CI Outlook - Archives

December 2011

December 1, 2011

Yesterday the market shot up in dramatic fashion.  When the smoke cleared the S&P was still down for the month.  And November was another volatile month with huge swings in both directions.  However, there were no real surprises.  As we wrote last month, the focus remained on Europe and to some extent China.  And in both cases the relevant central banks stepped in and saved the day.  The European banks received a necessary shot of liquidity from the central banks of seven different countries.  And by reducing reserve requirements, the Chinese government affirmed its change in focus from fighting inflation to aiding growth.  These two things are important.

First, in the case of the Chinese, we continue to believe they along with other developing nations will be the engine of expansion for the future world economy.  As you know we had liquidated our overseas holdings and refocused domestically going into 2010.  At that time we believed the combination of higher interest rates and inflation in the emerging world would slow their economies and crush their equity markets.  That was the result.  We also wrote that we would be looking to redeploy capital outside of the US when the time came.  That time is getting very close.  We believe China’s reserve cuts are the first sign (green shoots) that rapid growth will resume in the emerging markets.  In our minds that time frame is about to begin and if so our primary investments in overseas markets will be in ETF’s.  However if some specific securities fit the proper criteria we may buy them for you if appropriate.

In the second case, Europe, the central bank action is important for different reasons.  You may recall from previous letters we have believed that Europe never “took its medicine” as we did here in the US.  After the 2007-2008 banking debacle our institutions recognized their bad loans and took the appropriate actions to shore up their finances.  Europe’s banks, on the other hand, continued to deny they had any large quantities of bad loans, mortgage backed or otherwise.  Now their banks are facing the music.  The major problem for those banks is the structure of their funding sources.  Unlike banks in the US, most European banks are highly dependent on very short term, even overnight funding.  Therefore when confidence is disturbed their source of funds dries up, since in that situation no bank will lend to another.  Importantly, even if banks will lend they will only do so at very high interest rates.  That is why the coordinated central bank intervention yesterday was so important.  New cheaper funds became available, and for the time being European banks are freed up to buy the newly issued government paper necessary to finance the troubled members of the EU. 

So how does this tie together to help us make investment decisions.  First, the EC is China’s biggest customer.  Without them China’s growth slows.  Without demand fueled by Chinese growth, world economic expansion slows.  That in turn slows US export growth and our economy.  The bottom line is yesterday is the first coordinated move in trying to re-inflate the world economy.  Although we think this bought the EC some time we must still wait and see if they are successful in stabilizing their economies.  If so it is time to again invest in Brazil, Asia and other rapidly growing areas of the world.  If not our defensive positions in US based income investments is the cheapest safest place to position your portfolio.  Next year will be the time when those decisions will need to be made.  In the meantime we will continue to hope for the seasonal strength we all call the Santa Claus rally.

We hope this letter explains our current thinking.  As always we would love the chance to discuss our thinking or your investments with you.  Please call us with any questions or comments. 

Season’s Greetings,

CJ Brott               Karen Burns

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