26 April 2012

Market Update and Portfolio Strategy

Recent Economic Development

Recent economic data released continues to be mixed. In the US, retail sales numbers were strong, coming in better than expected and continuing the uptrend (see Figure 1). Manufacturing numbers were mixed with industrial production unchanged in March whilst durable goods orders declined more than was expected. Nonetheless, despite the weakness, the overall trend remains up for the industrial sector (see Figure 2).

Figure 1: US retail sales

Figure 2: US industrial production

US housing appears to have given the economy some hope. While home prices continue to decline, the rate is slowing (Figure 3). More importantly, new home sales appear to be improving. March numbers came in better than expected (328,000 versus and expected 318,000) while January and February data were revised upwards.

Figure 3: US home prices (year-on-year % change)

There has been some anxiety over the labour market with jobless claims inching up (Figure 4). While it pays to be watchful, other labour market leading indicators remain healthy.

Figure 4: US jobless claims

Over in Europe, a spate of flash PMI estimates confirms the challenges faced by European economies. Even Germany faces a contraction in its manufacturing sector, with the index falling to 46.3. The good news is that the larger sample-sized Ifo business climate survey continues to report an improvement in both the 'business situation' and 'business expectations' indices.

Figure 5: Germany's Ifo survey

Market Development

Markets have been in a correction mode for a while, triggered by worries over Spain and the mixed economic data. The success of recent bond auctions by various governments, including the just resigned Dutch government, confirmed that investors are still attracted to European paper so long as it is priced correctly. In essence, the ECB's long term refinancing operation (LTRO) seems to be working even as banks try to price the government papers accordingly.

Meanwhile, credit stress has been quite contained despite the European worries. TED spreads are stable (Figure 6) while fixed income investors are beginning to take on risk, favoring high yield bonds over US government paper (Figure 7).

Image courtesy of Stockcharts.com

Figure 6: TED spreads

Image courtesy of Stockcharts.com

Figure 7: Relative performance of high yield bonds versus US treasuries

If bonds are a good leading indicator, then the recovery in emerging market bonds (Figure 8) and high yield bonds (Figure 9) is a positive signal for equities. They have almost recovered the losses caused by the most recent correction and are headed for new highs.

Image courtesy of Stockcharts.com

Figure 8: Emerging market bonds

Image courtesy of Stockcharts.com

Figure 9: High Yield Bonds


Despite the worries emanating from Europe, we have yet to see a significant deterioration in risk appetite. Overall market signals remain positive during the correction with signs of improvement. We are thus of the view that the uptrend which started since December 2011 remains intact.

Portfolio Positions

No change to our overall portfolio positions for now. However for our core fund, the fund managers are seeking to deploy the extra cash to take advantage of low equity prices in emerging markets.

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