JANUARY 2011                                                                     Download PDF Version

Continuing to Manage Uncertainty

This is the time of the year for analysis of the past 12 months and predictions for the year to come. At Clarmond we prefer not to indulge in either of these exercises. Looking back normally brings disappointment for missed opportunities and looking forward should be a continuous exercise based on much longer term valuation models rather than merely being linked to changing of a date. However, the great and the good always publish their targets for the main indices and therefore, for interest only, below is a table of a number bank estimates for the year end level of the S&P 500:

It is even more interesting to examine the recent history of the banks’ year end predictions. Below are similar estimates for the years ending December 2008, 2009 and 2010. 

It is slightly unfair to reproduce these tables as not only do we ourselves never make similar predictions but also banks will review and alter their estimates throughout the year. These revisions again highlight the pointlessness of these year-end predictions as events can move so unexpectedly during the year; 2010 is a classic example of this. By mid-August the S&P 500 was down 6% for the year, Bernanke then outlined the second round of Quantitative Easing during his speech at Jackson Hole and subsequently the US markets rallied 20%. In December alone the S&P strengthened by 6.5%, approximately half of the gain for the year.

Therefore, although the various bank estimates look pretty accurate for 2010 the markets arrived there by an unexpected route; as David Rosenberg of Gluskon Shefff puts it ‘what is fascinating in the markets is that so many people can be right despite all their assumptions and lines of reasoning being totally off base’.

The December markets of 2010 were driven largely by sentiment and therefore, while it is dangerous to swim against a strong sentiment-driven market, in the remainder of this letter we will outline what we consider to be the fundamental issues that we will be concentrating on in 2011 in order to manage this year’s uncertainty.


Recovery Continues
History has shown that a financial crisis can lead to years of sub-trend growth, and therefore following such a substantial crisis a slow recovery should be anticipated. The recession, that ended in the US in June 2009, was the longest and deepest since World War II, and, because it was a financial crisis that led us in to the recession we have not enjoyed the ‘normal’ rapid expansion.

However, neither have we experienced a ‘double dip’ and therefore, by default, the developed world is now recovering. President Obama, in the third year of a his four year term with his popularity at a low, is not going to ‘do austerity’ and risk the economy stalling; his extension of the Bush tax cuts is an example of this determination. There is nothing to suggest that the normal cycle is different this time, it is just going to take longer.


Corporate Profitability
The largest companies in the S&P are sitting on surplus cash of $900bn, which is 10% more than 12 months ago. This will almost certainly lead to the following:

  1. Dividend payments being maintained and improved;

  2. Stock buy-backs continuing; and

  3. Merger and Acquisition activity increasing in 2011.

Corporates will also be benefitting as their margins will improve from recent cost cutting and the continuing low interest rates. In conjunction with these positive underlying factors we expect the search for yield to continue in 2011. Investors will rotate out of fixed income as they will seek good yields from a basket of global blue-chip companies. 


US Structural Issues
The US economy has a number of stubborn structural issues which are refusing to show signs of improvement. We are looking at the following with particular interest:

  1. Unemployment
    Unemployment remains stuck at high levels. The graph below shows the gravity of the current employment market.

While there has been some slight improvement the unemployment rate remains stuck over 9% and it is clear that it will take many years to return to the ‘normal’ 5% rate. Part of this will be a function of the statistics because as employment does improve then people who have given up looking for work will want to return to the workforce and thereby return to the ranks of the statistically unemployed; so expect the figure to stay stuck at higher levels for some time to come.

  1. Housing
    The housing market remains static with the Case Shiller index of leading cities showing a downturn towards the end of 2010. A sustained improvement in the housing market is an important foundation for the recovery of the wider market.

  2. Politics
    Although nationally the President is not ‘doing austerity’ at state level there is little option; Governors have to fill their budget gaps through tax hikes and service cutbacks. This has already led to a fall in the current government’s popularity, the rise in support for the right wing Tea Party and the current political stalemate in Congress. It is not yet clear whether the Democrats and Republicans will be able to work together; it must be hoped that the recent shooting in Tucson, Arizona, will foster a greater sense of cooperation.

An Asian Slowdown
Asia did not suffer the financial meltdown of the West. The Asian and Chinese consumer were great contributors to the growth of 2010 and we believe that this trend, over the medium-to-long term is an important investment theme. However, many Asian economies are overheating and their governments are using traditional monetary policy in order to slow them down. This would not necessarily be a negative. However, if Asia is seen to decelerate while the West remains at a lower level of growth this may lead to market jitters. Furthermore the Emerging Markets are attracting substantial capital inflows which will force governments’ hands and already certain countries are enforcing capital controls.

European Sovereign Crisis
The European debt crisis is far from over and will continue to rumble on through 2011 and beyond; as I write the spotlight has moved on to Portugal (which seems to have come through the first test) and the graph below shows the spreads over Germany of the main ‘problem countries’.

Bond Bubble?
The Western fixed income market is a nerve-wracking place to invest at the moment. Interest rates are low and inflation will be coming back into the market at some point over the next 12- 24 months. There is very little upside now in the bond market but plenty or downside and we are emphasizing to clients the need to re-assess their portfolios in light of this. Whether bonds are in a bubble or just suffering from a slow puncture the risk/reward is clearly not there.


  1. Recovery continues, although at a slow pace.

  2. Preference for developed equities over the emerging markets, although emerging markets remain important long-term positions.

  3. In developed equities prefer high yielding blue-chips (although this is now a consensus trade).

  4. Select active managers over generalist ETFs as the market is currently perfect for proven stock pickers.

  5. Avoid fixed income and carefully analyse any existing positions.

  6. For new money a barbell approach is required between equities and a larger cash position.

  7. Expect greater volatility in 2011.

Please do not hesitate to contact Christopher Andrew:

Christopher Andrew
Tel: +44 20 7060 1400    




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