Nevertheless, while taking all this into account by increasing slightly exposure to equity markets, we remain of
the view that the economy is still not out of the woods. Letters are often used to describe the scenario for getting out of recession: L-shaped, V or W shaped but one can wonder if the scenario might take a shape that is not present in our 24 letter alphabet… Interestingly, additional stimulus packages have been ruled out in the US in spite of an unemployment rate which is pointing towards the 10% mark. In such an environment, the “biggest consumer” in the world is worried and the savings rate in the US is raising steadily, a trend which is not helping
the exit from recession. Indeed, various advanced indicators such as the “Baltic Dry Index” (Shipping) continue to deteriorate.
As it is the case for many, we highlight the main two obstacles to a long lasting recovery being the indebteness level of governments and unemployment that continues to grow unabated. One must not forget that the Equity markets have performed in a very nice manner and so did credit markets. A parallel between these two in such a magnitude and for such a long period of time is highly unusual. With credit spreads having now narrowed back to pre-Lehman (and in some instances pre-subprime levels) we see much less value in the credit markets in which we
have advised to be very active. Currently,apart from some value in the carry, we do not expect much gains to be made on the tightening trend which has now more or less reached a plateau. During these past months, the Bond markets have normalised while Equity markets are still quite behind and away from their pre-crisis levels, leaving theoretically some potential for further appreciation.
The past semester has by all means been exceptional as contributing factors to a good performance were actually very little dependant on the Asset Allocation: Whether overweight in corporate bonds or Equities, the results are almost the same and very satisfying: It is very possible that many will be tempted to preserve Year-to-Date performance and move to the sidelines for a while.
Even if some fundamental reasons are valid in terms of explaining the recent equity market strength, one must also remember that there were very few alternatives, pushing investors to follow the momentum wherever it appeared: This lack of alternatives has become even more critical now that credit spread tigtening is nearly over: Investors cannot satisfy themselves with the yields given by money markets nor those of government bonds. The likelihood that they will now try and find new opportnities is high. We think that, in such a context, the real estate market has good chances to attract some renewed interest notably on the basis of its potential to offer some yields with a “relatively” limited downside risk. Selectivity of vehicles is going to be paramount!

Opportunities and how to seize them:
● The level of rates, credit spreads and even Equity markets leave little room for real untapped potential. Overall, we continue to carry existing positions in corporate debt, not really looking for further capital appreciation (either from rates movements or spreads tightening) extend progressively but in an orderly manner the Equities positions on market retracements and start searching for new alternatives where momentum might pick-up.
● On the currencies front we maintain our stance that is to view the EUR and the USD as weak currencies versus others, particularly those of developing countries with a strong budget and natural resources. Sterling has stabilized but remains – over the long term – at unattractive levels.
● We continue to take progressively profit in the BRL debt (currency based). We find the BRL to have lost some potential but the fat coupons remain interesting and offer nice carry for so long as the currency keeps at least stable.
● As per commodities our view on the Natural gas bounce has started being beneficial and should extend. Regarding industrial metals and Agricultural commodities, our recent positioning has offered very little return over the month of September but we are maintaining it on fundamental views and low levels. At least neutral exposure to precious metals is recommended as ballooning Central Banks balance sheets allow for future inflation jumps even if this is not expected to happen very shortly.
● In the Equity markets, position increases will be in the segment of subcontractors who have suffered from large companies (their contractors) taking a very harsh stance on cost control, delaying some expenses, Capex or various contracts. As these companies are now in a better shape, there will be room for such expenditures to resume, benefitting segments such as Media (only a little) Computer services, Heavy Machinery (that might
be a little soon though). We continue to make a strong stance on detailed analysis in order to assess value, looking at the financials, competitive positioning in order to select the right companies.
● We continue to avoid Car, “financing” companies and Airlines. Our exposure to financials remains more biased towards insurance companies than banks. We suggest directing exposure to Emerging Markets with a bit more weight towards Asia Pacific and still avoid China and suggest taking profits in Latam very soon even if the economy in countries such as Brazil are in much better shape than others.
● We continue to advise to buy liquid non-directional funds such as quantitative/statistical funds as a buffer for directional exposure taken in other asset classes.
● Real Estate vehicles are being analysed in order to add some yield potential to portfolios.
● Our Key Words remain Tradability, Simplicity, Diversification and Reactivity.
http://www.espiritosanto.com