Th€ Macrobat

The Macrobat

2010 Global Macro Outlook

Fixed Income

Fixed income real yield gains should prove very hard to come by this year. With a record amount of government supply coming online (especially in the longer maturities), expect to see rates rise by as much as 150 bps on the long end of the curve by year-end. Without the enormous spread compression that characterized corporate bonds throughout 2009, most fixed income returns would have been negative. Indeed, ten-year government yields rose by 175 basis points last year, while the total return of the U.S. investment grade corporate universe averaged 8%. Taking into account the fact that the Fed and financials were large net buyers of stimulus-led treasury issuance, their relative absence in 2010 should be even more marked. Speaking of the Fed, the “Will they or won’t they?” discount rate debate largely misses the point. For months, the Fed has been actively exploring ways to remove liquidity from the market with unorthodox, non-headline grabbing measures. Their activity in the reverse repo market, raising of reserve requirements, withdrawing of government sponsored leverage programs (TALF, TAF), and receding from their foundational role as mortgage buyers all point to Fed attention and creativity regarding U.S. monetary policy. A 25 or 50 basis point increase in the discount rate pales in comparison to the effects of their other actions. It is quite unlikely that Bernanke would even embark on this measure until mass market newsmakers (headline unemployment, congressional elections) are behind us. The risk/reward scenario isn’t nearly attractive enough yet for the Fed to risk the market’s resurrection when there are so many other tools at their disposal.

So with all of these apparent headwinds for fixed income, where can we find yield and value in a world that will see record new supply of treasury paper without last year’s natural buyers? The answer will once again rely on the Fed. If there is one thing the Federal Reserve has been successful at throughout the crisis, it is pushing investors out on the term structure. By keeping short term rates at virtually zero, they have funded a U.S. dollar carry trade which has forced the re-assumption of risk among virtually all asset classes.  Even a 25 or 50 bps rise in the discount rate would not significantly affect this yield grab, and that is not likely to happen until the second half of this year. The steepness of the yield curve is further evidence of their success in this respect. Expect this trend to continue throughout the year as buyers become very wary of the long end of the curve, given the Treasury’s announced plans for record 30-year issuance. Is it any wonder that the government would look to raise cash with 30-year yields around 4.5%?

As a core position, short-term investment-grade corporate bonds should provide a secure yield-based return, without being subject to the gyrations of the longer end of the curve. Variable-rate and step-up agencies between 1-3 years fit this profile and are yielding close to 3%, or 150bps over treasuries.

Sovereign emerging market bonds had a banner year in 2009, returning an average of 15%, with fully half of those gains coming spread compression. Although much of the global recovery is now baked into the cake, emerging markets economies are likely to outperform in 2010 by way of increased commodity and export demand. Combined with the aforementioned Fed subsidizing of risk appetites and the relative unattractiveness of the U.S. treasury yields, EM sovereign debt should provide decent risk characteristics for an average 5% yield.

Treasury Inflation Protected Securities (TIPS) similarly enjoyed healthy returns last year, despite the apparent lack of inflationary pressures. Indeed, deflationary headwinds dominated economic numbers for much of the year. However, market discounting of future inflation resulting from the government’s enormous quantitative easing measures combined with retail investor ETF TIP fund flows drove returns much higher. This year should not see as much bullishness in the sector, but newly issued, high CPI index prints deserve a minor allocation. While the capital protection optionality in a deflationary environment is not currently on market minds, a few policy missteps could change the picture.

High-yield U.S. fixed income was the star performer last year, returning an average 35% with fully 20% belonging to price appreciation. With yields hovering around 11%, expect most of this year’s return to come from the coupon rather than spreads. However, given the continued search for risk appetites and the waning chances of a double-dip recession, this asset class should provide an attractive equity-based return without being subject to the treasury market’s fundamental weakness.

Convertible bonds should round out the last of the attractive 2010 fixed income opportunities. Using the Barclays Capital Convertible Bond > $500MM Index as a proxy, a 6% indicated yield gives investors yet another hybrid vehicle to take advantage of the global recovery. With equities poised to continue their run throughout 2010 and M&A activity expected pick up greatly, these bonds should provide a stable return with potential for upside surprises.


