August 2010  

CARMIGNAC v i e w s

"I would prefer not to": this is how Bartleby, a scrivener for a Wall Street lawyer in Herman Melville's wonderful novella, gradually withdrew from all professional activity. With each new task that his boss set for him, Bartleby offered this ambiguous yet absolute form of refusal, to the point of absurdity. Personally, I haven't reached that stage, far from it, even in this holiday period. The global economy is changing all the time. The US economy is slowing, Europe is enjoying some respite and we are approaching the end of monetary tightening in the emerging countries. This scenario is materialising, as we wrote in our June reports. As a result, we have maintained a low level of exposure to the euro and have significantly underweighted equities. However, this summer transition period triggered a sharp fall for the dollar (-9% for the dollar index since 4 June) and a strong recovery for the most vulnerable sectors of the equity market (+27% for European banks since the low of 8 June). I would prefer not to have to say it but we did not handle these developments as well as we could have done over the month. Questions concerning the global economy and asset allocation are still tricky and it would be hard for us to offer specific, definitive answers. I would prefer not to make an attempt. The first and undoubtedly the most important concerns the US economy.

Annualised growth of 2.4% in the second quarter was obviously disappointing after rates of 3.7% and 5.6% for the previous two quarters. This is in no way surprising, as we had already explained in late June, "[an] economic downturn... is inevitable at this stage of the cycle". After contributing 1.9% to Q1 growth, inventory building accounted for just 1% in the second quarter. Investment contributed 2.1% to this growth, a satisfactory figure that rules out a further downturn in the US economy. However, net exports reduced growth by 2.8% as imports rebounded considerably. Consumer spending was also disappointing, contributing just 1.1% to Q2 growth. We could see this coming though. With unemployment at 9.5% (and a real figure possibly closer to 16% taking into account those who have given up looking for a job) and hourly wages up just 1% in real terms, one cannot expect miracles from US households. Should we be worrying about this tre nd already? We do not think so. We can expect modest nominal growth and low inflation on a medium-term horizon. Lest we forget, deleveraging is at work and has only just begun. It is worth remembering that total US debt peaked at 373% of GDP in Q1 2009, compared with 299% during the Great Depression. Since then, total debt has started to fall for the first time since 1946. At the end of Q1 2010, it stood at USD 52.1 trillion, i.e. 357% of GDP, down just 16bp from its previous high. 

This debt paring will take time and mean that growth will be structurally weaker than it has been over the last 20 years. This justifies the caution of the Federal Reserve and the Obama administration. Larry Summers, top economic advisor for the White House, took part in the fierce debate between economists in favour of immediate fiscal austerity and those who, like Summers, believe that supporting growth at the expense of a temporary widening of the budget deficit is the only way to generate a level of growth that would help stabilise public debt over the longer term. I would prefer not to enter the debate but what is important, and is worth noting, is that Keynesian stimulus is always a possible weapon in the fight to sustain an economy (and, incidentally, to avoid losing elections in November). Ben Bernanke, for his part, did not hesitate to highlight over the last few days the uncertainty surrounding the US economic recovery, its sustainability and its ability to create jobs. With the job market sluggish and the real estate sector struggling to regain its balance, the Fed's caution is justifiable. As such, the institution is ready to step in once again to reintroduce quantitative monetary measures that would support activity, employment and prices. Indeed, retail price inflation of just 1.1% has to make some kind of impression on Bernanke, a specialist in the Great Depression; as does a virtual absence of growth over the last five years. Indeed, since the first quarter of 2006, US GDP has been fluctuating around USD 13 trillion. These five years of stagnation are reminiscent of Japan's 10 years of lost growth. 

This explains the low interest rates. For example, after peaking close to 1.17% in early April, 2-year US government bond yields have fallen to 0.55% today. We identified the reasons behind a slowing of US growth but failed to attach enough importance to them. Justifiably fearing the situation in Europe, we underestimated the impact of the US/German 2-year yield spread on the EUR/USD exchange rate. This spread has gone from a premium of 34bp on US yields at the end of May to a discount of 21bp today. We made some adjustments at this point, reducing our dollar exposure to 45% for Carmignac Investissement and 38% for Carmignac Patrimoine.