Q2/2010 Outlook: Method in Maddening Mechanics of Muddling Through

This article was last updated on May 19, 2022

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As we expressed when 2010 commenced, portfolio management now needs to be wary of the socialization of capitalism. In the maddening mechanics of muddling through experienced in Q1/2010, we see re-establishment of risk premiums as likely to be a key development that will favor quality with flow through from sovereign debt risk vigilance into central bank, government, corporate and individual consumer actions globally. In globally encompassing interlinks as well as between foreign exchange, interest rates and equity valuation, it contrasts with binary expectations of double dip fear versus the seamless transition implicit in the sharp equity gains and junk bond yield spread declines over the last twelve months. The 2010s start with massive deficits in slow growth advanced economies, growth in Asia strong but due to inflation concerns likely subject to constraint and corporate earnings recovering on cost cutting and less so from revenue. Not just for financial institutions but also in sovereign risk, as the Greek and Dubai crises have demonstrated as is also feared in provincial lending in China, “too big to fail” needs expunging and transparency needs to be enhanced. A more salient blow than recognized against “too big to fail” may have been struck by German Chancellor Merkel in forcing an IMF/EU mix of financing for Greece, resisting subsidized credit extension and arguing for EU adherence reform, despite the reputed exposure of German banking to Greek debt. The complexities of exiting quantitative ease and massive deficits have us maintaining cash reserves to avail of opportunities as market driven risk premiums are globally re-established along with U.S. Treasury 10 year notes yields moving closer to 5% as benchmark. Our asset mix decision to favor gold bullion/precious metal as hedge reflects sovereign debt spreads and deficit adjustments as being integral to risk and prone to error. We judge that as risk premiums are re-adjusted among and within asset classes (such as sovereign debt), change in currency markets is likely to have large impact on portfolio return.

We prefer dollar assets as well as those in select smaller strongly managed areas like Australia, Canada, Norway, Switzerland and the ASEAN countries over the Yen and Euro, arguably until the Euro stabilizes closer to $1.20, closer to its inception in 1999. Contrary to bear market fears of double dip and to the seamless strength of equities so far, we see in muddling through the potential for equity correction on valuation constraint into the first half followed by recovery in the second half driven by 2011 earnings. Globally pending further correction in the euro which would detract from total portfolio return, we favor overweighting exposure to North America and Asia. Our favored equity areas lie with restructuring accomplished as favoring large cap integrated companies in market weight energy, alongside growth favoring overweight information technology in communications in particular and favoring overweighting continued restructuring now likely to be across the board in healthcare. We have favored gold/precious metals as hedge within market weight materials, and favor luxury as available to deliver value over basic goods in the underweight consumer discretionary and staples areas that can increasingly be considered in tandem. Finally, with dilution likely increasing from required capital re-build and less profitable fixed income in the offing as risk premiums are re-established, we favor strong balance sheets in the crucial financial sector.

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