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View from PSigma 'Lose Yourself' December 2010

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					                                            View from PIM
                                                                 “Lose Yourself'”

  Tom Becket, Chief Investment Officer                                                                 December 2010


                                                                       •   The cracks have again been papered over
During the last few weeks, many of the joys of 2010 have
revisited us, ensuring that nerves are frayed and minds                •   Is Santa on his way again?
tired heading towards the Christmas Break. Amongst the
usual suspects, chaos in the European bond markets and
                                                                       •   We are cautiously optimistic for 2011
the telegraphed announcement of QE2 has reignited an
onslaught of volatility. However, in recent sessions, the
                                                                       •   We have tactically increased equities
clouds have lifted (and the snow has passed) allowing
equity, credit and commodity markets to resume their
healthy rises. This should be no surprise and we                       •   But are now more balanced elsewhere
positioned ourselves for such a move, recognising
that December is often a good month for asset
markets, as a “Santa Claus Rally” traditionally brings           So, will it be a Happy New Year for investors?
festive cheer to investors. The current optimism has             Prospects for 2011 are incredibly difficult to predict and
been reinvigorated by another stubborn show of political         unfortunately Santa will not come every month.
unity in Europe and further profligacy by the spendthrift        However, our starting asset allocations are becoming
US government, where instead of reining in their runaway         somewhat easier to forecast, as many asset classes
deficit, they have decided to reward the ultra-rich with an      are now trading at what we believe are unsuitably rich
extension of tax cuts. Merry Christmas indeed.                   valuations. Driven by our persistent fears of inflation in
                                                                 the years ahead, we are still avoiding interest rate
The overpowering urges of most governments in the                risk in our credit selections, favouring short
developed world is still to pump their economies full of         duration high yield credit over investment grade
liquidity and encourage their consumers to spend the             bonds and global index-linked bonds over
economy back to full potential. Whilst in the short term         conventional gilts. At times this year it has certainly
this could be a potent driver behind economic growth             been painful not to own “duration” risk, but we believe
and corporate profits, further out the medicine could            that our strategy is sound and is now being rewarded.
cause some unwelcome side effects, with inflation                Certainly, if UK gilt yields were to back up further in
the chief concern. In fact, despite disinflation still lurking   the coming months, we might actually start to add
in the mature world, the emerging economies are already          them back in to our portfolios, thereby increasing
suffering from inflationary pulses, spurred by booming           diversification further. A yield of close to 4% on 8 or
commodity prices and abundant liquidity. In all-important        10 year issues would probably be enough to tempt us
China, the central bank there is desperately trying to           back in to the asset class. It is worth noting that despite
apply the breaks on their economy, which has unnerved            the recent improvement in economic data and our
investors in the region. We believe that their actions are       expectations for decent growth, there is still an outside
totally justified and would actually encourage them to           chance of a renewed economic slump in the quarters
move more aggressively.                                          ahead, conditions from which government bonds will
                                                                 benefit. In the last few weeks, we have also marginally
We expect the global economy to perform moderately               reduced credit risk throughout our portfolios, selling
well in 2011, although once again the driving force of           some of our positions that have gained strongly from
growth will be the emerging nations. Economic leading            yield compression this year and re-allocating to much
indicators in many emerging nations have turned                  shorter dated positions.
over recent months, but at present we can still
envisage sound growth. Given the huge amount of                  On balance, our preferred asset class for next year is
stimulus that has been hurled at the US economy, we              equities. Reassuringly we can still find pockets of value
have been revising up our expectations for growth in the         in equity markets, despite the fantastic gains of the last
world’s biggest economy as well. The UK is likely to fare        2 years. To us, the most attractive opportunities reside
less well, as the government’s relative penchant for             amongst the biggest global companies, with strong
austerity will temper our economic potential.                    franchises and healthy balance sheets.
Many companies have never been in a better financial                          2010 has been an incredibly difficult year for asset
state, with large amounts of cash on their balance                            allocators and investment strategists, but, as we
sheets, which could lead to reasonable returns to                             currently stand, one which has proved ultimately
shareholders, in the form of dividends and share                              rewarding for those who have embraced risk and
