Monthly Strategy – November 2010
In the last month global economic outlook has improved a bit. In U.S. we can see some signs of retail sales and manufacturing activity growing at soft rates, but growing; at the same time employment, housing, construction spending, durable goods orders are stagnating. Recent fall in initial jobless claims has to be confirmed this week as the reading will be striped out of Columbus day seasonal effects.
The inventory re-stocking is still boosting GDP growth, which is a two-edged sword. If the demand doesn’t pick up the possibility of a negative GDP growth print in Q4 remains.
In Japan and Europe we are seeing some some slowdown in economic activity because of exchange rate effects and slowdown in demand from their main trading partners; but both Europe and Japan economies are growing; at below average growth rates, but growing.
Chinese economy has avoided hard landing because government again eased monetary policy. The GDP growth will come down a bit, but it appears that the day of reckoning for Chinese economic model has been pushed further into the future.
And now comes the hard part. I believe that FED didn’t think that the economic readings would improve ahead of todays FOMC meeting. I think they have build excessive expectations of QE 2 size. In the mean time economic activity didn’t brake down and we had some big names criticizing the QE 2 (Bill Gross, Peter Orszag…). I could conclude that the FED will come to understanding that large QE would be irresponsible and that it will announce tomorrow some small(er) asset buying program.
Equities
I still believe that the market is overvalued because of excess money in the system; I believe that there is disconnect in what equity and bond markets are pricing – with equity being wrong; I believe we will correct to sub 900 level in the S&P 500.
Emerging markets fell like 2006.
Bonds
I think that Mr. Bernanke game plan is to have interest rates low longer than anyone expects (I don’t expect a rise in 2011); I believe that the quantitative easing will get an extension smaller in size compared with the first leg and that the extension will be announced tomorrow.
I expect that the short-term price trends in economy to be deflationary because of private and household sector de-leveraging (leading to weak demand) and large output gap (leading to strong supply).
Because of deflationary expectations I believe that the demand for government debt will be strong especially from bank side as they have large amount of cash reserves they are not using to lend to private sector.
I believe yields will go further down and curve will flatten further; in the longer term I believe the yields will be comparable to Japanese (bellow 1.5% for 10-year government bonds and bellow 2% for 30-year government bonds).
Commodities
Fundamentally, across all mayor commodities supply/demand balances weigh on supply side. Copper would be only here where we have some tightness (again, the talk of copper market tightness arises before market crashes). Excess money in the system has lifted the prices across the board.
Energy Commodities
Crude Oil – fundamentally, the market is over supplied; since crude oil is a high beta play on equity markets my target for WTI spot at 50 in the next six months.
U.S. natural gas – the supply/demand balance is better then last year, but altogether bad. Oversold, In my view one should go long here.
Industrial Commodities
Markets well supplied, if world economy slows down, this is the place to go short.
Agricultural Commodities
It is possible that China starts to boost its inventory of agricultural commodities. This appears to be the commodity class with smallest degree of over-valuation. If you believe in inflation, this is the commodity I would use for hedging.
Precious Metals
Short term, I see gold overbought and over-owned. And this has gotten worse in September.
Long term, in light of further fiat currency confidence problems the precious metals are place to be. I would buy this on meaningful correction.
Currencies
Despite FED being keen to fight every market weakness with dollar weakening my stance is unchanged. Smaller than expected QE 2 could spur dollar strength.
I still expect a strong(er) U.S. dollar and weakening of the Euro. I expect yen weakening against U.S. dollar and the Euro. Resource currencies could lose part fall on weaker commodity prices.
Agricultural Commodities, Aluminium, Ben Bernanke, Copper, Crude Oil, Euro, FED, FOMC, Gold, Japanese Yen, Natural Gas, Steel, U.S. Dollar