Market View - January 2011

The traditional festive rally in global equities during December put the icing on the cake of what was otherwise a difficult and at times traumatic year for equity and bond markets!

Overall returns from investment grade global bonds (as measured by the JP Morgan Global Bond index) were up 6.42% during the year although US Treasuries became decidedly more volatile following the Federal Reserve's announcement in the fourth quarter that it was going ahead with an additional $600 Billion worth of quantitative easing. With the US government's total debt now estimated to be more than $13.7 trillion (which excludes an estimated further $2.8 trillion of states' debt and $2 trillion of agencies' debt), at an average duration of 49 months, many commentators especially outside of America, expressed concern at the authorities' decision to continue with fiscal stimulus instead of introducing austerity measures similar to those we are seeing in the UK and much of Europe.

Only time will tell which strategy least impairs the potential for future economic growth as well as the patience and patronage of the investors invested in the respective countries' debt markets. Of course the ace up the sleeve of the US authorities is that the dollar is the world's reserve currency which effectively (at least in theory) allows it to continue funding its future liabilities through issuing fresh dollars indefinitely.

However with its annual debt refunding rate (i.e. the amount of money it needs to raise to both replenish maturing bonds and fund the budget deficit) currently at $4.3 trillion, the US has to be careful its creditors don't begin to suspect that "the emperor is not really wearing any clothes" and has reached a point where it cannot ever again fund its liabilities without resorting to the printing presses! A recent comment from the FT's Lex column summed up the situation when suggesting that America's credit worthiness could be on the line and that "barring another flight to safety in other asset classes, yields on US Treasuries in 2011 are more likely to test 2010 highs than lows."

The first 2011 edition of The Economist magazine also warned against too much optimism for the coming year in its Buttonwood article titled "In a spin" (in analogous reference to the old television entertainers who would dart to and fro in front of their studio audience frantically trying to ensure that the numerous crockery plates they had spinning on the end of long poles continued to do so for the duration of their act). The article opened with a timely reminder of where we still are in the scheme of things "The banks are weak, the American housing market is still in the doldrums and the global imbalances have not gone away."

The Economist suggested that the main areas of concern remain in place with Europe pursuing austerity, China trying to rein back bank lending, and the US opting for further fiscal stimulus. The article concludes "The authorities have kept the plates spinning by dint of an enormous effort and some unprecedented monetary measures, but the underlying problems have not been solved, and the law of gravity cannot be suspended for ever."

Overall returns from global equities ended positive for the year with the MSCI World index up 7.25% in December to finish 2010 up 9.55%, while the FTSE 100 here in the UK rose 6.53% during the month to end up 9% higher than at the beginning of 2010 and the S&P 500 index in the US climbed 6.53% to end the year 12.78% higher! Even European equities which had hitherto suffered a miserable 2010 on the back of the Sovereign debt crisis joined the party in December to finish up 4.82% over the month and up 4.13% over the year, while as in the previous year (when they rose 74% in 2009) the star of the equity show was the Emerging Markets sector which rose 7.02% in December to give a total return of 16.36% for 2010!

Commodities also had a stellar year albeit combined with high volatility in most cases. Cotton was undoubtedly the star of the show with a gain of around 85% for 2010 while many commentators favourite alternative to the US Dollar as a safe haven, namely gold rose 28%. The worst performing commodity of 2010 was Natural Gas which fell 32% over the year.

So to the future and the inevitable $64 Million question as to whether this is going to be a prosperous year for investors? We remain cautiously optimistic for the coming year, especially for global equities which remain our preferred asset class,  but acknowledge that as in the past few years, risk adjusted returns will not come easily and investors will need to be careful of the many pitfalls that likely lie in wait.

Accordingly we believe that we can look forward with anticipation to the inevitable opportunities that 2011 will provide for us.

Best wishes for a prosperous and happy 2011!