Expect Increased Volatility As We Move Into a new “Normal”
Corporate earnings and economic growth are not always easy bedfellows; often an increase in one precedes an increase in the other, and vice a versa. This ‘normal’ action causes both volatility and investment opportunities over time. It is not uncommon however for these two “tectonic plates” to stick, then shift violently to cause severe spikes in market volatility and value. A catalyst typically precedes such events. Following three months of seismic activity and pre-shocks we finally witnessed a huge shift this summer as the realisation dawned that economic growth was failing to keep pace with much improved corporate earnings (global credit issues a probable catalyst). Having gyrated in a broad band for much of the year, equity markets capitulated with many recording losses of 10% in less than a week. With much of the pressure having been released will markets revert to normal or can we expect further after-shocks this year?

Conspiracy theorists of the world unite!
As we highlighted in our investment note of Friday there was no one piece of economic or fundamental news that should have caused an almost ten percent sell-off in global equity markets. Mostly the news, whilst not particularly negative, was “tepid” and we were ourselves somewhat surprised at the depth of the reaction. Our thoughts last week were there may be much to consider in the coming 7-10 days as it all seemed a little too contrived.

The stock market can only sit and wait for a political decision.
With less than a fortnight to go before the 2nd August deadline, US Republicans and Democrats continue to disagree over the terms under which the US debt ceiling may be raised in order for the Federal Reseve to continue funding Government spending. Basically, to prevent the economy from shutting down. However, the debate is gridlocked; not helped by the Democrats ceding their majority control in the House of Representatives in the mid-term elections. There has been significant market speculation about what would happen without a resolution but one thing is clear, the consequences would be dire. At the very least, a new financial crisis would quickly emerge. And it would be global.

The policy options on both sides are running out.
As the Greek debt crisis enters a crucial phase, speculation over whether a solution is even possible is leading to greater volatility in stock and bond markets. Predicting how the end game plays out is guesswork hinging as it does entirely on the policy decisions of the IMF, EU,ECB and the Greek Government. A way out of the default scenario may be possible but will require remarkably courageous political decisions which have eluded the various parties thus far.

Directionless markets focus on short term news.
A glance at the chart of any of the major global equity markets reveals that equities have barely moved a step since the beginning of February, around the time when events in Egypt began to escalate. Since then geopolitical events and natural disasters have seen equity markets develop into a saw-edged pattern reflecting very short term “risk on, risk off” trading with no real direction. The financial media attempt to ascribe a wholly discreet reason for every twitch and turn in daily movements, but it remains a frustrating market for those trying to understand whether we are entering the final chapter of the global financial crisis or simply caught in a short term `value trap’ which will see equities enter into a new late-bull stage.

Earthquakes and the Global Supply Chain.
Henry Ford in 1923 is reputed to have said "Any customer can have a car painted any colour - so long as it is black." Ninety years later Ford have now released a statement stating that customers can now order certain models in any colour BUT black as there is a shortage of paint pigments from their Japanese suppliers.

Is the Tragedy in Japan a Tragedy for Global Financial markets?
The Japanese markets were hit hard early Monday morning, with the Nikkei trading sharply lower around the 9,600 level, down 6%, triggered by a panic sell off by investors fearing a slowdown in the Japanese economy following the deadly earthquake. The rest of the markets around the Globe, at this point, seem to have absorbed this bad news and are for the most part trading normally. Though Japan will struggle to recover from this strongest earthquake, we do not expect this to derail the world’s economy and believe the $183 billion injected by the Japanese central bank into its economy will be able to keep its financial system stable.

Will higher oil prices force the hand of Central Banks?
With growing international support for rebel opposition in Libya, including the sending of arms, trade sanctions and embargos, and the seizure of billions of dollars claimed to belong to Gaddafi in Switzerland and the UK, one can only expect tensions in the country, and indeed the region to continue for now. Against this unsettled backdrop in one of the world’s more significant oil producing areas, we discuss the probable effects on both the oil price and the knock on effect for commodity price driven inflation – a key issue for investors this year!

Are the emerging markets becoming overheated?
Recent tensions in Egypt and Tunisia have highlighted the fragility of emerging markets; not necessarily economic fragility, but fragility of sentiment. Following overall strong performance in 2010, investor sentiment has quickly soured leading to significant outflows from funds investing in emerging regions. Below we ask if this is a knee jerk reaction to the Middle East unrest, or symptomatic of a wider problem.

Traversing the financial markets in 2011 will be more straight forward but we must remain viligent as to the path we follow.
We believe that 2011 will be another year of good opportunity for investors able to proactively position themselves to deal with transient volatility and market dislocation we can anticipate. The fragile economic recovery which started in 2009 gathered strength last year and proved resilient enough to overcome a number of obstacles thrown in its path. There are unprecedented global efforts firmly underway to maintain the momentum of the recovery and we expect economic and corporate earnings growth to remain a positive factor. This we believe will lead to a clear polarisation between the performances of individual asset classes. Asset Allocation will be key to performance in 2011.

In this note we review our thoughts and predictions we made at the beginning of 2010.
At the beginning of 2010 many were still shell shocked from the rollercoaster ride that was 2009 but some investors, including us, predicted a profitable investment year for 2010. Indeed we believed that the 2010 would mark the beginning of a new era of opportunity for investors, an era that would not take its cues from the ‘lost decade’ we had just witnessed but one that would see the beginnings of solid longer term growth. Never one to hide behind the annals of time we present, as we do every year, our January 2010 note and throughout this document critically access the preciseness of our thoughts and predictions.

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