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First Quarter, 2006

Judging from the positive price action of domestic stock markets during the first quarter, all appears to be going quite well. Indeed, investor complacency seems to be the rule as evidenced by the low level of the volatility index and the continuing decline in risk premiums for all types of low-quality investments. Even concerns regarding rising domestic and global inflation and interest rates are (for the moment, at least) of no concern to equity investors. Credit for this presently optimistic state of affairs should be given where it is due. The domestic economy is growing at a solid rate. Perhaps most important in this regard are the employment figures which present an encouraging picture of strong corporate growth.

Client portfolio have experienced an extraordinarily strong first quarter in this current environment as the various investment themes and strategies we have described in previous quarterly letters continue to work in our favor.

How long these trends will continue is impossible to predict. It seems to us that the explosion in the price of gold and other precious metals is reflective not only of rising inflation, but also diminishing faith on the part of our global neighbors in the reserve currency status of the dollar. Around the world there is a growing trend to begin diversifying countries’ reserve currencies away from the dollar. As global demand for the dollar begins to decline (as may now be happening), domestic interest rates are likely to increase to entice foreigners to continue lending us money. We think there is a high probability this trend will continue with eventual negative implications for domestic stocks and bonds.

Last quarter we discussed the yield curve inversion with its negative implications for GDP growth six to nine months into the future. We are happy to report now that the inversion risk has receded. You see, for the first time since the Fed began raising short-term interest rates approximately two years ago, long-term rates are now moving higher in line with short rates. Thus, domestic recession concerns (based upon the yield curve) are no longer influencing stock market behavior.

Every six months the International Monetary Fund ( updates its economic databases of world economic growth by regions and by countries in a document entitled "World Economic Outlook." This study enables an interested observer to get their arms around the big picture of capital flows between countries. Why is this important? Perhaps the reason is best explained by the old investment maxim which says that in order to make money with your investments you’ve got to "follow the money." The "World Economic Outlook" puts into clear perspective where "the money" is going. Here is a summary of some interesting facts from the most recent report dated September 30, 2020.

  • Growth in consumption in the U.S. and other industrial countries has been fueled to a significant extent through consumer borrowing, which has its limits. Our fiscal health continues to deteriorate and our debt loads are growing at rapid rates. We are import driven.

  • Emerging markets are increasingly export driven and many emerging market countries are generating governmental budget surpluses for the first time and using these surpluses to pay down their government debt and lend money to the industrialized countries.

  • Inflation rates in emerging market and developing countries continue to decline, while at the same time inflation is gradually increasing in the world’s industrial or developed nations.

  • Private consumption growth in emerging markets is almost twice the rate of industrial countries.

  • Growth rates of global investment in emerging markets are significantly higher than that of industrial countries.

  • Financing conditions in emerging markets are very favorable. Their cost of capital continues to decline. Emerging market bonds of many countries are moving towards investment grade status.
  • Emerging countries’ equity markets have been the best performers in ’03, ’04, ’05 and to date in 2006.

  • Industrial nations of Western Europe, Japan and the U.S. are facing massive increasing fiscal hemorrhaging due to the monetary demands of aging populations and low relative birthrates by global standards. Emerging markets on the other hand, have younger age demographics and rapidly expanding population growth with considerably less strain on their budgets from entitlement programs.

  • Energy consumption is expected to continue rising at a rapid rate in emerging markets for years to come, placing continuous pressure on oil prices. In India, for example, auto ownership is forecast to quadruple by 2030. Some 75-110 million people are projected to enter the labor force in India in the next decade.

  • Ten emerging market countries have repaid their loans to the IMF ahead of schedule in recent years. The IMF’s current loan portfolio is the smallest it’s been since the 1980’s.

  • The report cites a rise in protectionist sentiment in industrialized nations as a potentially significant fly in the ointment for continued robust global growth. U.S. politicians have clearly demonstrated a growing xenophobia in spite of U.S. free trade rhetoric. But China and India, the two most important emerging markets, also contribute to the problem with their own restrictive trade policies.

For us, this Economic Report is akin to peeking into a window and observing fundamental changes in the dynamics of the world’s economies as they unfold before our eyes. The information has served as the impetus for our recent increases in the proportion of client portfolio holdings of non-U.S. equities.


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