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
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