In BSW Blog, Economic Outlook, Emerging Markets, Portfolio Commentary

Economic Outlook:

From our perspective, the world can currently be categorized into three distinct groups: the stimulists, the austerity camp, and the inflation-hawks.  These categories describe the monetary and fiscal approaches being utilized by each group to address their primary economic concern.  The United States is a stimulist and its primary concern is job growth (or lack thereof).  The US is effectively doing everything it can to stimulate economic growth, and thus job growth, including loose monetary policy (printing money), loose fiscal policy (keeping interest rates low), federal spending, and stimulative tax policy (the extension of the Bush tax cuts).

In Europe, debt levels are the primary concern following the debt crises in Greece, Ireland, Portugal and Spain.  As such, Europe has taken a nearly polar opposite approach to the US and is pursuing austerity.  Austerity, which means enforced or extreme economy, was Merriam-Webster’s most frequently searched word in 2010.  In a nutshell, austerity is tightening one’s financial belt by paying down debt (often by increasing taxes) and reducing spending by cutting benefits and services.

Emerging or developing nations, particularly China and India, are the inflation hawks.  Inflation is a BIG problem in the emerging world because incomes are smaller.  As such, food and energy constitute a much larger portion of an individual’s spending.  In Brazil, Russia, India and China, consumers spend about 20 percent of their income on food, compared with just 6 percent in the U.S.  This dynamic is even direr when energy costs are included, as food and energy account for 33 percent of China’s consumer price index (CPI) and 45 percent of India’s CPI!  This puts emerging economies in a very tough position because central banks typically fight inflation by raising interest rates.  However, with interest rates at zero in the developed world, higher interest rates in the emerging markets attract (hot money) investor capital.  As more money flows in, inflation may actually accelerate because there is more money circulating to buy the same goods and services.  So until the US and Europe begin to raise their own interest rates, the emerging world has been painted into a very tricky economic corner.

Distilling all of this down, the US is doing everything it can to stimulate growth, Europe is spending less and raising taxes, while the emerging world resorts to unconventional means of cooling their economies and slowing inflation.  These policy responses create strong headwinds or tailwinds for investors and, as such, we have positioned our portfolio to take advantage of these evolving dynamics.

2011 Positioning:

US Large Cap & Emerging Markets

The US’ stimulative policy stance should bolster demand and favor US equities, while inflationary pressures and efforts to slow economic growth will create a drag on emerging market equities.  Even with this policy drag, emerging markets will still likely grow more quickly than their developed market peers.

Software & Health Care:

Thus far, the US economic recovery has been a “jobless recovery” with unemployment hovering near 10 percent.  One of the reasons for this lack of job growth is that companies are increasingly trying to boost employee productivity via technology rather than adding workers. The big winners in this scenario are software companies, which still enjoy rather obscene profit margins and pricing power.

The healthcare sector is a fallen-angel of sorts and has languished for several years due to uncertainties and concerns about Obama-care.  With the Republicans winning a Congressional majority this past November and promising to re-visit (or even repeal) Obama-care, healthcare companies’ prospects should brighten.


We hope this Portfolio Commentary provides you with better insight into the components of your growth equity portfolios and our current economic and investment outlook.  If you would like to discuss these positions or your portfolio in greater detail, please don’t hesitate to contact BSW.  As always, we are happy to help.

-David Wolf, Chief Investment Officer

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