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October 2012
!"#$#%&"'#()*##+ Growth outcomes are driven by the balance between aggressive monetary policy and declining global economic data
The economic outlook for the near term is quite mixed. Growth has been disappointing around the globe and most regions remain fragile with slowing growth in Asia, a subpar recovery in the US, and ongoing, significant strains in peripheral Europe. The offset to this negativity are extremely aggressive policy support by central banks around the world. Both the fragile nature of the global economy and the policy responses from central banks has been more intense than consensus expectations. Sticking with the “data” side of the economic scales, the following table shows forecasts that have all been revised down considerably over the past 90 days. In fact, several forecasters have noted that the recent period has seen the sharpest pace of downgrades in recent years. The subsequent chart shows these reductions to forecasts over a longer period of time for key regions. Economic recovery is anemic at best or perhaps stabilized in an optimistic interpretation. Consensus Forecasts (Real GDP (%Y/Y) Global Developed US Euro Area Germany France Italy Spain UK Japan Emerging Asia China India South Korea Latin America Brazil Mexico EM Europe Russia Turkey
2013 is expected to be better than 2012, but it’s still a sub-par recovery by any measure
2012 3.1 1.3 2.2 -0.5 0.8 0.1 -2.4 -1.6 -0.3 2.4 5.2 5.6 7.7 5.9 2.6 3.0 1.7 3.7 2.9 3.8 2.9
2013 3.6 1.3 2.1 0.2 1.0 0.4 -0.6 -1.4 1.3 1.3 5.9 6.0 8.1 6.9 3.5 3.9 4.2 3.4 3.3 3.7 4.3
Source: Bloomberg
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Octobeer 2012 Consensus GDP G Forecassts
GDP Fo orecasts have been b declining g rapidly
Source: Barclays
Aggressivve global centrall bank policiess have driven equity e mark kets
Shifting to the t “policy” side of the scaales, there is nno doubt that central bankss have committed to t significant and extendedd liquidity reggimes. Financcial markets hhave responded to o ECB annou uncements to ‘‘do whateverr it takes’ and to QE3 annoouncement from the Fed d in a mannerr that would iindicate these scales are tippping in favorr of policy intervention n. QE1, QE2, and Operatioon Twist all saw similar m market reactionns with a wave of liqu uidity bidding g up asset pricces. Monetary policy time lin ne
Markets ts have reacted fa avorably to aggrressive monetary policies.
Source: Barclays
The eco onomic scales willl only tip towards growth, g however, if more fundam mental improvem ments are seeen.
There is no way w to say th hat these meassures put the eeconomy on a buoyant patth. Of course, argu uments are possible that ‘itt could be worrse’. Howeveer, the more ssimplistic conclusion is i that central bank interveention has prooven to give thhe markets shhort-term fuel (althoug gh with succeessively less ppositive outcoomes) but is nnot impacting the economy in a fundamentaal sense. It apppears clear tthat more is reequired in ordder to create sustaiinable growth h which obvioously includess job growth, housing marrket recoveries, etc. e Hope mu ust be convertted to some ddegree of realiity that fiscal imbalances will be resollved. U.S. eleections and political hostillities surroundding the ‘fiscaal cliff’, austerity pro otests in Euro ope, serious geeopolitical tennsions in the Middle East, and other tangential faactors leave a lot of doubt tthat traction w will ever be ggained on the fundamentall front.
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October 2012 The magnitude of the problems is tremendous. But there can be improvement in these fundamental areas although much time is required. In the medium-term it seems as though the policy fuel that drives financial assets will run out and more fundamental changes will have to happen. The problems are well known – Three-quarters of the US deficit was financed by the Fed while foreign governments’ purchases account for the rest. We need to see 250,000 new jobs per month on average over the next five years to get back to 5.5% unemployment rates. The list of negatives could go on and on. An “all clear” signal will not be required for markets to do better, but in the mediumterm the ups and downs of the economy are likely to keep the markets from trending dramatically.
