Monday, May 9, 2011

Soft Patch Upon Us

A number of indicators have led us to believe that the economy is probably slowing at the moment. For example, regional manufacturing surveys have been trending down recently, unemployment insurance claims may have broken their previous downtrend, the Economic Cycle Research Institute recently issued a warning based on their Long Leading Index, defensive equity sectors have been outperforming, commodities took a big hit last week, and treasury bonds have been rallying. On balance, it would seem that recent evidence is pointing to an ebbing in global growth.

Some slowing doesn’t have to be catastrophic, and could have the positive side effect of reducing commodity prices (which should help profit margin pressures that were building) and giving the Federal Reserve plenty of reason to remain accommodative, or dare I say an excuse to implement a QE3 program? In other words, this could be the elixir that leads to one last leg higher for the equity market. On the other hand, any time growth begins to slow investors should be on guard for worse than a benign outcome, and we will be keeping our antenna up in case an easing in growth looks like it’s becoming material, and of a more malignant nature.

From a positioning standpoint, we are now focusing on our commodity positions, which don’t seem like a good bet if growth is slowing. In the very short term they are likely oversold after last week and could bounce. If we get it, we think it will be a good chance to sell. We are also taking a look at some of our high beta positions, and will be scrutinizing our bond exposure given a slower growth environment since we are currently underweight duration. We don’t feel it’s time to adopt a maximum defensive posture yet, but some minor adjustments and a close eye on incoming data is the order of the day.