asset management

Market Letter (May 04, 2012)

Markets today: Labor Markets: Apr Non-farm Payrolls disappointed once again (115K vs. 160K [est] & 154K [for Mar after a +34K revision]) as private sector job creation came in sharply weaker (130K vs. 165K [est] & 166K [for Mar after a +45K revision]) but well above the recent ADP report on private employment (119K [Apr]). Revisions to prior two months added a significant 53K: Mar (34K) and Feb (19K). April marks the nineteenth straight monthly increase in payroll employment, which has grown by 3.104mn (or 163k per month) during this period. Its moving average for the rolling quarter now stands at 176 (53K). Within private payrolls, job creation in the Goods-producing sector slowed to 14K (vs. 38K [Mar]), as manufacturing moderated (16K vs. 41K), mining flat-lined and construction fell again (3K vs. 2K). Job creation in the Service-providing sector also decelerated (116K vs. 128K). However, all sectors except Transportation (16.6K vs. 1.8K) and Information (2K) added jobs, which included a big turnaround in Retail Trade, acceleration in Professional/Business Services and Wholesale Trade, and slower gains in Leisure/Hospitality and Education/Health. In the government sector, Federal jobs fell (4K), while State jobs grew very modestly (0.5K). However, bulk of the job losses continue to come from Local governments (12K) and in the education sector (10.7K), unfortunately. On a 12-month roll basis, job losses in government stood at 213K (or 18K per month). Average workweek was unchanged at 34.5hrs, while factory workweek (40.8hrs; 0.1) and overtime (3.4hrs; 0.1) edged up. Average hourly earnings rose to 23.38 (1), but its YoY gain slowed (1.8%) widening its gap with CPI. Household Survey reported a surprise dip in Unemployment Rate (8.1% vs. 8.2% [est & Mar]), as the number of unemployed declined at a slower pace (173K) than the size of the labor force (342K). Number of unemployed also declined sharply (12.5mn; 173K); of which those who have been jobless for 27 weeks or more fell to 5.10mn (207K), or 41.3% (1.2%). Interestingly, those marginally attached to the labor force (2.363mn; 11K) as well as involuntary part-timers (7.85mn; 181K) rose, the latter offsetting the down-bias from contracting labor force on the broad measure of unemployment/underemployment and holding it steady at 14.5%. At an aggregate level, both labor force participation (63.6; 0.2%) and employment-population ratio (58.4; 0.1%) extended their declines. NY: Equities rolled over and the Treasury curve flattened. Dollar surged against all its rivals, except JPY, which caught a safety bid. Oil took a solid beating. Commodities fell across the board, Gold, Silver and Sugar being the exceptions. Volatility spiked in the front-month, but rose more modestly going into the future. Correlation rose sharply. Weekly Close: Dow (13038, 1.4%); S&P (1369, 2.4%); NASDAQ (2956, 3.7%); R2K (792, 4.0%); VIX (19.2, 17%); 10yr (1.89, 6bp); 2/10 (162, 5bp); FN4.0 (80, 1bp); EUR (1.3082, 1.3%); DXY (79.49, 1%); CRB (297, 2.7%); Oil (98.4, 6.2%); Ngas (2.29, 4.7%); Au (1642.6, 1.3%); Ag (30.29, 3.4%); Cu (3.722, 2.57%). Macro Outlook: Unlike in the prior month, we are not so intrigued by todays payroll data, as the hand of seasonality is writ large in its substantial upward revisions, even as stable work-week and upticks in factory hours, overtime and average earnings lend support to our thesis that the pace of thaw in labor markets had not dropped as sharply as the headlines might suggest. Unconvinced by disconnects between the tape and our model predictions, strong retail (and same store) sales and productivity trends, we were categorical in our last months commentary that an upward revision was inevitable: we expect March payroll number to be revised up and do not think it presages the path of employment growth in the months ahead. We remain more sanguine on that front. Todays +28.3% revision to March headline payrolls and +37.2% to its private sector component clearly go beyond the realm of standard error. On the one hand, they point to inefficient data compilation and limitations of seasonal adjustments, but on the other they reassure that job creation is progressing; perhaps with the clich but not as fast as it should be. Numerically speaking, private payrolls have grown 4.247mn (averaging 163K per month) over 26 straight months starting Mar10. However, its 3-month moving average has slowed considerably of late and is now at 183K (49K),