Some of the economic data gives hope of stabilization, but generally there continues to be pressure
ISM Purchasing Managers Index B6 A6 @6 ?6 >6 5666 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 Source: Bloomberg
Case Schiller 20 City Home Prices YoY 56 36 An improvement in the real estate sector would help the economy
6 Ͳ36 Ͳ56 Ͳ>6 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635 Source: Bloomberg
Change in Non-Farm Payrolls 3666 As would an uptick in employment
@66 6 Ͳ@66 Ͳ3666 5666 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 Source: Bloomberg
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Octobeer 2012 Household Debt D Service Ratio – Debtt payments ass % of person nal income Delevera aging of households is showing up u more clea arly
Source: JP Morgan n
Inflationaryy Environmen nts and Assett Markets The ultima ate result of currrent monetary policy is inflation. It may still be a ways w off, but the im mpact on assets varries from market to o market
Source: JP Morgan n
The currency markets aree likely to conntinue on a traack of generaal EUR weaknness with USD on deffense much off the time agaainst some of the other majjors and emerrging markets as a whole. The dollar will reetain safe havven status, how wever as we hhave seen routinely ov ver the past seeveral years. Commitmentt to USD for m most core alloocations is prudent with h non-USD ex xposures retaained for tacticcal activity onnly. Japanese Yen Ye D6 C@ C6 B@ B6 E90Ͳ33
F+$Ͳ33
G,HͲ33
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E90Ͳ35
F+$Ͳ35
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Source: Bloomberg g
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October 2012 Euro 3JC 3JA 3J? 3J5 3 6JC 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635 Source: Accuvest Global Advisors, Bloomberg
Mexican Peso 3A 3? 35 36 C 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635 Source: Bloomberg
FX Forecast vs. USD as of Sept 30
A renewed, gradual decline in USD is expected based on various valuation metrics
G1+*U !Y0'"9 &09N'8 S+0X,R #$=1$,-'9 E,W'"1 V1$( Q1$( Ͳ6J5BK SU9'89$= Ͳ6J>@K :U'$9 Ͳ6J?6K :9$9=9 Ͳ6J?5K Q10,9 Ͳ6JACK E989R-'9 Ͳ6JBAK T+--'9 Ͳ6JC6K S9'<9$ Ͳ6JDBK G'$(9H10, Ͳ3J6>K !+-*098'9 Ͳ3J?5K L10<9R Ͳ5J53K P$'*,= Q'$(=1. Ͳ5J?AK F9H9$ Ͳ5J?AK O+01H, Ͳ5JB5K G<,=,$ Ͳ5JBCK G<'*N,089$= Ͳ>J6@K #$='9 Ͳ>J35K L,< M,989$=Ͳ>J?BK Ͳ?J66K
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!"#$%&$' (##)$%*+&*,- ./$#)$%*+&*,Source: Accuvest Global Advisors, Bloomberg
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October 2012
!,(&)&!-' Stocks are “high” in the short-term given the big run recently.
“Buy low and sell high” is a trite yet powerful concept. Remembering that basic tenet, however, can keep one focused on pertinent points. The trick comes in knowing when the market is low or high. However, you don’t have to pick tops or bottoms, rather general levels of altitude. In portfolio management, ‘high’ might refer to an extended valuation or perhaps an unattractive relative valuation to other asset classes. On this basis, the equity market is not necessarily high.
Longer-term, the market could be considered “low” given the relative attractiveness versus other asset classes.
Stocks seem attractive in the medium to longer-term based on absolute valuation metrics that are below historical averages and in-line with levels that have created solid returns in the past. (See country ranking data in table that follows). On a relative value basis, stocks also seem attractive compared to bonds on a variety metrics with the earnings yield gap expressing that concept in perhaps the most powerful way (see chart). However, this relative valuation has been stretched even more in the past and can persist over extended periods of time. Relative value therefore also creates a longer-term view of the equity market Country Ranking Data – As of 9/31/2012 0 !+)-*-12 3),4&5 Ͳ 65,)&Ͳ 7$)8
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@J3 55JA CJC DJ3 35J5 BJA BJB 35J6 >JD 35JA AJ? 33J? >BJ6 3CJ? 33JB 53J5 33JA Ͳ>J> AJA 3@JB 3BJ? DJC 33J? 53J6 3DJ3 35J6 @J6 35J>
6J> 6J5 6JC 6J5 6J> Ͳ6J5 6J> 6J3 Ͳ6J3 6J5 Ͳ6J3 6J5 Ͳ6J5 6J5 Ͳ6J3 6J5 6J@ Ͳ6J3 Ͳ6J3 Ͳ6J3 6J6 6J6 6JB Ͳ6J3 Ͳ6J3 6J3 6J? 6J?
