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asset management

Market Letter (Jun 06-10, 2011)

Markets this week: Tepid to outright weak incoming data boosted pessimism and drove investors to the sidelines this week. Weekly Close: Dow (11980, 1.4%); S&P (1274, 1.9%); NASDAQ (2654, 2.8%); R2K (783, 3.1%); VIX (18.49, 3.0%); 10yr (2.97, 2bp); 2/10 (256, -----); FN4.0 (86, 6bp); EUR (1.4342, 2.0%); DXY (74.82, 1.4%); CRB (347.9, 0.2%); Oil (99.25, 0.97%); Ngas (4.76, 1.0%); Au (1533, 0.6%); Ag (36.32, 0.36%); Cu (4.05, 1.9%). Macro Outlook: The combination of structurally weak economic recovery in OECD countries, central bank tightening in Emerging Markets to combat inflation and the chain of events (ending of QE2, supply disruptions following Japanese earthquake/tsunami, higher inflation from surging energy and food costs, extreme weather, Washington gridlock over extending the debt limit, cutting deficit, regulatory reform and concern over government shutdown, etc.) riding on seasonality has led to softness in market sentiment. However, US and global economic expansion are much better entrenched now than a year ago, when BP oil spill, Greek debt crisis, Flash crash and angst over healthcare and financial sector reforms persuaded businesses to take a wait-and-see approach, and undermined confidence. However, as many discovered last summer, overly pessimistic extrapolations could mean missed opportunities. We earlier noted that oil price decline holds the key to fresh impetus that would re-accelerate the global recovery at this stage. The willingness on the part of S/Arabia, Kuwait and UAE to pump more, the potential ending of the Gadhafi regime, and the de-escalation of the crisis in the Middle East and Nigeria constitute strong supply-side responses in this regard. At the same time, deflating real wages and the shift towards savings in order to consolidate household balance-sheets will continue to dampen the demand side and lead to greater stability by driving the oil price lower. In addition, there could also be some policy maneuvering targeted to bring down the oil price. Another key ingredient to infuse momentum back into global recovery is Asian growth. The concern over China slowing is very valid, but we must note here that the YoY gain in inflation has a significant base-effect at this stage which will start to fade away post Jun. We would be keenly watching to see if PBoC raises rates over this week-end. We also like to think that too much is being read into what was unsaid by Bernanke that he gave no hint of QE3. Be that as it may, the Fed still has plenty of ammunition, nonetheless. As we wrote on 06/02: .. the Fed can provide incremental stimulus by incenting banks to draw down their excess reserves and extend credit, maintaining the size of its asset purchase program through re-investment, and being on hold longer with regard to rates. Amid pervasive pessimism investors have chosen to ignore the strength of the corporate sector, which today has the wherewithal to hire, in a meaningful way. With productivity declining at the margin (1.3% vs. 2% [Q410]), costcutting as a strategy has peaked and any recovery in aggregate demand has to be met through the labor market. For instance, our forecast of 2.6% GDP growth may well mean creation of an incremental 100K jobs per month. Bottom-line: Technical factors, which by definition are temporary in nature, are weighing on the economy and markets at the present juncture. Of course, not everything is technical. Structural factors continue to cast their long shadows, but that is not new data. Even as the current recovery lacks the strength to print a 4 handle on growth, it can still muster a decent number, albeit below-par. The gradual pick-up we see in money supply signals improving demand for and supply of credit, which the Fed could facilitate with its policy tools. Besides, some fiscal measures, such as extending payroll tax cuts, are also within the realm of possibilities. Therefore we remain relatively sanguine that the recovery may start to re-accelerate by late summer. Click here to access our top global macro calls for 2011. Portfolio Strategy:
Click here to access our Q2 2011 asset allocation schematic.

Shiva Ganapathy

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This proprietary and confidential document is a market commentary meant for informational purpose only and not an advice or solicitation or an offer to enter into any transaction.

Marco Polo Asset Management

75 Broad Street, New York