29 February 2012

Market Update and Portfolio Strategy

Recent Economic Developments

The US continues to lead improvements in the global economy. Recent numbers from both the jobs and housing sectors (in the US) point to better days ahead for the US economy. Rising sales of existing homes is pushing supply down to 5.6 months (Figure 1), the lowest level of inventory since the economic recovery which started in 2009. We expect demand for housing should pick up and spur new housing construction now that affordability is high (Figure 2).

Figure 1: Months of supply of homes at a new low.

Figure 2: Housing affordability at an all time high.

Judging by the fall in unemployment claims, the jobs sector is improving (Figure 3). Back in 2010 and 2011, economic risks surfaced when unemployment claims failed to improve. As such, a continued decline in unemployment claims will now be indicative of the increased hiring by corporate America, and possibly how far the rally in risk assets can go.

Figure 3: Unemployment insurance claims falling.

Perhaps one of the most watched events would be the ECB's second tranche of the Long Term Refinancing Operations (LTRO). Having seen how successful the first LTRO was in Dec 2011, investors may have high expectations on the take up rate and the potential impact on financial markets. Now that European financial stocks are up 29% since late November, quite a fair bit of financial market stability has already been priced into the markets. There is a good chance that credit may actually flow to the real economy this time round as industrial companies with bank licenses may tap the LTRO for the first time1. Signs of recovery are also showing in Europe where Germany's iFO business climate indicator continues to rise2.

Market Development

Risk markets appear to be consolidating, with oil prices at $109 being the excuse to book some profit. Eventually high oil prices will act as a headwind sometime in the future. For now, signals from various markets suggest risk appetite is rising and economic growth looks sustainable. Cyclical stocks continue to outperform the market while defensives lag. Fixed income indicators show credit risk falling while investors continue to prefer yield over safety. One negative signal we see is the outperformance of precious metals over industrial metals (Figure 4). Nonetheless, so long as industrial metal prices continue to rise, the benefit of doubt should be given to the current 'risk-on' trade.

Figure 4: Precious metals outperforming industrial metals


We see markets likely to consolidate for now. However, based on market signals, we expect economic momentum as likely to be sustained in the months ahead.

Portfolio Positions

We have shifted to portfolio neutral to portfolio overweight equity positions in the last rebalancing call just before Chinese New Year. We do not advocate any further changes at this time. Please talk to your advisers if you have not yet rebalanced your portfolios as this market consolidation is presenting a good opportunity to do so.

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