Monthly Strategy – Holiday Edition – December 2010
In the last months global economic outlook has improved a bit. In U.S. we can see signs of personal consumption and manufacturing activity growing at soft rates, but growing; at the same time employment, housing, construction spending, durable goods orders are stagnating. Fall in initial jobless claims is clearly being offset by inflow of people into the workforce; job creation still weak.
The inventory re-stocking is still boosting GDP growth, which is a two-edged sword. Nevertheless the possibility of a negative GDP growth print in Q4 has faded further.
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.
It is clear now that Chinese economy has avoided hard landing (because of well executed monetary policy). Main threat to the global economic growth comes from coming China monetary tightening. High inflation rate in China leaves little choice for Chinese policy makers. Interest rate rise(s) and(or) some other way(s) of monetary tightening are imminent, in my view. This will translate in negative headwinds for asset prices both in China and globally. Commodities and Chinese real-estate could be the hardest hit asset classes.
China GDP growth will come down a bit, but for the time being I do not expect that Chinese government and central bank lose control over the situation. It appears that the day of reckoning for Chinese economic model has been pushed further into the future.
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 that sub 900 level in the S&P 500 is out of the question now.
I expect flat or slightly positive holiday season.
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 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 has worsen in the month. In my view one should go long here on seasonal factors.
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
Long term, in light of further fiat currency confidence problems the precious metals are place to be.
Currencies
Despite FED being keen to fight every market weakness with dollar weakening my stance is unchanged.
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 and Chinese tightening.
Agricultural Commodities, Aluminium, Ben Bernanke, China, Copper, Crude Oil, EU, Euro, FED, FOMC, Gold, Japan, Japanese Yen, Natural Gas, Steel, U.S. Dollar