asset becomes a concern to me.

Where should the rest of the portfolio be?

The balance should be split between equities and certain categories of fixed income. In equities, we like U.S. large-cap, dividend-paying companies, with maybe about 10% of your equity holdings allocated to emerging markets.

Why the emphasis on U.S. equities, as opposed to emerging markets?

From a value standpoint, equities are very attractive. When you look at the earnings yield on equities relative to bonds, U.S. equities are exceptionally cheap. There is also a pretty solid uptrend in earnings growth in the United States. And given that the dollar is so cheap, this is probably not the pivotal moment to be diversifying away from the dollar. But it would be imprudent not to have an allocation to the emerging markets, because within the next 20 to 30 years China, India and Brazil are likely to account for a much larger percentage of the world market-cap.

STOCKS CLIMBED TO THEIR highest levels in 26 months, with the Dow Jones Industrial Average reaching its highest peak since Lehman Brothers’ collapse set off a world-wide financial crisis. Now what could possibly Sherpa stocks higher?

Last week’s 3.6% gain was delivered on the backs of two long-anticipated events: Republicans seized control of Congress in the midterm elections, and the Federal Reserve said it will pump $600 billion into our economy, by buying roughly $75 billion worth of Treasury securities per month through next June. It also helped that manufacturing activity expanded in October and the U.S. economy added 151,000 new jobs, the best showing since April.

Several catalysts are needed to extend that high, the first of which involves tax policy. “With 36 different tax programs set to expire on Jan. 1, some clarity is needed on any potential extensions of part or all of the tax cuts,” notes a well known Wall Street strategist. Traders are already counting on an extension, and this strategist’s call for 2.2% economic growth next year, for example, could be slashed by half if the Bush tax cuts were allowed to expire.

Also, “confidence remains more subdued than it could be, especially as way too many Americans believe that the country is headed in the wrong direction,” he adds. A persuasive plan to cut our deficit and chip away at the government’s ballooning debt burden might surprise skeptics and could help restore economic confidence in the long run. The president’s commission for deficit reduction will report on Dec. 1.

Meanwhile, corporate America must squeeze greater earning power from today’s hospitable interest rates. Standard & Poor’s 500 companies are on track to earn a weighted average of $85 a share in 2010, according to Thomson Reuters. While analysts’ projections for earnings to grow 13% next year to $96 seem rather optimistic, it will take a mere 4% improvement to surpass the previous peak in profitability, when companies earned $88.18 in 2006.

If today’s leaner, meaner companies merely matched their 2006 prowess and earn $88 a share next year, the stock market would be valued at 13.9 times future profits. Only once in the past two decades has the S&P ended a year with a price-to-earnings multiple of less than 14, notes BofA Merrill Lynch strategist David Bianco. That was in 1994, when the Fed was hiking rates and the 10-year Treasury yield was pushing 8%. Today, the Fed is hell-bent on keeping rates low, and the 10-year yield is slumping at 2.5%. Bianco sees S&P profits topping $90 next year and thinks “there’s room for stocks to rally on the earnings outlook alone.”

Of course, valuation multiples and public confidence are so low because our government is burdened with debt, and investors are rightly concerned that much-needed austerity measures will crimp profits in future. That’s why this uncomfortable rally was populated largely by performance-chasing professionals, and even as stocks rose 17% over the past 10 weeks, individual investors yanked more than $39 billion from U.S. stock funds and plowed $83 billion toward bond funds.

The S&P 500 is now 21.7% below its 2007 peak. To close that gap, more investors must believe that stocks offer a viable–or at least cheap—hedge against the inflation that must eventually follow the Fed’s frenzied money printing. As the dollar slid further last week, crude oil and copper rose to 2010 highs, and gold closed in on $1,400 a troy ounce, a record.

The Dow ended the week up 326, or 2.9%, at 11,444. The S&P 500 rallied for a fifth straight week and snagged its ninth gain in 10 weeks. That’s its highest finish since Sept. 19, 2008, and the benchmark is up 9.9% this year. The Nasdaq Composite Index added 72, or 2.9%, to 2579, while the Russell 2000 jumped 33, or 4.7%, to 737 (Source: Barrons Online).

In an unusual week, U.S. Stocks, Foreign Stocks, and Bonds all advanced.  During the last 12 months, U.S. STOCKS outperformed BONDS. 

Source: Morningstar Workstation. Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  Three, five and ten year returns are annualized.  Assumes dividends are not reinvested.