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April  

2010  

         

Risks & Opportunities

     

       

 

Duncan  Morton  III,  CFA   The  following  document  is  a  compendium  of  quotes  from  last  month  from  individuals  or  institutions  whom,   we  believe,  are  providing  the  proper  perspective  on  current  global,  economic,  and  fiscal  matters.         At  the  bottom  of  each  section,  Risks  and  Opportunities,  SummitVIEW  will  offer  our  interpretation  of  the   quotes  or  our  perspective  on  the  themes  of  the  quotes.     Disclaimer:   All  material  presented  herein  is  believed  to  be  reliable  but  we  cannot  attest  to  its  accuracy.  Neither  the   information  nor  any  opinion  expressed  constitutes  a  solicitation  by  us  for  the  purchase  or  sale  of  any   securities.      

Please  do  not  forward  


SummitVIEW   9   Risks  &  Opportunities      

SummitVIEW: What  explains  the  human  condition  to  ignore  changing  forces  until  one  is  forced  to  respond  to  those   changing  forces?    Those  who  profess  to  be  forward  thinkers  by  nature  of  their  job  title  (investment   strategist)  or  vocation  (economist)  that  continue  to  rely  on  near  sighted  analysis  of  the  current   economic  conditions  are  many.    For  an  investor,  objective  thinking  requires  removal  of  emotion  and   individual  expectation  so  that  cogent  analysis  of  current  conditions  can  occur.       Our  country  is  run  primarily  by  baby  boomers  and  their  progenitors.    Regarding  the  decisions  the   country  needs  to  make  on  healthcare  and  government  entitlements  such  as  retirement  benefits  and   Medicare,  how  are  the  "leaders"  of  our  country  going  to  make  the  right  decisions  for  the  country's   future  when  the  baby  boomers  and  their  elders  believe  their  retirement  includes  access  to  the  very   services  that  need  reformation?    With  Congress  unwilling  to  make  few  (adjusted  from  'any'  as   Obamacare  recently  came  to  fruition)  decisions  on  the  aforementioned  social  and  economic  issues  to   ensure  a  future  sustained  by  increasing  productivity  and  economic  growth,  how  does  an  investor   position  assets  for  what  will  be  a  tough  transition  to  a  new  economic  and  social  regime?     One  does  not  have  to  think  too  long  to  begin  to  develop  theories  as  to  the  "what"  to  solve  the  countries   structural  deficiencies.    What  if  we  became  an  export  country?    Due  to  the  high  debt  levels  in  the  public   and  private  sectors  the  US  dollar  is  weak  and  expectantly,  over  the  long  term,  should  continue  to   weaken.    Like  Japan,  couldn’t  the  country  start  to  export  goods  to  other  countries  that  are  growing,   those  countries  where  development  of  a  middle  class  is  only  beginning?         What  about  easing  immigration  restrictions  so  skilled  labor  can  emigrate  to  the  US  to  stimulate  the   development  of  export  companies?    The  newly  formed  companies  could  sell  goods  to  the  founders'   home  lands,  in  turn  increasing  employment,  and  ultimately  raising  productivity  levels.    Since  housing   was  the  recipient  of  billions  of  US  dollars  over  the  last  10  years,  aren't  there  a  lot  of  vacant  homes,   whether  multi-­‐family  or  single  family,  waiting  to  be  filled  by  productive  individuals?    (Thomas  Friedman   makes  this  same  appeal  in  his  New  York  Times  column  from March 21, 2010.)   What  if  tax  laws  governing  the  transfer  of  wealth  from  one  generation  to  the  next  were  structured  to   incent  employee  ownership?    Would  our  country  benefit  from  an  increase  in  productivity  and  a   reduction  of  long  term  government  entitlement  programs  if  company  owners  were  incentivized  to  sell   their  companies'  shares  to  their  employees?      Would  employees  who  are  company  owners  work  more   productively,  thereby  mitigating  the  increasing  demands  on  the  country's  resources  by  an  aging,  entitled   population?      

