We feel the US is now in the second stage of a three-stage economic recovery. The first stage commenced in March 2009, when fiscal and monetary policy stimulus essentially saved markets worldwide from a multi-year depression. That stage has segued into the current stage of inventory rebuilding and the healing of corporate balance sheets. The final stage, which usually completes economic recoveries, is the resumption of job creation and self-sustaining demand growth. Last quarter we felt this stage was stalled, and going into the 3rd Quarter we have real concerns yet some reasons for optimism.
We believe the Federal reserve and the central banks of many developed economies will be hard pressed to raise short-term interest rates until job creation emerges, which we think will be more likely in 2011. For the time being, interest rates remain range-bound. Since there are clear constraints on growth such as looming budget deficits, higher costs of employment and the continued deleveraging of the consumer, we don’t expect this recovery to be as robust as usual. That doesn’t mean, however, that investors cannot find areas of opportunity, particularly in equities. These opportunities are just more rare in this market.
In the US we are seeing a recovery that is very real but very uneven. Sectors such as Technology and Industrials are seeing better relative performance due to the rebuilding of depleted inventories in the wake of the 2008 crisis and recovery of worldwide capital outlays. Consumer cyclical stocks have recovered from 2008’s extreme pessimism due somewhat to a loosening of consumer gloom and demographic growth in some economies. Emerging market consumers continue to gain buying power, and the biggest risk to these economies is not too little growth but too much, too fast. We are encouraged by steps taken in China and India to recognize and address these risks.
Risks to the worldwide economy remain in the form of political risk, deflationary headwinds in developed market economies from budget deficits, continued nagging unemployment, housing oversupply, and tougher earnings comparisons ahead. Governments are being forced to address structural deficits, and defaults are clearly possible. The removal of stimulus and loose monetary policy is also a risk to continued recovery. The skill of central banks as well as the will of governments and the governed will be tested in the months ahead, and the markets are closely watching the drama play out.
For the 3rd Quarter we recommend overweighting of the Technology, Energy & Industrial sectors, underweighting of the Financial, Telecom & Utilities sectors, and neutral weighting of Consumer Staples, Consumer Discretionary, Health Care, Materials and Industrials. We maintain equity and fixed income weightings at neutral levels. We have maintained allocations in international equities and fixed income, and we have increased our weighting to alternative sectors such as real estate and hedge strategies.
Our Core Growth and Income Portfolio, reflecting our neutral portfolio asset allocation biases for the 3rd Quarter 2010,is weighted as follows:
