Strategic Retirement

May Market View

Last month in this newsletter we talked about a possible pull back in the markets as we entered the traditional “sell in May” period particularly given that QE2 was coming to an end. Whilst the equity markets did indeed sell off, the major damage occurred in the commodity markets, copper prices were down 10% and silver by a staggering 34%. We have discussed in the past the “Dollar carry trade” with commodities being used to hedge the currency risk. Borrow money cheaply in the USA and invest it in high yield countries such as Australia, you can get 4.50% on deposit in Sydney. However, easy money is coming to an end so it is time to bank gains and move the money back to America, hence down go commodities and up goes the Dollar as the super-rich run for safety and they do the same thing with their shares. So the markets watch the Dollar, if it goes up then equity markets go down and vice versa.

Copper

figure-1-may-2011

This chart shows the Copper ETF. Copper is an important commodity, the majority of buying is not for speculative purposes but for industrial. Copper is key to the Chinese, Indian and Brazilian industrial revolutions. Copper is needed for virtually every part of the infrastructure from water pipes to electric and telephone cables. The Chinese are building scores of new cities and they simply can’t do this without copper.

Despite the recent selloff the trend remains up, if the Chinese make a policy mistake and slow down too much then it will be here where it will be seen first.

PIMCO

There are many in the investment world that like to pontificate, most can be safely ignored as they have often have an alternative agenda or more specifically something to sell, there are however a few who have immense influence and should be listened to. Warren Buffett and George Soros are two but they are very equity related, one that concentrates on Bonds is Mohamed El-Erian of Pimco. An Egyptian national, he spent 15 years at the International Monetary Fund and joined PIMCO in 1999, and then moved on to manage the Harvard University Endowment fund. He is joint CIO and CEO (with Bill Gross) of Pimco which manages the world’s largest bond fund ($240billion); his views are listened to by Presidents and Central Bankers around the World. Pimco’s view therefore is the market’s view. As such we have to understand exactly what they are thinking and they have just published their Investment Outlook for the next 3 to 5 years.

Pimco believe that there will be “a bumpy journey to a new normal. The advanced economies will continue to experience sluggish economic growth, high structural unemployment, increased regulation, and constant pressure for private sector deleveraging. Emerging economies will maintain the breakout stage of their development phase. They will deliver high economic growth, strong currencies, and increasingly close the income gap with the developed world.”

So we are looking at a two tier Global economy the US, UK and Europe struggling with massive debts and a lack of consumer spending due to high unemployment. The western governments have no weapons left to stimulate demand. “Interest rates have been repressed; the dollar has also been devalued. The net effect has however been a double edged sword. Good asset price inflation has created a hugely positive wealth effect, while bad inflation has created a new tax on individuals in the form of higher commodity and energy prices.” Pimco are saying the consequences of QE have been mixed; the inflation drag on consumer spending has offset the benefit of lower rates. This is exactly what has happened in the UK, the benefit of lower rates to those on tracker mortgages has been spent at the petrol pump.

Looking forward Pimco say, “there are some encouraging signs that speak to an accelerated healing of the global economy over the next three to five years.” There are also signs they say that suggest that emerging economies are “well anchored on their historical development breakout journey; and that China, in particular, will be able to navigate what is inherently a complicated middle income development transition.” Unfortunately, there are also signs that point to an uneven global recovery as well. El-Erian talks of the debt overhangs in advanced economies where “projected rates of economic growth are not sufficient to avoid mounting debt and deficit problems.”

“Advanced economies will face sluggish (call it 2%) growth and persistently high unemployment that becomes more structural (and therefore protracted) in nature. Emerging economies will achieve higher growth (in the 6% range), and their income and wealth levels will continue to converge to those of advanced economies. Millions more will escape poverty. But this will not be without its own set of challenges, including recurrent inflationary concerns.”

Emerging Economies

figure-2-may-2011

figure-3-may-2011

This chart again from Pimco but using IMF data shows the disparity between the global presence of Emerging economies and how much money is invested in Emerging Market investments by US investors.

They are very under-owned and at some stage just as happened with Europe in the 1980’s there will be some significant catching up to do.

The second chart highlights the “Old World’s” problem, large debts, getting worse. This is in marked contrast to the Emerging Economies.

So we have potentially true globalisation taking place with the old and new worlds merging together. We are already seeing this at the stock level with companies like Korea’s Samsung appearing in Global Equity, Far East, Technology and Emerging Market Funds. But we must also expect inflation and high unemployment for much longer than is normal. As long term investors we have to follow the growth, both at the Bond and Equity level, and that is pointing towards the new world.

Markets

In the short term May holds sway and the “what happens post QE2” gloom is prevailing on markets. It looks like Greece is reaching another crisis point and global traders are running for cover by buying US Treasury Bonds and the Dollar. They will be back though, as the returns there are far too low to cover their management fees. Whilst many are questioning the strength of the recovery, particularly in the US, there is no hard evidence that it is faltering, it just not accelerating in the way that we all want. As ever the flow of economic news will be the key, it won’t take much good news, either about Chinese inflation or US Unemployment to change the tone. In the long term however, as Pimco believe there is much to be positive about the Global economy, providing you are in the right place.

May 2011

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