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Call #1: Some risks to the global economy appear to be fading.

Global equities rallied last week, pushing stocks back toward their October highs, as investors reacted to two new developments:

  1. Signs of progress in Europe. Investors are focusing on some preliminary evidence that policy makers are getting more aggressive about combating the crisis in Europe. This has taken several forms including a coordinated global effort by many of the world’s central banks to ease the strain on bank funding, which is a big problem for European banks. Investors also have rising expectations that European politicians are inching closer to a plan for fiscal integration, and that the European Central Bank is softening its opposition to using its balance sheet to help fight the crisis.
  2. Better-than-expected U.S. economic data. The second factor supporting markets is more evidence that - absent a worsening European crisis - the broader global economy can avoid another contraction even while Europe is likely to experience a recession (if it isn’t in one already). Most economic data, particularly in the United States, continues to come in at, or better than, expectations. One data point I want to highlight is last Thursday’s November ISM manufacturing report. The headline number came in better than expected and continues to improve from its summer lows. More importantly, the new orders component shot up in November to its highest level since April. As I’ve mentioned in the past, new orders tend to lead gross domestic product growth. Thursday’s new orders component confirmed my view that fourth quarter U.S. GDP growth should be healthy, perhaps close to 3%.

While we’re not out of the woods yet - European politicians will need to deliver a clear and credible plan at their summit later this week - at least some of the non-European risks to the global market, such as a weakening economy in the United States, appear to be fading.

Call #2: Remain overweight on global energy companies

I’ve been advocating an overweight to energy all year, and I still view the sector as a good opportunity for three reasons.

  1. Global energy stocks look particularly inexpensive. Energy stocks are up roughly 5% year to date, performing well ahead of global equities. Despite the outperformance, the sector remains cheap. It currently trades at roughly 11x trailing earnings, a 15% discount to the broader market.
  2. Potential for attractive yield. Global energy stocks currently offer a yield of around 2.25%.
  3. Potential for elevated oil prices. I expect that despite the slow recovery, oil will remain elevated due to strong demand out of emerging markets, supply constraints and geopolitical risks.

A potential vehicle for accessing energy is the iShares S&P Global Energy Sector Index Fund (NYSEARCA:IXC).

Disclosure: Author is long IXC.

Past performance is not indicative of future results.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments typically exhibit higher volatility.

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Source: Fading Market Risks And Bright Opportunities