CJ@ 36JB BJ? BJ@ Ͳ>J6 AJ> 36J3 3BJ5 3>JD 33J3 @JB 35J3 Ͳ5JC CJD 6JD >J@ 33J> DJ3 BJ5 BJ> 3?J@ DJA CJ@ BJD AJD 36JA ?J? CJ@
CJA 3J? 36J3 @JC ?J3 36J6 35JD 5@J5 53J3 3?J6 @JD ?JD Ͳ5J> 3BJD 3@J@ 55JC 3DJA DJB 3>J3 3AJC ͲDJB 3BJ? 3AJ? CJ3 >?J6 35J3 DJD 5?JD
6J3 Ͳ3JB >J@ 3J5 Ͳ6JC 3J5 Ͳ3JB Ͳ3JB 3J> Ͳ3JA 5J> Ͳ3JB Ͳ3J6 6JD 6JC 3JA Ͳ3JB 6JC 6J@ ?J? Ͳ3JB Ͳ3J> Ͳ3JA 6JA 3J5 5J@ Ͳ6JD 3JA
3?J? 33JB 3>J6 3AJ5 56J3 36J6 35JB 35J5 3@JB 3AJ6 33JA 35JC 53J6 33JC 3@JC 5>JC 3@JB @J@ 3>J5 3?JC 3>J3 3@J5 3BJ@ 55JA 3AJ6 33J3 33J? 3?JC
35J? CJC DJ@ 3>J6 3AJ6 DJ6 36J6 36J3 3?JB 3?J6 CJ6 CJ@ 33J@ CJA 3>JD 3AJC 36J5 @J5 3>J> 33J@ 36J3 35J? 35J? 3?JC 33J> DJD 33J6 35J>
(H$)+1$ 9$'*+- 9+" 9*-
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Source: Accuvest Global Advisors, MSCI
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Octobeer 2012 Earnings Yield Yi Gap
An examp ple of the relattive attractiveeness of stocks can n be seen when meeasured against bonds using ea arnings yield and comparing g to bond yiellds
Source: UBS
Short-term m market direction has h been driven by QE3 and other agg gressive monetaryy policy that mayy not be sustain nable withoutt more economicc stability seeen
In the shorteer-term, ‘high h’ might be m measured moree in terms of tthe price of broad indexes such h as the S&P 500. Levels that reflect a market movee that has gonne too far and too fast compared to market historry, arriving att price levels that could bee considered exhausted, overbought, o extended or otther market vernacular that all means siimply that prices are to oo high. Fortu unately, theree does not havve to be a binaary, all-in or all-out, approach to the “sell high h” mantra. R Risk reductionn in an increm mental, marginnal way can have powerfful effects oveer time. The market may hhave arrived at these kindss of levels now. The ‘sugar high’ h of QE3 continuing, thhe wall of woorry causing bbears to continually capitulate, and a tremendou us cash balannces finding thheir way into stocks on eveery small pullback cou uld drive the market m higheer without a coorrection. Hoowever, a certtain amount of protection n of gains is required r and/oor a modest hharvesting of ggains can alsoo be considered. Finally, rotation within coountry exposuures can, in effect, “buy loow” and “sell high” given g the very y essence of tthe strategy of gaining expposure to attraactive countries (lo ow valuation, strong momeentum, strongg fundamentalls, and low risk) and discarding ones o that do not n possess thoose same traitts. Exploring some of thesse strategies a bit more can give ideas of how portffolios will be managed in tthe near-term. As a starting reference, consid der some assett allocation reecommendatiions currentlyy by some larger bankss.
Views on n asset allocation n reflect the wide range r of views on n risktaking in various timefra ames
Asset Alloca ation Table Firm F Baank of Americca HS SBC JPM Morgan UB BS
Stocks 50% 11% 60% 45%
Bonds 35% 64% 25% 33%
C Cash 3% 5% 115% 6%
Altss 12% % 20% % 15% %
Hedge. Witth volatility lo ow, the cost oof options is aat low levels. Using the VIIX to create a view of this point, it is clear that marrket participaants do not haave to pay as m much as normal for some s ‘insuran nce’ or protecction on the doownside. Thee cost of the ooption is an asset that wiill gradually decay, d but witth a put optioon in place a ccertain amounnt of the
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October 2012 portfolio can be sold at a predetermined price, thus minimizing downside price moves. There is no limit to participating in gains in the market if prices move higher. The cost of the option would be lost in such a scenario, but that is the case with most insurance. The analogy of insurance is appropriate in that the cost of a hypothetical hurricane policy is low if there are presently no clouds in the sky. And just because you have insurance on your home, that doesn’t mean you want a hurricane to appear. However, if it does you are protected. This works well in portfolio management as one can retain intact full exposure to strategies that have been in place with a longer-term view. Volatility Index Volatility is low making options less expensive. Hedging a portion of the equity portfolio during the ‘sugar high’ of QE3 could be prudent
366 C6 A6 ?6 56 6 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635
Harvest gains. Some marginal selling of positions that have run their full course and are expensive relative to other stocks can certainly make sense as well. This kind of management clearly fits in the Tactical ring of CST portfolios which means the portion of a portfolio that can be “in” or “out” of the market must be limited. This is important because there is a risk in making a call that an index, a theme, a country, or a strategy is fully exhausted, can be sold and then re-bought at better levels. Persistent and consistent gains cannot be counted on in this kind of approach.
