Asset Class Returns As At end-July 2010

Its getting interesting as we step into the second half of 2010, which I believe will be quite bullish for equities in general. July was a great month for the major asset classes—prices rose across the board. It was the best calendar month overall for the markets since last November, the last time that all the broad measures of stocks, bonds, REITs and commodities posted gains in a single month. Indeed, the Global Market Index (a passive measure of all the major asset classes) rose 5.7% in July, its best month since May 2009. Looks like I am not the only one starting to take on new positions.

REITs were the big winner, posting a 9.7% return in July. Equities weren’t far behind, particularly in foreign markets, in part because of the falling greenback. The 5.2% retreat in the U.S. Dollar Index (the biggest monthly decline in over a year) helped boost the dollar-based returns in stock markets in developed- and emerging-market nations overall. July’s rebound in stocks generally helped claw back a fair amount of the losses incurred after the previous two months of selling.

In just one month the foreign equity from developed markets have more than overtaken the up-down first 6 months and notched ahead on a year to date basis. Emerging markets equity in the month of July alone has doubled the entire gains for the first 6 months. These are very bullish signs.

The fact that REIT is still the top gainer after gaining more than 50% this year indicates that bottom fishing among the most distressed asset class has gathered momentum.

Meantime, there's the argument that relative valuations have moved in favor of stocks. The bulls say that equities are attractively valued next to bonds, which have posted a strong run so far this year. The Barclays U.S. Aggregate Bond Index is higher by 6.5% through July 31. U.S. equities, meanwhile, are more or less flat. And with the 10-year Treasury yield dipping below 3% last week while US corporate earnings have recently soared to record highs, some strategists think it's time to raise equity allocations and cut back on bonds.

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Equity Strategy 2H 2010 & Asset Class Returns As At end-June 2010

Just passed the halfway mark. REITs finally took a hit, is this the beginning of the double dip. Do I believe in the double dip, yes of course. Only that the dip will be more restrained, not a significant or prolonged dip. Things move in cycles and like pendulums. Share prices are the same, they will sing to one side, over swing a bit and the correct. This is because the data are but collection of human behaviour, and masses will never react perfectly. They will chase a share price that is running until it overshoots, and attract sellers to come in. When the balance shifts to the other side, you will see it overshooting on the downside again.

June was another rough month for risky assets, although the losses were considerably deeper with U.S. stocks from a dollar-based return perspective. REITs also took a hit: for the first time since the opening months of 2009, real estate securities dropped by more than 5% for the second month running.

Bonds held up well in June. This is probably due to the threat of deflation taking a toll on investor sentiment, the safety of fixed-income (even at unusually low yields) attracted capital flows last month like moths to a flame.

US equity took the hardest hit in June. Was this an adjustment to the European crisis and the Euro crisis? Probably. Was it trying to discount a flattening of recovery, probably. Was it due to funds closing their books and squaring off positions and waiting for the right levels to reloan in 2H, absolutely.

But what we all should be focusing at is the YTD figures. Commodities are down by nearly 10% and foreign developed stocks have retreated by more than 13% in dollar terms—the steepest decline for the major asset classes on a year-to-date basis through June’s close. There has been some flight to reserve currency assets, but US equity did follow suit, much of its YTD losses came in the month of June alone.

So we are giving back all gains this year and more. Is this a risk aversion period? I think the sell in May rang true and it coincided with the Greek, Hungarian and Portuguese malaise, followed by the weakening Euro, which threatened demand for exports from the rest of the world.

China had to do a lot of braking in its domestic economy and the Shanghai index reflected that for the past 3 months. Now they have to contend with pressures to have a stronger yuan as well.

Some may cite the fact that many governments have piled on too much debt and that will come back to haunt us. Well yes, but not so soon. No one is going to put a gun to the US and ask them to lower their debts within the next couple of years. While the same seems to be happening in Europe, it is mainly a sovereign issue not a corporate issue.

We are actually still in the midst of a newly created liquidity bubble. Thanks to Bernanke and many of the other governments, we have printed and poured too much liquidity into the global financial system. We are also locked in with globally benign interest rates. Tell me what do the above ingredients make?

But why the recent pullback. Well, even when you are driving a Porsche, you are limited to how far and fast you can go if there is a traffic jam. Be sure, we have a highly powered underlying liquidity revving its engines. We just need the traffic to clear up a bit: Euro steadying a bit; unemployment growth flattening out but not down trending aggressively; corporates continuing to put out good quarterlies; etc.

