2nd QUARTER 2007 MARKET COMMENTARY & OUTLOOK
JULY 2007
Hello to all and Happy Summer! We enjoyed seeing many of you at our May 24th client seminar and thank you for coming. In keeping with the seminar topic of global investing, this newsletter will recap important themes from the seminar and then provide our view of today’s overall economic and investing climate. The overriding theme is as follows:
The world is still in the early phase of a period of tremendous economic growth with enormous benefits to its populace and investors.
Important sub-themes are as follows: 1) Emerging countries, and particularly China, have experienced dramatic economic growth and are playing greater roles in the world economy; 2) The United States, with its lower growth rate, likely will continue to slide in terms of global economic dominance; and 3) We believe it is critical to have broad investment exposure to growth regions and sectors around the world. This includes holding broadly diversified international equity funds as well as large U.S. multinationals that are positioned to benefit from global growth.
In 2006, the size of the total world economy was $48 trillion. The U.S. contributed $13.2 trillion, or 27.5% of the total, followed by Japan with $4.4 trillion, Germany, $2.9 trillion, and China, $2.6 trillion. India stood at 13th place with $900 billion. Looking out to the future with projections from Goldman Sachs, the picture is quite different as emerging countries continue to grow much faster than the U.S. By 2030, China and India combined are expected to have an economy equaling that of the U.S. And by 2050, China’s economy alone is expected to be considerably larger than ours, and India will be fast on our heels in third place. After a very big gap, Japan, Brazil and Russia are expected to hold the fourth, fifth and sixth positions.
With 60% of the world’s population and tremendous gains in productivity in recent years, Asia’s rapidly growing role in the world economy is nothing short of extraordinary. Fortunately, many emerging countries have made significant improvements in controlling inflation, stabilizing currencies, strengthening banking systems, deepening capital markets, and lowering fiscal deficits. In our view, stronger fundamentals in emerging countries have reduced investment risks substantially from the late 1990s when several countries experienced currency crises. Of course, valuations are always a separate consideration from fundamentals, and we are mindful that international equities, and particularly those of emerging countries, have outperformed U.S. equities for the past two years. Over time, we expect to continue adding to international allocations in a very gradual and deliberate manner.
With strong growth in global trade and technology, economies and financial markets are more integrated than ever before. Discussions about economic growth and inflation increasingly are framed in global terms rather than single-country terms. For example, strong global growth has helped to buoy the U.S. economy during its housing slump; on the hand, if trading partners such as China experience rising inflation, it can translate to higher inflation in the U.S. since we import heavily from China. Discussions about currency exchange rates, trade policies, off-shoring and immigration become increasingly important in an integrated global economy. And with rapidly growing population and production, the need for global policies to protect the world’s resources and environment will continue to mount.
Despite the strong equity market performance in the second quarter, domestic investors appear to remain fixated on the double threat of higher inflation and a slowing economy. The Federal Reserve continues to focus on controlling inflation despite the paltry GDP annualized growth rate of .7% in the first quarter of 2007. Inflation concerns led to a notable increase in interest rates as evidenced by the 10-year Treasury yield hitting a five-year high of 5.3% on June 12th. This, combined with continued concerns about how weakness in the housing market would affect the overall economy, pulled equity prices downward from the record highs reached on June 4th. But after the 10-year Treasury yield slipped back below 5.25% and U.S. retail sales for May came in stronger than expected, the Dow demonstrated strong resilience, posting its single highest gain of the year, 187 points, on June 13th and finished the month near that level (despite ongoing volatility).
Uncertainty is business as usual in financial markets, and so we must stay focused on long-term fundamental trends rather than on trying to time short-term gyrations. In the long run, equities have proven over and over again their ability to provide attractive inflation-adjusted returns. With the global outlook looking stronger than we have ever experienced, we expect equity investors will reap handsome rewards from ownership in companies with global exposure. However, as we emphasized at the client seminar, it’s important to expect a bumpy ride!
Once again, we express our appreciation to you for trusting us to help you achieve your financial goals. Please contact us if you have any questions or changes occurring in your financial life. We wish you an enjoyable summer.
Sincerely,
SPERO-SMITH INVESTMENT ADVISERS, INC.
Robert C. Smith Mimi Lord, CFA
President & CEO Sr. Vice President, CIO
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