Groundhog Day – The European Edition
Reminiscent of the 1993 film where Bill Murray finds himself repeating Groundhog Day over and over again, global capital markets again are being held hostage by the rolling sovereign crisis in Europe. The steep market sell-off in recent weeks serves as a vivid reminder that the path toward a "solution" in Europe will be neither linear nor quick. With Greece flirting with an exit from the EU, sovereign yields in Italy and Spain around 6 percent and global capital fleeing for safety--volatility-weary investors are finding these events as tiresome as waiting for a rodent to see his shadow.
What is the endgame for Europe? Never underestimate the ability of policy makers to find a new way to "kick the can" down the road. Though in the near-term; government leaders are opting for the most politically expedient path--ultimately they will be forced to act in the best interests of their respective nations. For Greece, we believe they will come to their senses and realize that the costs of exiting the Euro are so high that they will accept austerity terms and remain. For Germany, we anticipate that they will eventually endorse a closer fiscal union. In short, we believe that the 17-member European Union will remain intact … for now.
Much can still go "right"
Market volatility will most certainly remain elevated as the media continues to provide nonstop coverage of the potential for a financial contagion in Europe, stubbornly high unemployment in America and an uncertain economic growth rate in China. The aforementioned risks not withstanding, with equities underowned and undervalued, there are a host of potential positives for risky assets that received little media attention.
Specifically, the potential that soaring Spanish and Italian interest rates force policy makers into action sooner rather than later, that slow job growth prompts the Fed to initiate "QE3," the prospect of the Supreme Court repealing Obamacare and bipartisan action to address the pending "fiscal cliff" could all could serve as near-term catalysts for equities.
Barring any change in our fundamental thesis, if the equity market were to sell-off approximately 9 percent to 1,200 on the S&P 500, we would view this as a buying opportunity.
Asset allocation At this juncture, we are comfortable with the allocation strategy that we outlined in our January 2012 Outlook titled "Must Be Present to Win." Recognizing the growth risks around the globe, we remain underweight international equities, neutral bonds and large-cap equities. We are overweight "tactical," which is a basket of both public and private vehicles (commodities, private equity, hedge, etc.) that collectively have a low correlation to core asset classes.
Becoming more U.S.-centric We are maintaining our current asset allocation, reflecting our belief that the U.S. will continue to be a pocket of economic strength relative to the rest of the developed world. Accordingly, we are in the process of modestly realigning our large-cap domestic sector weightings to increase exposure to industries and companies that derive a larger percentage of their revenues domestically. As such, we are reducing our commitment to technology and industrials, sectors that are relatively export-heavy in their customer mix, and increasing our weightings in consumer discretionary and telecommunications.
As always, if you have any questions, please do not hesitate to contact us.
Best regards, Investment Policy Committee George Hosfield, CFA Marc Fovinci, CFA Ralph Cole, CFA