buybacks. Mergers and acquisitions should also be a                           used volatility to their advantage. Looking forward,
significant support for equity markets in 2011. We                            we are guardedly optimistic about the prospects
believe that there will be good earnings growth next                          for investment returns in 2011, but acknowledge
year, but again the engine will be vigorous consumptive                       that it is likely to be extremely hard going once
powers of the emerging consumers. We still prefer to                          again.
have a balanced equity exposure across global
markets, including in the unloved Japanese market.                            In 2010, it has been easy to feel like both a genius
It is possible that we might run with our maximum                             and a dunce within a matter of days, but sadly our
equity weightings next year, although our focus will                          prognosis is for repeat bouts of schizophrenia in the
be on “quality” companies in the developed world                              months ahead. Noticeably, during the year, Stanley
markets, which our research suggests are trading at                           Druckenmiller, a legendary hedge fund manager who
an almost unprecedented discount to emerging market                           led George Soros to force a devaluation of the British
and lower quality companies.                                                  Pound in 1992, retired, arguing that the current
                                                                              conditions did not allow for sensible macroeconomic
Of course the path forward for equities is unlikely to be                     investment strategies, underlining just how difficult
a smooth, one-way street in 2011 and there are a                              and distorted conditions have become. Next year it
number of “micro” concerns that are giving us plenty of                       will again be important to hold our nerve and stay
food for thought. In particular, with profit margins in                       the course with investments we favour for the
many industries already at extremely high levels, it is                       long term, but also be proactive in your
hard to imagine a further expansion over the next year.                       investment strategy to ensure the best returns.
With consumers still cautious about their job
prospects and inflationary pressures being fuelled                            It is inherently dangerous to look out further than the
by rising commodity prices, 2011 just doesn’t look                            immediate future, particularly with so many moving
to us to be a year when companies can justify                                 variables currently in play. However, we are still
significant price rises. We might be adopting too                             concerned about the lasting impact of Quantitative
cautious an attitude, but certainly our industry contacts                     Easing, the perils of money printing and ultra-loose
are suggesting that a fog of uncertainty still lingers over                   monetary and fiscal policy. There is a real chance
end demand in 2011. Therefore, with expectations now                          that beneath the many flimsy sticking plasters
for earnings growth so high and following on from two                         that have again been applied to the debt-scarred
years of good returns, there is certainly scope for                           global economy, wounds are festering and
disappointment. We note that in the industrial sector,                        infections could once again afflict the patient in
where margins might in particular be pressurised, many                        the years ahead. As Eminem once sang, you
company insiders have already started to sell shares in                       shouldn’t “lose yourself in the music” that the central
their own companies. We have therefore reduced our                            banks and governments around the world are
exposure towards the more cyclical areas of markets,                          currently playing to keep financial markets in their
including commodities, and increased our investments                          merry dance. At some point, we will have to pay the
in consumer staples companies.                                                price for the excesses of the last decade, despite the
                                                                              authorities’ ferocious attempts to postpone that pain
Elsewhere in our portfolios we have continued to                              for another day. As Eminem went on to sing; “The
reduce our commercial property exposure, where we                             clock's run out, time's up over. Snap back to reality,
believe that the potential for capital returns is muted                       oh there goes gravity.” However, we don’t feel that
and the income opportunities in the prime assets we                           the day of reckoning is now or in the near future.
favour have mostly now been taken. Reducing our
property exposure also is part of our move to
increase liquidity in our strategies.
                                                                                                                                  Thomas Becket
                                                                                                                         Chief Investment Officer
                                                                                                                              9th December 2010




                                The value of investments and the income from them can fall as well as rise. An investor may not get
                                back the amount of money that he/she invests. Past performance is not a guide to future
                                performance.

				
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