market folly

UK based hedge fund Brevan Howard is out with their monthly market commentary, providing economic updates across the globe. In their June 2010 outlook, they highlight how risk appetite quickly faded after everyone seemed to have re-risked much throughout 2009. Year to date for 2010, Brevan Howard's BH Global Limited is up 0.20%. While many other hedge funds turned in horrible performance in May, Brevan Howard suffered only minor losses, down only -0.06% in that month. Brevan Howard of course is one of the world's largest hedge funds.

Focusing on the US economic climate specifically, the hedge fund opines:

"In June, risk appetite faded further in response to domestic as well as foreign threats to expansion. Most notably, investors began to question the sustainability of the recovery due to stalled consumption spending, housing roll over, and the downshifts in the labour market.

After having surprised on the upside earlier in the year, retail sales have slowed to a crawl in the last two months and prior consumption data has been revised down. The more muted trajectory of spending better aligns with our macro view, which emphasises the headwinds from lacklustre income growth, stagnant wealth and credit constraints. Housing has suffered from a hangover after the expiration of government subsidies. Furthermore, although mortgage rates are approaching record lows, we believe that housing demand will continue to wane due to excess supply, the fear of price declines and tight credit conditions. In the labour market, job creation stepped down as businesses evidentially remained cautious about expanding payrolls. Meanwhile, layoffs have moved sideways at an elevated level. The labour market continues to be our central focus, so recent developments are definitely causes for concern. Nevertheless, we believe the risks of a double-dip recession are overblown.

Not all the news is bad as productivity growth has been well maintained. Remarkably, businesses are still able to find ways to rein in labour inputs in order to enhance profits. One area where firms have relaxed the purse strings is capital expenditures, which have been impressive this year. Manufacturing production has been especially robust although more moderate gains are in store as the inventory cycle matures.

Wage and price pressures continue to be absent and the biggest risk to the outlook remains the threat of deflation. Investors have come to appreciate these risks as breakeven inflation has collapsed. Survey measures on inflation are steadier, but without a reliable understanding of the expectations formation processes, we are wary of the reassurance they provide.

Finally, the negatives in the macro data have spawned a debate about fiscal and monetary policy options. Fiscal expansion is constrained by investor and voter concerns about yawning budget deficits. Much attention has been focused on the Fed restarting large scale asset purchases, but those lack punch when markets are functioning and Treasury and mortgage rates are already at or near record lows. Other options are politically risky for the Fed, for example buying municipal bonds, or simply not legal, for example buying equities. Without positive alternatives, the Fed will have to rely on pinning down the short rate near zero for an even longer "extended period."

So the hedge fund definitely thinks the US will need to keep rates low in order to fan any current signs of a recovery. It's always good to see a top down macro assessment of the US' situation from a prominent hedge fund on the other side of the globe. Fellow UK based global macro fund Prologue Capital shares their cause for concern. While Brevan Howard didn't address any specific portfolio positions, those of you looking for particular investments can head to Perry Capital's most recent letter as well as East Coast Asset Management's bullish case on Becton Dickinson (BDX) to get your fix.