Monthly Insight

December 2010

As 2010 comes to a close, the Global Equity Fund [GEF] remains cautiously optimistic as the global economy has been transported from the infirmary to out-patient rehabilitation. We hope to see a marginal improvement in macro conditions in what appears to be a flat to positive 2011.

In domestic markets, the headline unemployment number was announced slightly higher at 9.8%, private sector job growth has been improving over the last few months, albeit slowly. When factoring in underemployment, the powers in Congress and the Federal Reserve will have their hands full accomplishing their dual mandates: jobs and inflation. Housing prices experienced strong month over month improvements, but the absolute measure must be considered and that number remains low for most metropolitan areas. From a corporate earnings perspective, we saw strong numbers in the third quarter, with a 64.6% earnings beat rate above the historical average of 62.5%. These entities, especially financials, have shifted balance sheet controversies to income statement issues, with the top line continuing to be tested. We expect demand to continue to be tepid, especially in a consumer deleveraging environment and absent a resurgence in employment. Additional headwinds could be encountered in allowing the Bush-era tax cuts to expire and a lack of evident government support for extending unemployment benefits.

We continue to remain bullish on emerging and developing markets, especially in Asia, as continued economic and social gains show a source of aggregate demand absent domestically and in Europe. While many of these economies are driven by strength in commodities, they also represent a chance for positive real interest rate exposure. Key risks include uncertainty in currency fluctuations, inflation, monetary tightening, and political unrest. While fiat intervention has stayed off the headlines with a stronger dollar stemming from European crises, it could come back in full force in the future. Many emerging markets have already put caps on their foreign investment flows through taxation as increased inflation becomes likely in the future. China and India have taken multiple steps this year to raise rates, but it appears to have done little to combat the headline inflation figures. We expect further rate increases, but this has not swayed our outlook for growth in these regions. Obviously, actions on the Korean peninsula will spook the markets every time there is displayed military action.

There still appear to be a few remaining skeletons in Europe’s closet as sovereign risk continues to be artificially jawboned in the opposite direction of actual action. Greece, followed by Ireland, denied the fact that they needed bailouts, but in an about-face, quickly accepted large bailouts over mounting concerns of repayment and rising CDS levels. Now the focus turns to Lisbon and Madrid, where we are seeing the same anti-bailout rhetoric from the countries’ leaders. While Portugal seems to be next in the crosshairs, the GEF believes that the Spanish economy is much more robust and diversified than the other peripherals and should be able to circumvent larger scaled ECB intervention. It is important to note that as austerity measures continue, we could see heightened political risk in more socialist minded countries. Not surprisingly, a majority of this sovereign debt is held by banks in relatively stronger European economies, hence the “contagion.” Germany continues to be a model country in terms of economic and export potential, however, the anchor that is the rest of Europe could continue to be an inhibitor. The European Central Bank continues to pour liquidity into the system, however, the policy making will continue to be ineffective with so many countries with different economic needs. Surprisingly, the first country to trigger the “leverage red flag”, Iceland, has rebounded dramatically, essentially at the cost of its bond holders. Iceland’s OMX index is up over 15% percent this year, the third-largest gainer in Europe after Denmark and Sweden, two of the lowest debt to GDP countries in Europe.

Lastly, but certainly not the least important, has been the seemingly exponential rise in commodities. Inputs for many manufacturers and daily consumption could cause costs of goods to increase affecting both corporate and consumer wallets. The S&P GSCI Commodity Index is up 10% QTD, 14% YTD, with notable inputs of cotton and silver appreciating 65% and 45% quarter to date, respectively. The cost of crude has risen to a two year high and natural gas levels continue to rise in international markets, both of which are reflected in our high energy exposure relative to the benchmark. We are currently forecasting a slight decrease in crude due to increased non-OPEC inventories and pace of recent spot increases, but are forecasting $90+ WTI by mid-2011. In emerging markets, continued pressure on prices could be a factor of quality of life whereas developed markets will experience pressure on margins.

Written by Andrew Cameron, Energy Analyst, 12/3/2010