Aftermath

In his award-wining book, “When Markets Collide”, incoming PIMCO CEO, Mohammed El-Erian makes the following statement: “…in contrast to past episodes of US economic slowdowns, emerging economies have two distinct secular forces going for them; and these should prove sufficient to partially offset what is likely to be a relatively prolonged period of lower import demand on the part of the Untied States. First, the internal components of aggregate demand are coming online in a gradual and robust manner, thereby offsetting the prospect of reduced exports to the Unties States. Second, these economies – and in particular the commodity exporters – are looking to a period of relatively high export unit values.”

Mr. El-Erian goes on to point out that “There is also a third factor that is more cyclical in nature. The robust nature of many of these countries’ balance sheets – historically unusual – gives them the ability to stimulate internal consumption and investment.”

Investment Strategy Implications

In the aftermath of the credit crisis, three patterns re the equity markets and economy appear to be underway:

• Sector rotation (within a bottoming process, range-bound market) producing the likely winners and losers of the emerging economic environment
• Secular trend of a slowing US (and other developed countries) growth (driven in large part by deleveraging)
• Secular trend of higher emerging economies' growth rates (an evolutionary form of decoupling)

Should the second two patterns become a reality, the first will likely show some manifestation of them, although the full effect of an emerging markets global growth driver may take some time to register with investors. What appears to be very intriguing is the prospect that US domestic growth-oriented investors will find themselves disadvantaged (from an investment performance perspective) if the global macro secular trends Mr. El-Erian and others describe do in fact occur. The logical result will be an investment situation similar to the end of the dot-com bubble phase when many value investors were forced into owning growth issues just to maintain some semblance of relative performance.

Clearly, the longer-term investment winners in the above described scenarios will be those who recognize the secular trends and act on them sooner rather than later.

Note: For those interested in learning more about one such emerging economy, Brazil, you might want to consider a program that I am affiliated with that will take place one week from today (October 28) at the Bloomberg headquarters in New York City. For more information and to register for Brazil Day 2008, click here

To register, use the following login and password:
login: vinny
password: vcatabd08

“Inflection Day” Rally: Progress Report and Forecast

Since “inflection day”*, the equity markets have witnessed a modest increase in risk appetite. This is evidenced by several indicators (credit spreads, TAF and TSL auctions, for example) as well as by the trading action between and among various market indices.

To illustrate, the charts to your left show the risk appetite increase but it is not as uniform as one might suspect. And a few surprises are found.





Chart 1** (upper left) shows the performance from a size and style perspective. Note that the top performer is the Mid Cap group (overall - MDY, value - IJJ, growth - IJK). In the number four performance slot is Small Cap Growth (IJT). The rest (Small Cap, Small Cap Value, Large Cap, Large Cap Value, Large Cap Growth, and Micro Cap) are bunched fairly closely together with Micro Cap (IWC) at the bottom of the list.

Chart 2 (upper right) looks at the data from a US economic sector perspective. Here, Energy and Basic Materials assume their global growth story lead position. And “defensive issues” such as Healthcare and Consumer Staples are at the bottom of the list. The remaining sectors are bunched together. However, it is interesting to note who is in the number three performance slot – Consumer Discretionary.

Chart 3 (lower left) takes us to the global markets with the lead country/region held by China (FXI). The second cluster contains Japan (EWJ), Latin America 40 (ILF), and Emerging Markets (EEM). The bottom grouping is anchored at the bottom by the United Kingdom (EWU).

Chart 4 (lower right) provides a look at the BRICs. Once again, China (FXI) heads the group with Brazil (EWZ) in second place. Russia (RSX) is third. And the S&P 500 (SPX) just ahead of highly volatile India (INP)

So, what does this all mean?

Investment Strategy Implications

The above charts provide equity market performance evidence of a return to risk among investors. Higher risk styles, countries, and regions have generally produced the best “inflection day” rally results thus far. There is also performance evidence that US investors believe economically sensitive sectors such as Consumer Discretionary are likely to be near term beneficiaries of the rebate checks in the mail.

From a macro strategy perspective, however, there is much to be concerned about re the sustainability of the “inflection day” rally beyond the end of the summer.

For example, it has been argued on this blog and in my reports that the equity markets are a touch ahead of themselves, that the return of investor risk appetite (including a higher degree of comfort re earnings) is premature at best. The pain to be experienced - economic, financial, and political – going into 2009 may surprise many ready-to-return-to-risk investors. The same goes for those who seem ready to resurrect the Goldilocks scenario (is Kudlow listening?).

That said, it has also been argued here that in the very short term (as in this month), valuation levels and certain technical analysis data suggests the “inflection day” rally may fade a bit before resuming after Memorial Day (US).

Again, so what does this all mean?

I may be wrong but here goes:

Flat to down in the very short term; up through the end of summer; possible mega market top within the next six months; investor hell on earth in 2009.

*So declared by many market mavens as being March 17 – Bear Stearns bailout day.
**click on images to enlarge.
Note: All dates are from March 17 (“inflection day”) through the close yesterday.

News Alert: Brazil Government Debt Upgraded

According to news sources (which have not hit the major newswires as of the time of this posting which is 3:06 PM), Brazil's government debt has been upgraded. This had been expected in the second half of this year. So, this announcement caught investors off guard and pleasantly surprised.

By raising the rating to investment grade, Brazil's cost of capital will almost certainly decline. Additionally, the upgrade opens the door for more capital that is restricted to investment grade only.

Recently, news re the large oil fields off the Sao Paulo coast of Brazil had stimulated much investor excitement. This excitement was tempered with comments re questions as to the size of the fields (as high as 40 billion barrels - Tupi and Sugarloaf/Carioca fields combined) and the complexity extracting the oil (up to six miles deep, among other factors).

Investment Strategy Implications

One of the investment positions in the Model Growth Portfolio* is ILF - Latin America 40, which is comprised predominantly of Brazilian issues, some Mexican issues (mostly energy), and a smattering of other Latin American companies.

More on this story as details become better known.

*see performance chart to your left.
Note: Accounts managed by Blue Marble Research hold positions in ILF and EWZ (Brazil ETF). Neither Vinny Catalano nor any member of his family hold positions ILF or EWZ.