Archived: September 17th, 2009
Investment Policy Committee Newsletter
September 17th, 2009
Personal consumption in the U.S. makes up over 70 percent of the country's gross domestic product, a significant global factor since the U.S. accounts for nearly 25% of the world's GDP. The actions of the U.S. consumer, as measured by the personal savings rate, are therefore vital to the future of the global economy. In the LOM Investment Policy Committee's view, an increase in the U.S. personal savings rate will likely lead to a double dip recession as consumers hunker down and spend less. On the other hand, a decrease in the personal savings rate could lead to a boom for the economy and equity markets but will cause inflation.
LOM believes that this unknown factor, the U.S. consumer's propensity to save, for the next 4 to 6 months will be the essential data in forecasting equity, bond, currency, and commodity price movements.
Our strategy for the next quarter will be to push aside the bulk of the "noise" from economic data and instead focus carefully on the U.S. consumer. In addition to published numbers, we will examine raw data, surveys, and make observational inferences. At this time, the LOM Investment Policy Committee is leaving its strategic asset allocations unchanged. However, we anticipate updating our recommendations as we gain further insight into the behavior of the U.S. consumer.
At our last Investment Policy Committee meeting, we determined that we would lower our equity allocation by 5% if the S&P 500 crossed the 950 mark. In the second half of July, the S&P crossed our target and we reduced our allocation to 45% from 50%. We allocated the 5% balance to cash in order to keep our powder dry .
Fixed Income Markets
Although government bond yields have increased from record lows seen 9 months ago, rates are still at historically low levels. We see very little upside potential from here and believe that it is no longer a question of if rates will rise, but rather a question of when rates will rise. Although unclear when it could take effect, inflation remains a looming concern. In our view, short-term and floating rate bonds are the most attractive fixed income investments since they will relatively outperform longer-term, fixed rate bonds in a rising rate environment. We are also bearish on corporate credit and believe that the risks no longer outweigh the rewards. We are leaving our target bond allocation unchanged at 25.0% with a continued focus on short-term maturities .
The expectation that the U.S. dollar is going down or on the verge of a collapse is almost universal. This short dollar stance is generally based upon the following three reasons: the leftward leaning stance of the U.S. administration, foreign central banks selling their dollar holdings, and because the U.S. trade deficit requires an export of dollars to an increasingly unenthusiastic global audience.
However, change is in the air. In the last 18 months, the U.S. personal savings rate that has gone from almost 0% to 4.2%. If the savings rate holds at 4% to 5%, this means the U.S. will generate around $450 to $550 billion a year in savings. This has implications for the need to export dollars or for the real risk of a reduction in foreign central bank dollar holdings. In politics, as left leaning as some of the rhetoric out of Washington remains, the reform of the U.S. health system has demonstrated that even with a populist president and control of the legislature, dramatic change is not as easy as imagined by the left. Next year the legislature will be facing mid-term elections (1/3 of the Senate and all of the House of Reps), where there will be a likely swing back to the centrist right.
Lastly there is the fact that when any markets view becomes almost universal (i.e. sell the U.S. dollar), there is a strong danger that even a small change in the fundamentals to improve the dollar's prospects can have a dramatic impact on its price. Conversely it would take a significant further degradation of the dollar's prospects to have a significant further sell off. In other words, the risk/return on a dollar short position becomes asymmetrical. We are therefore not as bearish on the dollar as most. At this time, we are leaving our strategic currency allocations static as we review our expectations for the U.S. personal savings rate.
Recommended Global Allocations
|Equities||45.0%||-5.0% ||US Dollar||63.0%||—|
|Alternative ||20.0% ||—||JPN Yen||4.0%||—|
|Cash ||10.0% ||+5.0%||Swiss Francs||4.0%||—|
These recommendations are targets and do not represent specific trade ideas. Not suitable for all investors. For further information call LOM Asset Management Limited or your local Investment Advisor. LOM is licensed to con-duct investment business by the Bermuda Monetary Authority.