Country rotation continues to be one of the best tools to get efficent stock market exposures
Rotation of country exposure. A fitting analogy would be that of a horse race; you are not exiting the race, merely changing horses to one that seems to have better prospects from this point in the race. This kind of concept fits with the ‘buy low, sell high’ theme as a portfolio is swapping out of a fully-valued asset into one that is relatively cheap. With a wide disparity amongst countries’ fiscal and monetary policy as well as political stability, the opportunity for meaningful and beneficial relative returns is clear. View again the country ranking data above and note the range in P/E ratios alone of 5.5x to 22.6x. The stock market’s attractive relative valuation should drive prices higher over time. Once again, however, the short-term has been driven by liquidity while fundamentals have waned. The following table shows year-end S&P 500 levels as well as the P/E ratio that would be in place at that time given the analyst’s earnings estimates. This kind of valuation seems reasonably attractive, although notice that forecasts are for index levels more or less in line with where the market is now. The subsequent chart shows how these earnings estimates have been falling as of late which gives one pause when considering current price levels.
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Octobeer 2012 S&P 500 Yeear End Foreecast Table Based on year-end y S&P 500 price targets, PE P ratios will stiill be attracctive Forecasts do show that therre is not much upsiide in the market expected ex from curreent levels
20012 Close
2012 EPS S
20122 PE
1450 1425 1330 1425 1500 1475 1250 1430 1167 1450 1525 1360 1412 1440 1525 1167
$102.00 $98.50 $101.00 $103.00 $100.10 $102.00 $100.00 $105.00 $100.00 $102.00 $102.50 $101.00 $101.22 $101.00 $105.00 $98.50
14.22 14.47 13.17 13.83 14.99 14.46 12.50 13.62 11.67 14.22 14.88 13.47 13.79 14.03 14.99 11.67
Bank of Am merica Bank of Montreal M Barclays Citigroup Credit Suissse Deutsche Bank B Goldman Sachs S JP Morgan n Morgan Stanley Oppenheim mer UBS Wells Farg go Mean Median High Low
S&P 500 In ndex compareed to earnings gs forecasts
However, the S&P 500 hass been rising while earnings forecasts f have deeclined
. Source: UBS
S&P 500 In ndex compareed to previouss market topss
Even th hough market prrices are back neear old highss, the valuationss now are much more attracctive
Source: JP Morgan n
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Octobeer 2012 Historical Bull B Markets
The currrent bull market move m has not rea ached historical averages in term ms of magnitu ude or length of the t move orr
Source: JP Morgan n
ear Decliness vs. Calenda ar Year S&P 500 Movement M durring US Debt Downgrade Possible political p turmoil arround the ‘fiscal clifff’ could create a situation s similar to last summer (2011) when US debt was downgrad ded and the stock k market plung ged
Source: UBS
Corporate Cash C – Amou unt and Uses Corporatiions hold large amo ounts of cash comp pared to history which could leead to shareh holder friendly activity such as dividend d paying, M&A, M and share bu uybacks Source: JP Morgan n
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Octobeer 2012 S&P 500 Historical Hi Retu urns
Source: JP Morgan n
Strategy Keeeping neutral allocations foor potential coontinuation off current markket run. Con nsidering addiitional hedgess at slightly hhigher index leevels. Also hhedging equiity exposure by b utilizing vvolatility contrracts. Add ding volatility y hedged expoosures to US stocks Exp pect tactical op pportunities tto build Satelllite and them matic plays on any weaakness with ex xpectation thaat economy w will stabilize, Europe will m muddle alon ng, and the yeear will end att slightly highher levels thann today. Allocations
!""&'(&)*$+ :U U'$9 7, ,0.9$R #$= ='9 Q1 10,9 T+ +--'9 G1 1+*U !Y0'"9 SU U9'89$= S+ +0X,R P$ $'*,= G*9*,-
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6+&$CC*&$ #$ $&,&:1 1$",$*09*,= "11+$*0R 9881"9*'1 1$71 18= .'$'$( -*1""X&99-'" .9*,0'98- --*1"X7+%&*%+C !% %%.'+/0)+)&;1 189*'8'*R U,=(,== ,[+'*R O. .,0('$( .90X, *)H H*'1$- *1 U,=(,, =1<$-'=,
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October 2012
.&/!0'&$"#%! The Fed has pledged to provide massive liquidity for an indefinite period, meaning rates will stay low for a long time