After 2008 and an unsightly Q1 of 2009, last year produced stellar returns for global equity markets. The torrent of liquidity that world governments unleashed was the primary driver of these returns and will continue to be throughout 2010. Perpetually low short term rates in the U.S. should keep the dollar low, which in turn will provide ample carry funding for U.S. equities.  Combined with increasing unease over inflationary pressures stemming from commodity price increases and a burgeoning debt burden, our equity market is primed to return somewhere in the order of 10-15%, with the bulk of those returns happening in the first half of the year. Although companies are unlikely to resume hiring until a clearer profit picture emerges later this year, corporate spending is already showing broad signs of improvement. This bodes well for a cyclical posture going into early 2010. The sustained uptrend that equity markets have been trading in for the last ten months  has manifested itself in rock-bottom index option volatility. A sector-based net long portfolio with index tail risk protection is the most balanced way to take advantage of these scenarios. Information technology, energy, and basic materials hit upon the three industries most likely to profit.

Information technology should see significant gains as corporate spending focuses on hardware and software upgrade cycles. With the advent of Windows 7, tech companies have found a reliable operating system to attach its architecture to. Given the widespread reluctance of businesses to adopt Vista for their workstations, the natural upgrade cycle was subjected to a disproportionately long lag. Combined with the sealed corporate purses for the last 18 months and extremely attractive hardware pricing, information technology is poised for a blockbuster year.

Energy companies have a lot going for them in 2010. A weak dollar, strong Asian demand, a resurgent manufacturing base, and so far, an unseasonably cold winter should all be largely supportive factors for commodity prices this year. Oil prices are up 16% in the last two weeks alone, reaching levels unseen since October 2008. Expect this trend to continue, as increased prices are unlikely to crimp demand for at least another 20% on the upside.

Basic materials stocks outperformed the broader index 2-1 last year, as global stimulus and government infrastructure projects worked their way into the economies. Expect this year to bring even greater gains as these programs fully take root and natural demand from emerging market economies picks up in concert with the recovery.

Utilities often represent a defensive posture during a cyclical growth cycle, but given only a moderately bullish U.S. equity outlook, their near 5% dividend yield is an attractive counterbalance to an otherwise high beta allocation. Consumer staples similarly should provide a smoother consistency of returns should trend growth appear in fits and starts.

Real Estate Investment Trusts (REITS) have been outstanding performers in 2009 after being pummeled throughout ’08. Valuations are stretched and large amounts of good news are discounted in most real estate sectors at this point. However, unlike commercial, residential real estate is showing some signs of bottoming. While it may be early, this sector is worth a small speculative allocation, given the extension of homebuyer credits and depressed refinancing rates.

While keeping a net long U.S. sector exposure, two prime candidates for underweight immediately stand out: telecom and consumer discretionary. The telecom sector’s margins and footprint is being increasingly squeezed by internet telephony. Similarly, mobile handset providers are exploring new ways of circumventing traditional carrier contracts and agreements. This week’s announcement by Google of their own branded, unlocked phone is just another step forward in the evolution away from traditional carrier-based fee structures. Consumer discretionary and luxury brands will not necessarily suffer this year, but until the labor picture begins to significantly brighten, do not expect these sectors to return to pre-crisis levels anytime soon.

Unlike the U.S., China’s recession was relatively short and shallow. Their stimulus measures were bold and immediate. PMI numbers across the region have shown widespread improvement, and some 2010 GDP forecasts are upwards of 10%. Expect China to be a primary driver for global recovery this year, from commodity demand to domestic and foreign consumption. Economies directly benefitting from Chinese resurgence should likewise experience correlated growth effects. Taiwan, with its recently elected Pro-China government has opened the doors to trade even further, now allowing direct flights to the mainland for the first time in July of 2008. South Korea is another economy poised to take advantage this year. Home to Samsung, LG, and Hynix Semiconductor, the country should benefit greatly from renewed tech spending, with China as their main trading partners.

