BLOG

The economy is normalizing according to a number of measures. The past two years represented a severe adjustment process due to the high debt accumulated during the economic bubble and the high levels of spending relative to income. The recession was in fact an adjustment of consumer behavior, and because consumption is two thirds of GDP, the downward adjustment in personal spending translated into a substantial recession. There is now evidence that a good deal of the adjustment process has occurred, demonstrated by a sharp rise in personal savings rates and a generalized, ongoing reduction in debt.

From this, all economic indicators are following. There has been a marked improvement in manufacturing, sentiment, leading indicators and employment, although we should expect the rebuilding of employment to be slow as companies have excess inventories and capacity which needs to be worked through first. With a rising economy, commodity prices are edging up, with oil nearing $87 per barrel. GDP growth in the fourth quarter of 2009 grew at 5.6%, which was due to an unusually large amount of inventory rebuilding in anticipation of future growth. It will not be so large over the next few quarters, but nonetheless the recovery’s momentum is building.

While inflation remains subdued in the U.S., it is picking up in China. Food represents one third of the Chinese consumption basket, and drought has increased grain and rice prices, while meat prices are up over 70% in recent years. There is also evidence of wage inflation in the coastal regions of China, while real estate prices are spiking. A revaluation of the Chinese Yuan would cool down import prices, because China imports a great deal of oil, food, and commodities, which, because they are priced in dollars, would suddenly become cheaper to the Chinese. It is possible, even likely, that this will occur at some point this year. Given the amount of imports from China, both in the U.S. and the Euro zone, this may result in some price inflation of the goods we import. This may also lead to a lower level of imports, as U.S. goods become more price competitive, which will have a positive impact on the trade deficit.

Investors should note that there are still trillions of dollars sitting in cash, checking accounts and money funds seeking a home in a near zero interest rate environment. With any further signs of recovery, it is quite possible that the liquidity driven rally seen over the past year continues.

The threat to the recovery lies in fiscal rebalancing, as governments cut spending and raise taxes. We are likely to see spending cuts as well as tax increases in the coming years. In some countries, (as in some U.S. states) this will be severe. Favoring tax efficient investments going forward thus makes sense, but only if risks are well taken into account.

Grant Rogers
Partner

Global Disclaimer
This report has been prepared by Metis Capital Management LLC. This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed in this report are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst responsible for the preparation of this report may interact with trading desk personnel, sales personnel, other analysts, journalists, and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Metis Capital Management LLC is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. Metis Capital Management LLC accepts no liability for any loss or damage arising out of the use of all or any part of this report.