Modest economic growth coupled with an unambiguously dovish Fed argues for yields to decline further from current levels. Also, as attention shifts to the fiscal cliff at yearend with no resolution in sight, investors’ concerns about an adverse shock to the economy could rise. At current levels, the US economy has been weaker than the Fed forecast at the start of the year, and growth expectations for the next few quarters have steadily trended down. QE3 was announced with language that can only be interpreted as Fed intervention continuing for perhaps years. With the USD retaining safe-haven status, there is little doubt that rates will stay low for an extended period. The accompanying table shows the forecast of top banks of the US Treasury 10-year yield out to the end of 2013. A very slight uptick can be seen, but essentially rates are expected to stay low. 10-Yr Treasury Yield Forecasts (78 forecasts)
Notwithstanding the Fed’s stance, forecasts do show an uptick in yields over the next year
Median Forecast Average Forecast High Forecast Low Forecast
Q3 12 1.7 1.68 2.1 1.25
Q4 12 1.75 1.8 3.25 1.35
Q1 13 1.89 1.93 3.76 1.3
Q2 13 2 2.11 4.03 1.4
Q3 13 2.2 2.27 4.2 1.5
Q4 13 2.4 2.46 4.8 1.5
To be fair, such forecasts have proven to be very incorrect in the past. The most recent example was the near unanimous view that rates were to rise during 2011 to near 4%. However, the fact was that rates declined hard to their current levels. There is little doubt that rates will rise in the future. The 30-year bull market in bonds is essentially over, but it will not be reversed easily. Long Term Bond Yields 3C 3A 3? 35 36 C A ? 5 6 3D@> 3D@@ 3D@B 3D@D 3DA3 3DA> 3DA@ 3DAB 3DAD 3DB3 3DB> 3DB@ 3DBB 3DBD 3DC3 3DC> 3DC@ 3DCB 3DCD 3DD3 3DD> 3DD@ 3DDB 3DDD 5663 566> 566@ 566B 566D 5633
The thirty year bull market in bonds is over if for no other reason than there is not much lower rates can decline
“Don’t Fight the Fed” means, however, that rates are likely to stay low and portfolios can hold bonds knowing that there is an implicit ‘put option” to Bernanke
36 \,90 \',8=- \1\
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Source: Bloomberg
The famous (and accurate) “don’t fight the Fed” maxim is in play now, meaning bonds need to be held in portfolios with a maturity profile that gets out on the curve into an area where there is yield and, perhaps more importantly, where a certain amount of risk can be hedged out of the portfolio. Over the past few years, the truly only noncorrelated asset class to stocks and other risky assets was US Treasury bonds; the longer, the better. Even if yields were to back up and treasury positions declined, it
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Octobeer 2012 Treasuryy bonds also provvide an effective hedge in a ‘risk--off’ environ nment
Credit sprreads are attractivve and should be stable
would undou ubtedly be in the context oof a rallying eequity markett. The flip sidde would also be true,, meaning thee best portfoli o diversificattion can be foound in long bbonds which are im mportant in th he current, hazzy market envvironment. Credit also has h a part in portfolios. p Exxposures acrooss the maturiity spectrum aare being considered, which includ des longer-durration bonds. Additionallyy, dipping dow wn the credit spectrrum is also im mportant as ‘sttealth risk’ exxposures to a low-growth; low interest rate environmentt means attracctive spreads aand stable creedit profiles. H High yield is also part of o this picturee and continuees to be attracctive based onn spreads. It should be noted, howeever, that junk k spreads are nnot as attractiive as they haave been. Still, the carry involved wh hile the econo omy stabilizess and rates rem main low shoould add returnn to the portfolio. The T Fed is sup pporting bondds and liquiditty means creddit should be aavailable for issuers to o roll debt and issue new ppaper. Emerging market m bonds do d have valuee as well. As mentioned inn the FX com mmentary, emerging cu urrencies are attractive a andd sovereign boonds issued inn local currenncies create a unique possitioning oppo ortunity as a ssatellite invesstment. Otheer yield-related strategies are expresseed in a more detailed d way iin the alternattive strategiess portion of thhe portfolio, so ome of which is described iin this BPV. Recent Yield d Curve Movvements
The yield d curve has been n fairly stable sin nce 2009
Source: UBS
High Yield Spreads S and Default Ratees High yield d spreads have narrrowed. Lower defa fault rates reduce som me of the risk in holding h such bonds b
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Octobeer 2012 European Sovereigns S â&#x20AC;&#x201C; 10-yr 1 bond yiields
The criisis in Europe ha as driven bond yieelds to breakdow wn to preEuro diffe ferentials
Source: JP Morgan n