I have changed my views on the Euro, I think it will stablise here 1.25-1.30 and not go any closer to 1.00 to the USD. Herein lies the key. The Euro crisis may have blighted our views too much. Look closer, most of Europe's top companies are benefiting strongly overall. We missed the picture that this is more a sovereign thing. Many of the companies are already getting an 18%-20% boost in receipts (added competitiveness) thanks to the weaker Euro - we all know that that is more than double the net margins of most companies.



European industrial production actually rose 0.8% in April much better than the average forecast of 0.5%. One of the better leading indicators of economic activity is cargo carriers, Fedex's recently reported that Europe is seeing solid activity, very much different from the picture the media would have us believe.

China may be the weak link in 2H. In addition to the yuan, the high interest rates, the yet to subside property bubble, we now have a snowballing labour issue. The Honda-Foxconn developments should ensure a cascading and rippling effect on all labour wage demands across China, watch it balloon in the coming weeks.

I think US equity and emerging markets equity will be quite positive for most of 2H2010. I see the Dow testing 11,500 and the FBMKLCI testing 1,450 before the year is over.

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Fiscal Deficits, Current Account Surplus & Asset Class Returns As At May 31, 2010

Wow, May was THE month alright. Look at the returns for May. Everything were red except for US bonds. May was the worst month for the major asset classes since the dark days of February 2009. Virtually everything suffered with more than trivial losses. Treasuries were the exception, thanks to the revived rush to safety.

Stocks around the world led the decline, with foreign developed markets posting the biggest loss among the major asset classes. What changed the sentiment so sharply in May? A renewed fear of deflation was one catalyst. Investors are increasingly focusing on the growing burden of debt that weighs on the global economy, particularly in the mature countries of Europe, Japan and the U.S.

It was inevitable that the surge in asset prices across the board would come to an end. That doesn’t mean that expected risk premiums are nil or negative. But the investment landscape ahead is set to become more complicated. In the spring of 2009, as it became clear that the global economy wasn't going to implode after all, the markets repriced assets accordingly. Markets are no longer trading in anticipation of another Great Depression.



We may have avoided another Great Depression but we now have the The Winter of Euro-Discontent. To a large extent, we can say that this is more localised than the subprime mess. In another angle, the Eurozone crisis is a different version of the US/UK subprime mess as well.

The US and UK governments acted swiftly to contain the mess, by rescuing dubious companies that cannot be allowed to fail. The US government can print money liberally and even with an enlarged debt, the US is still the US. Not so for many of the governments in the Eurozone. If Greece was the US, Greece would not have been under such a spotlight. It would have been able to print its way out of its troubles.

What is real is we are going to see a long period of deflation within Eurozone, with equally weighty weights on the Euro currency, and other independent European currencies. Public debt or sovereign debt inhibits movements in or grandiose monetary policies. While they have to placate foreign buyers of the attractiveness of their bonds, they are hamstrung by not being able to do deficit-stimulus. Unemployment and social unrest will only climb.



All this will mean that other countries may be wanting to delay tightening, such as the US, China and a host of more vibrant emerging markets. When investors compare the EU with the rest of the world, its obvious. Then you STILL have a low interest rate regime everywhere, in fact a prolonged low interest rate environment - that will cause funds (now on the sidelines) to pour into the US and other emerging markets. The more EU plays out the cards they were dealt with, the more optimistic I am of a strong equity market for the US and emerging markets in 3Q and 4Q.

Technically, Japan is in a more difficult position with a huge fiscal deficit but they still have a current account surplus, and that should be the key in estimating the probable recovery by EU countries in crisis. Watch their current account movements and signs of improvement will mean they are on the mend. Well, we all know that that is not going to happen till 4Q2010 if not later.

As a side note, Malaysia looks impressive with its strong current account surplus, and owing to our deficit-stimulus funding, our fiscal deficit is a bit high but not exceedingly so. Being an emerging market economy, it would be wise to bring the fiscal deficit down gradually over the next 3 years.

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Asset Class Returns As At end-February 2010

REITs continued to be bought up aggressively as the deep discounts saw many funds taking the plunge to buy for value and recovery. Commercial properties are still a long way off to normalisation but its gratifying to see activity there, and the returns for the past 12 months was nearly 100%.

The trend in February was again one of posting a wide range of results and a shifting pattern of winners and losers on a monthly basis. This isn’t a shock, but more of it is probably coming, meaning that a new set of challenges await for managing asset allocation relative to the trend for much of the past 12 months.

February saw some weakness triggered by the Greece situation. Commodities and US stocks were the only ones posting positive monthly gains. Sovereign debt issues were hit as investors priced in the higher default risk.

I suspect the better performance of REITs and commodities were probably linked to rising yen and dollar carry trades. We can expect more of the same. Other than that, I do not see any strong asset class trends appearing, expect muddling performances from the rest over the next few months.

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