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

asset management

after rising to a recent high of 255K in Feb. Public sectors losing streak seem to have returned, with negative prints for both Apr and Mar, following a minor positive break in Feb, which too was revised down slightly in todays report. Looking at the data in isolation could lead to some concern at this stage that we may be entering a period of Negative Goldilocks that is, payroll data that is neither too weak to prompt a Fed assault, nor too strong to signal accelerated growth. Bernankes recent presser and Fedspeak (including one yesterday by San Frans Tarullo, widely seen as a committed dove) signal that the central bank will be unwilling to step in, unless things get really worse. Besides, approaching US elections also limit policy wiggle room for the Fed, which seeks to maintain neutrality. That being said, our broad macroeconomic analysis takes us to other recent incoming data that do not belong to the high-frequency genre. Firstly, Q1 corporate performance has been good. Earnings growth at 8% was above its longterm average, with 68% of the reporting firms beating expectations. Revenues grew at 6%, which is a very decent clip. Secondly, the Fed revised up its economic projections, pegging the central tendency on GDP growth in 2012 to 2.4% 2.9%. This is significant in the context of Q1 productivity growth slipping into negative territory (0.5%). Thirdly, credit is growing as seen in Beige Book as well as in Senior Loan Officer Surveys (31% [Apr] vs. 19.6% [Jan]). Fourthly, housing is in a bottoming process, if not bottomed already. Shadow inventory is clearing and in some areas supply is coming in short. Investment demand remains strong and affordability is at its highest in recent times. Census Bureau projects a jump in household formations to 1 million units this year (vs. 600K [11]). Even on the high-frequency data front, Claims showed improvement in its most recent print (although it remained elevated during the survey week). Apr ISM Manufacturing came in strong. Also, in todays report, the weakness was centered around Transportation/Warehousing and the Government sector. The former is positively correlated to yesterdays negative surprise on Apr Same Store Sales, which reflected early Easter and warm weather bringing forward spring demand. The latter perhaps is not too much of a surprise and may even get worse as fiscal issues come to the fore. However, there were also areas of strength in Apr payrolls, notably the big rebound in Retail Trade and acceleration in Professional and Business Services hiring. And there were sectors like Leisure/Hospitality and Education/Health, which continue to add jobs, albeit at a much slower pace. Portfolio Strategy: Comparisons were being made on a year-on-year basis over the past several weeks to say that the market may selloff repeating its Q2 performance in 2011 a dj vu moment. Todays weak jobs report might lend a helping hand there. While there are similarities between now and same time last year, there are also some notable differences. For instance, as opposed to complete lack of clarity on Greece then, what we have today are giant LTROs and EFSF, a more pragmatic ECB and a Europe trying to change its tune from austerity to growth. More importantly, ECB and other central banks of the world have essentially taken the left tail risk off the table and remain committed to staying accommodative. Besides, there is no Arab Spring this year and the tensions built up along the Straits of Hormuz have clearly subdued over the past month or so. Credit and funding markets have been stable and there is general belief that co-ordinated policy will act to prevent precipitous chaos sweeping through global markets. Risks however remain, for sure. Europe is still a huge issue, the nature and extent of Chinas slowdown is opaque and the US coast is far from clear. However, to us market participants, price is the only truth and perhaps thats where we find our inspiration to stay constructive amid all this din. Despite mixed to outright-weak data flow, policy uncertainties and inscrutable politics playing out on local and global stages, US equities have displayed remarkable resilience. The ever-present skepticism over growth only seems to guide the market higher. Even in todays sell-off, future volatility did not flare up as expectations down the line appear to be more sanguine than for the present. Similarly, despite the spike in correlation it is still below its 12-month average. Besides, cheaper oil is a catalyst for the economy and stocks, Retail in particular. And re: French elections, there is widespread concern that a socialist victory would mean higher taxes and a business unfriendly government. While that may or may not materialize, for an economic zone that is risking a slide back into serious recession, new leadership could also mean an opportunity to shift away from its stifling austerity framework towards stimulus and growth, which it so desperately needs but has been unable to find a figure to rally behind. Growth, even if it is mostly gesturing, can lift sentiment and markets, and so, a political change in France could even have the opposite effect of what many may have come to expect. Shiva Ganapathy (See marcopoloam.com for more)

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