10 Year Treeasury
Yields are a low
A @ ? > 5 3 6 5636 5633 5635 5663 5665 566> 566? 566@ 5566A 566B 5566C 566D 5 Source: Bloomberg g
BBB Corporate Bond Sp preads 3666 Spreadss have narrowed d but are attractivve if the economy is stable
C66 A66 ?66 566 56 663 5665 566 6> 566? 566@@ 566A 566B 566C 566D 5636 5633 5635 5 Source: Bloomberg g
High Yield Bonds B - Spreead to Worst
5635
5633
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High yield d spreads are rela atively attracctive
5@66 5666 3@66 3666 @66 6
Source: Bloomberg g
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October 2012 Emerging Market Bond Spreads 3566 3666 C66 A66 ?66 566 6
Emerging market bond spreads have also narrowed as risk-on environment has taken hold
Source:Bloomberg
Strategy Duration will continue to be extended in US Treasury issues Caution is still warranted as bonds are overbought and subject to large corrections in a risk-on rally. Returns in treasury bonds are mathematically limited at these low levels. Clipping such low coupons will not be tremendously rewarding, even if upside risks are limited. Corporate bonds still have the benefit of above average spreads at a time when rates are extremely low. When expressed as a ratio, the yield on corporates appears even more attractive. Cautious, tactical moves out the yield curve and down the quality spectrum will create meaningful outperformance. Such moves must be on weakness in the bond market and not at times of extreme risk-off sentiment. Allocations !"&'(&)*$+ I'%,0-'Y',= #7 :0,='*
K,-'2 AJL0D :,)$ 1&/+'23 405&'(&)*$+ I+09*'1$ :9-U
6+&$CC*&$ !"&'(&)*$+ V'(U R',8= O.,0('$( .90X,*- ]81"98 "+00,$"R^
' ' ' ' ' ' ' Accuvest Global Advisors 4th Quarter Big Picture View 2012
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October 2012
1*)!2$1)&3!After turbulent performance in Q2 2012, Q3 2012 was characterized by calm price action and a stealthy rally in risk assets. Compared to the volatility and risk aversion seen during the summer of 2011, this summer was pleasant surprise for risk managers. The CBOE Volatility Index (VIX) is currently three times lower than the level registered just twelve months ago. Nonetheless, the hedge fund industry is currently on pace to underperform the S&P500 index for the fourth consecutive year. Managers have struggled with low macro-economic visibility and the absence of stable, tradable, trends lasting for more than a couple of weeks. This yearâ&#x20AC;&#x2122;s equity market returns have been driven by a handful of quick bursts, which have been difficult for managers to time. Furthermore, hedge funds have maintained an extremely cautious approach towards risk over the last 12 to 18 months. As of mid-August, the median equity beta of alternative strategies remained in single digit territory, suggesting near neutral exposure to equities. Hedge fund managers were underexposed to risk assets coming into the summer, and clearly believed that markets needed a new catalyst before they could move higher. The month of September 2012 may be remembered as the month when central bankers around the world took decisive steps to reduce systematic risk. The subsequent announcements by China, the ECB, Fed, and the Bank of Japan may well have been coordinated in an attempt to end the speculation of a hard landing in China, an implosion of the euro zone, an imminent recession in the US, and further economic decline in Japan. As systematic risk has abated and re-priced, markets have rallied and investor sentiment has shifted to cyclical uncertainties. In that respect, we note that the Citigroup Economic Surprise index continues to improve, but is now quite extended to the upside. For the moment, it appears that hedge fund managers have acknowledged a positive shift in systematic risk as recent performance shows increased exposure to equity market directionality. Hedge Fund Risk and Return â&#x20AC;&#x201C; Last 12 months 7% Long/Short Equity Index
6%
Macro Index 5% CTA/Managed Futures Index
Return
4%
Merger/Risk Arbitrage Index
3%
Relative Value Aggregate Index
2%
Event Driven Index Distressed Index
1%
Fixed Income Arbitrage Index 0% Market Neutral Equity Index -1%
Emerging Markets Index
-2% 0%
2%
4%
6%
8%
10%
12%
14%
Volatility Source: PerTrac and HedgeFund.net