A non-Asian country which is also likely to profit off an Asian rebound is Australia. Australia has the dual benefits of being both a net commodity exporting economy as well as a major Asian trading partner. Already having been the first developed country to raise interest rates last year, Australia’s economy is apt to continue firing on all cylinders.

Although Russian companies are no stranger to corruption and privatization, elevated energy prices translate into huge petrodollar reserves. Although it is an uneasy relationship for U.S. interests, Russia and China’s increasingly favorable trade terms create win-win scenarios relative to other nations. While clearly speculative, Russia’s underperformance relative to many Latin American emerging markets last year should give a foundation for reversion this year.

Indian equities had an outstanding 2009, and with its society moving from an agrarian to manufacturing base, it should stand to benefit from renewed global demand. Political bureaucracy and inefficiencies have always been hurdles for this nation, but it is clearly one of the largest ships on a rising tide of global recovery.


Above all asset classes, commodities perhaps have the greatest potential for 2010. Due to their inherently volatile nature, they cannot occupy an outsized allocation in a balanced macroeconomic outlook. However, the prospects for raw material inputs and base metals have rarely been brighter. While an important fundamental driver for higher oil and gold prices is a weak dollar, it is by no means the only tailwind. Meanwhile, a small agricultural allocation in corn is a natural portfolio diversification out of dollar-based commodities.

West Texas Intermediate Crude approximately doubled in price throughout calendar 2009. While these types of gains are unlikely to be repeated, increased global demand, particularly from Asia, will continue to support prices well into the latter part of 2010. The only clear risk to $100 oil at this point would be a rising dollar on the back of a flight-to-quality move. However, fundamentally speaking, until short-term rates rise in the U.S., the dollar will be subject to continuous carry overhang.

Like oil, gold enjoyed a tremendous run in 2009, especially during the second half. Gold has three majorly supportive factors going for it. One, its perception as an inflation hedge. Valid or not, the weakness of the dollar combined with the anticipation of inflationary pressures are the fuels that feed gold prices. Second, central banks worldwide are under-reserved in gold relative to the U.S. Although this largely stems from U.S. stockpiles dating back to the gold standard, global central banks (especially Asia) have recently stepped up their purchases, perhaps as a way of quasi-diversification out of U.S. dollars as the reserve currency of choice. Lastly, unlike other commodities, gold has always maintained a crisis premium. In an environment where exogenous market shocks are becoming commonplace, gold’s reflex rallies provide a hedge for an otherwise risk-tolerant posture.

Non-USD Cash

With the U.S. dollar firmly under the foot of the Fed’s zero interest rate policy, a modest cash diversification into other currencies is recommended. Expect commodity-based currencies such as Australian and Canadian dollars to rally as much as 10% this year, while the Euro can be expected to outperform based on expectations for earlier monetary policy tightening.

2010 Macro Model ETF Portfolio

Bonds 40% $400,000
Equities 37% $370,000
Commodities 10% $100,000
Non-USD Cash 9% $90,000
Cash 4% $40,000
TOTAL 100% $1,000,000
Bonds Investment Grade 1-3 Yr Bonds 15% CSJ
  Emerging Market Bonds 10% EMB
  High Yield Bonds 5% JNK
  Convertible Bonds 5% CWB
  5 Yr TSY Bonds 5% IEI
  30 Yr TSY Bonds -5% TLT
Equity Chinese Equities 5% GXC
  Taiwan Equities 2.50% EWT
  Korean Equities 2.50% EWY
  Indian Equities 3% EPI
  Australian Equities 2% EWA
  Russian Equities 2% RSX
  Information Tech 5% XLK
  Energy 5% XLE
  Basic Materials 5% XLB
  Utilities 3% XLU
  Consumer Staples 3% XLP
  Residential REIT 3% REZ
  Telecom -3% IYZ
  Consumer Discretionary -3% XLY
  SPY June 105 Puts 2% SWG+RA
Commodity Oil 3% OIL
  Gold 5% IAU
  Agriculture 2% DBA
Cash EUR 3% FXE
  AUD 3% FXA
  CAD 3% FXC
  USD 4% USD


April 2014


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