Download Asset Allocation View, October 13, 2010

OCTOBER 13, 2010
TACTICAL ASSET ALLOCATION VIEW
A periodic outlook by MFC GIM’s Tactical Asset Allocation team
Don Rich
Head of Tactical Asset Allocation
Capital markets are experiencing a liquidity-driven
rally that we did not expect. The new variable is the
growing probability that U.S. and perhaps other
monetary authorities will follow Japan with renewed
monetary stimulus in coming weeks. We are
defensively positioned, but do not plan further
portfolio risk reduction pending greater clarity on
this development.
Chinese import demand are among the key
weakening indicators. On the other hand, U.S.
consumer demand remains cautious but is holding in
– a key difference from the 2007-08 downturn.
Fixed Income – Positive on U.S. Treasuries
The prospect of an open-ended schedule of massive
Federal Reserve purchases as part of renewed
quantitative easing has strengthened investor demand
for U.S. treasuries and could see 10-year treasuries
rally to 2.0% from just below 2.5% now.
Asset and Market Survey
High yield corporate bonds remain among the riskiest
of risky assets, but along with the rest, are finding
support in the prospect of renewed Fed market
intervention. The dark lining in that silver cloud,
though, is that a faltering economy would hurt
corporate prospects and could trigger a rush for the
exits in what looks like a very crowded, frothy trade.
Economy – Prospects grow for accelerated,
renewed quantitative easing
Equities – Negative on expected earnings
downgrades
The TAA team and a growing consensus of opinion
expect U.S. monetary authorities to re-introduce
quantitative easing policies earlier than previously
expected and possibly as soon as November. This
prospect has whetted risk appetites and could tilt
the balance in favor of an eventual self-sustaining
moderate recovery. We believe authorities will keep
markets guessing about the eventual total size of the
monetary print run. But for “QE2” to succeed where
the first round failed, it will need to trigger renewed
bank lending and renewed consumer borrowing
(particularly in the form of mortgages).
Equities are yielding only slightly less than high yield
bonds, a situation not seen since the mid-1980s. We
think the short-term* adjustment will come through
a downward revision in earnings yields – accompanied
by a less rapid drop in prices – as markets digest a
weaker economic outlook. Only after that adjustment,
and sometime after June 2011, do we expect a
sustainable market rally that will send equity yields
further down to more normal levels relative to bonds.
We remain defensive in the face of the rally because
our indicators of tactical market risk are at extreme
highs. So is investor complacency. This combination is
fertile ground for a sharp correction in risky asset values
if economic or market events surprise on the downside.
There has been little change in the direction of
economic fundamentals. U.S. employment and
*"Short term" </= 6 months, "Long term" > 6 months
Currency – Positive on U.S. dollar, negative
on Australian dollar
Currencies are another market that looks ripe for
reversal. Expectations of renewed quantitative easing
have put the U.S. dollar under pressure. We think the
OCTOBER 13, 2010
market has got ahead of itself, though, as the timing,
size and success of QE2 remain uncertain. Our charts
indicate the greenback is at oversold levels last seen
in November 2007. Driven by commodity-related
demand/speculation, the Australian dollar is similarly
overbought. The Canadian dollar has recently moved
in line with its U.S. counterpart and could offer a
safer haven than other commodity currencies in any
correction.
Commodities – Negative as rally not
fundamentally based
The prospects for QE2 are weakening the US$ and
causing increased interest in real assets across the
board. Since the commodity rally is in response to
expectations of further monetary easing, and not
fundamentals, we expect it to fade when
fundamentals re-emerge as the driving factor.
Commodities are a key manufacturing input. It is
intuitive, therefore, that commodity prices have
historically tightly tracked global industrial production.
Global industrial production is decelerating and we
expect commodity prices to correct as the QE2
euphoria fades.
MFC Global Investment Management® ('MFC GIM') is the asset management division of Manulife Financial Corporation. MFC GIM’s diversified
group of companies and affiliates provide comprehensive asset management solutions for institutional investors, investment funds and individuals
in key markets around the world. This investment expertise extends across a full range of asset classes including equity, fixed income and
alternative investments such as oil & gas, real estate, timber, farmland, as well as asset allocation strategies. MFC GIM has investment offices in
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at www.mfcglobal.com. MFC Global Investment Management®, Manulife and the block design are trademarks of The Manufacturers Life
Insurance Company and are used by it and its affiliates including Manulife Financial Corporation.
The opinions expressed are those of MFC GIM's Tactical Asset Allocation team as of October 2010, and are subject to change based on market
and other conditions. The opinions may differ from other MFC GIM groups that use different investment philosophies. The information in this
document including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be
superseded by subsequent market events or for other reasons. MFC GIM disclaims any responsibility to update such information. All overviews
and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional
tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife Financial, MFC Global
Investment Management®, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not
guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf
of MFC GIM to any person to buy or sell any security and is no indication of trading intent in any fund or account managed by MFC GIM.
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