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October 2012 Looking forward, a core allocation to a diversified portfolio of alternative strategies will be further build out. Satellite allocations to liquid alternative strategies well-positioned for medium-term relative outperformance will also be emphasized. Satellite strategy allocations are driven by four distinct investment models designed to optimize: volatility contribution, return relative to conditional value at risk, momentum, and fundamentals. Satellite allocations, listed by level of attractiveness, are as follows: x Credit-oriented strategies exposed to spread tightening and the corresponding credit rally. x Event-Driven strategies with exposure to solid equity markets and the revival in Merger and Acquisition deal flow. x L/S Equity strategies with a long bias or net long equity market exposure. x Global Macro strategies positioned to reap profits from commodity and equity exposures while mitigating losses driven by long exposures to fixed income and the USD. Lastly, tactical allocations designed to mitigate the downside risk of an admittedly cloudy macro-economic horizon. Given the ever-present potential for a shock to the financial system, a conservative allocation to managed futures is also part of the portfolio. Trend following strategies, both short-term and long-term, now have a net long exposure to equities; however, these exposures are dynamic and will adjust to capitalize on asset class momentum whether it is positive or negative. Furthermore, in the event of a return to risk aversion and increasing systematic risk, exposure to long duration US Treasuries and put options on global equity indices are in pay. Hedge Fund Returns 2002
2003
Convertible Arbitrage 8.75%
Distressed 28.32%
Macro 8.33%
Event Driven 25.56%
Distressed 3.05% Equity Market Neutral 0.13% Merger Arbitrage -1.86%
Event Driven -4.58%
Equity Hedge -4.71%
2004 Distressed 17.50%
2005 Distressed 6.98%
2006
2007
Event Driven Equity Hedge 15.81% 10.50%
2008
2009
2010
2011
2012
Macro 4.83%
Convertible Arbitrage 60.17%
Convertible Arbitrage 13.19%
Merger Arbitrage 1.48%
Convertible Arbitrage 6.10%
Distressed 28.14%
Distressed 12.10%
Distressed -1.79% Equity Market Neutral -2.12%
Distressed 4.50%
Event Driven Equity Hedge 13.17% 5.83% Equity Market Equity Hedge Equity Hedge Neutral 20.54% 7.68% 4.69%
Distressed 14.72%
Macro 9.12%
Merger Arbitrage 12.88%
Merger Arbitrage 8.58%
Merger Arbitrage -5.37% Equity Market Neutral -5.92%
Merger Arbitrage 3.50% Equity Market Neutral 3.46%
Macro 3.97%
Convertible Arbitrage 12.62%
Event Driven 8.38%
Event Driven -21.82%
Merger Arbitrage 2.48%
Equity Hedge 11.71%
Distressed 6.36%
Distressed -25.20%
Macro 3.29%
Event Driven 1.58%
Convertible Arbitrage 2.95%
Convertible Arbitrage -0.72%
Macro 7.79% Equity Market Neutral 7.70%
Convertible Arbitrage 5.25% Equity Market Neutral 3.47%
Macro 18.88% Convertible Arbitrage 10.16% Merger Arbitrage 7.67% Equity Market Neutral 1.94%
Equity Hedge -26.65% Convertible Arbitrage -33.73%
Equity Hedge Event Driven 24.57% 11.74%
Event Driven 3.88%
Event Driven Equity Hedge Event Driven Equity Hedge 25.04% 10.49% -3.30% 3.52% Equity Merger Market Arbitrage Macro Macro Neutral 11.65% 8.10% -4.15% 2.18%
Macro 4.34% Equity Market Neutral 1.43%
Merger Arbitrage 4.71% Equity Market Neutral 2.81%
Convertible Arbitrage -5.16%
Merger Arbitrage 1.44%
Equity Hedge -8.36%
Macro 1.08%
Source: HFR
The outlook for commodities is being discussed within the Alternatives Asset portion of the BPV going forward. One of the Investment Committeeâ&#x20AC;&#x2122;s key themes is increasing demand for natural resources, so consistent review of the space is relevant, but it fits best in a broader discussion about non-financial assets as a whole. With global growth having stalled, it seems unlikely for commodity prices to continue without a correction which has already unfolded. Weaker demand from China and
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October 2012 Europe has caused oil prices to decline. Grain prices were elevated due to severe drought conditions, but have started to retrench. Monetary policy notwithstanding, the degree of risk undertaken to hold commodity positions currently is too great as Europe, the US and China all lack near-term game changers economically speaking. Best/Worst Commodities YTD Ͳ?6
Ͳ56
G1R2,9$ E,98 G1R2,9$:10$ G'8%,0 _U,9* :1"19 T&)& 79-18'$, 718= M'$" `,9=
6
56
?6
A6
C6 A?JC@
>?J@A 5CJ? 5?JA? 53JA5 3BJC? 3?J@C 35JDA 35J3B 36J6B
G1R2,9$ )'8 Ͳ?JB3 :0+=, )'8 Ͳ@JAD `'%, :9**8, Ͳ@JD@ L9*+098 79ͲCJCD G+(90 ͲDJ?@ `,9$ V1(Ͳ36J5@ :1**1$ Ͳ3DJCB :1YY,, Ͳ5@J?A )09$(, F+'",Ͳ5DJD> Source: Bloomberg
Gold is an interesting exception and has an ongoing place in portfolio construction via gold mining stocks. An uptick in gold prices is likely given the ongoing debasement of USD, unattractiveness of EUR, and too few other currencies to create a deep enough pool for investment. Miners continue to be a leveraged play on this view. Their volatility has been significant recently and there could be some tactical increases and reductions to positions, but the theme continues to have legs. Broad Commodities 5@6 566 3@6 366 @6 6 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635 Source: Bloomberg
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October 2012 Oil Prices 566 3@6 366 @6 6 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635 Source: Bloomberg
Gold Prices 5666 3@66 3666 @66 6 5663 5665 566> 566? 566@ 566A 566B 566C 566D 5636 5633 5635 Source: Bloomberg
Strategy Alternative assets and strategies continue to be important building blocks in portfolios. Broad core exposure will be seen via liquid and transparent vehicles. Focusing satellite exposures in fixed-income arbitrage and event-driven strategies. Building additional commitments focus on long/short equity and global macro strategies. Allocations (C&$)-+&*H$2 A?@0D 6+&$CC*&$ !"&'(&)*$+ Z'W,=Ͳ'$"1., 902'*09(, O%,$* =0'%,$ 9$= E,0(,0 !02'*09(, `1$(aGU10* ,[+'*R 781298 E9"01 1&/+'23 :1$%,0*'28, 902'*09(, Z+$=9.,$*98 0,89*'%, %98+, E90X,* $,+*098 E1.,$*+. 9$= 0,%,0-98405&'(&)*$+ E9$9(,= Y+*+0,I'-*0,--,= -,"+0'*',GH,"'98 -'*+9*'1$/0'%9*, ,[+'*R
Accuvest Global Advisors 4th Quarter Big Picture View 2012
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October 2012
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Octobeer 2012
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Accu uvest Globall Advisors
4th Quarteer Big Picturre View 20112
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October 2012 General Disclosures The material provided in this report is for informational use only and should not be seen as an offer to sell or as a solicitation of an offer to purchase any security or to subscribe to any investment or advisory service. This information was obtained from the disclosed sources and is believed to be reliable. The information is subject to change without notice. Accuvest Global Advisors does not guarantee the accuracy or completeness of the information nor make any warranties with regard to the results that may be obtained from its use. Debt and equity investments associated with certain foreign countries may involve increased volatility and risk due to, among others, political risk, sovereign risk, economic quality, liquidity risk. Differences in the extent of these risks vary from country to country, among investment instruments, and over time. Investing in non-U.S. securities, including ADRs, may entail certain risks. The securities of non-U.S. issuers may not be registered with, nor subject to the reporting requirements of the U.S. Securities and Exchange Commission (SEC). There may be limited information available on foreign securities. Foreign companies are generally not subject to uniform audit and reporting standards, practices and requirements comparable to those of U.S. Securities. Some foreign companies may be less liquid and their prices more volatile than securities of comparable U.S. companies. In addition, exchange rate movements may have an adverse effect on the value of an investment in a foreign stock and its corresponding dividend payment for U.S. investors. Past performance is not indicative of future results. You should not assume that any future performance of any security or country referred to in this Report will be profitable or equal to any corresponding performance levels that might be provided. Investment risks are borne solely by the investor and not by AGA. Where included in this report, MSCI sourced information is the exclusive property of AGA. Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an "as is" basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. Certain names, words, titles, phrases, logos, icons, graphics or designs or other content in this Report are trade names, trademarks, or protected by copyright laws. Any unauthorized re- transmission, copying or modification of trademarks and/or the contents of this Report may be a violation of federal or other law that may apply to trademarks and/or copyrights and could subject the copier to legal action. Unless otherwise authorized, no one has permission to copy, redistribute, reproduce, republish, store in any medium, retransmit, modify or make public or commercial use of, in any form, the information contained in this Report. Accuvest Global Advisors is registered with the SEC. All disclosures and marketing brochures are available upon request.
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