Please do not forward  


SummitVIEW   10   Risks  &  Opportunities     Certainly,  company  owners  would  welcome  a  means  to  build  succession  plans  with  tax  advantages,  and   employees  would  welcome  an  opportunity  to  fund  personal  retirement  plans  with  shares  of  the   company  funding  their  livelihoods.       Tax  deferral  options  for  closely-­‐held  security  sales  exist  currently  in  the  form  of  employee  stock   ownership  plans  (ESOP's).    However,  restrictions  on  reinvestment  for  sellers  prevent  more  from  utilizing   ESOP's  as  an  option  for  succession  and  asset  diversification  planning.   How  does  the  country  go  about  solving  our  fundamental,  structural  deficiencies?  It  is  an  important   question  to  ask.   Considering  the  age  of  those  running  our  country,  whether  political  or  business  leaders,  is  immigration   reform  possible?    Are  the  leaders  of  our  country  subject  to  jingoistic  views  that  cloud  their  willingness  to   address  our  social  realities?    With  an  aging  population,  a  labor  force  that  supports  more  and  more  non-­‐ workers,  and  government  bureaucracy  that  continues  to  burgeon,  what  measures  are  being  taken  to   address,  fundamentally,  the  long  term  structural  reforms  that  are  required?    With  healthcare's  emphasis   on  longevity  will  the  country's  structural  problems  perpetuate  longer?    Can  those  who  expect  to  reap   the  "benefits"  to  which  they  believe  they  are  entitled  make  choices  that  benefit  their  successors  more   than  themselves?   The  debate  about  healthcare  lacked  essential  economic  discussion.    The  debate  centered  on  the  right  of   individuals  to  healthcare.    What  was  lacking  in  the  debate  was  how  the  country  meets  increased   demand  on  the  healthcare  system  without  driving  up  all  costs.    From  an  economists  perspective,  the   debate  lacks  a  discussion  on  supply.       Without  a  commensurate  increase  in  supply  of  healthcare  practitioners,  the  cost  of  healthcare  likely   increases.      Perhaps  so  called  'preventive  modalities'  offer  some  relief  for  the  increased  demand.   Legislators  could  force  insurance  companies  to  cover  preventive  modalities.  The  immediate  effect  would   be  an  increase  in  the  supply  of  practitioners.    Where  was  that  discussion?   The  willingness  of  the  many  to  ignore  history  boggles  the  mind.    If  one  knew  nothing  of  history,   assuming  a  quick  return  1)  to  full  employment,  2)  to  high  consumer  spending,  3)  to  increased  demand   for  housing,  and  4)  to  continued  United  States  global  hegemony  would  appear  logical  if  not  inevitable.    Not  surprisingly,  humanity  as  a  culture,  as  a  collective  body,  has  a  history  of  exceeding  the  economic   boundaries  of  its  time.    In  the  development  of  western  civilization,  there  is  more  than  one  example  of   hegemonic  domination  and  collapse.       In  each  of  the  historical  examples,  be  it  the  Romans  or  the  British  most  recently,  the  expansion  of  credit   to  an  economically  infeasible  level  played  a  part  in  the  culture's  hegemonic  collapse.    For  the  United   States  its  moment  in  time  to  deal  with  an  economically  infeasible  level  of  debt  has  arrived.    How  the   country  decides  to  handle  the  credit  contraction  will  fill  history,  economic,  and  finance  books   henceforth.      

Please do not forward  


SummitVIEW   11   Risks  &  Opportunities     Until  now,  the  credit  contraction  has  been  offset  by  an  increase  in  governmental  obligations.    Increasing   governmental  obligations  likely  prevented  a  major  collapse  in  the  socio-­‐economic  framework  that   defined  the  recent  past.    As  a  result  of  the  Federal  government's  fiscal  policy  and  the  Federal  Reserve   Bank's  monetary  activity,  the  labor  force  experienced  a  contraction  of  only  6  percentage  points,   approximately,  on  an  absolute  basis  and  a  150  percent  contraction  in  percentage  terms.   Credit  contractions  occur  over  many  years  not  many  months.    Many  have  views  that  the  US  will  recover   from  its  credit  bubble  in  due  course  and  return  to  the  normal  we  all  remember.    As  cycles  in  history  take   many  years  to  unfold,  acceptance  of  a  new  reality  is  not  easily  achieved.      Human  nature  tends  to  glorify   the  past  ("the  good  ol'  days")  while  ignoring  current  events  that  will  be  upon  reflection  viewed  as   seminal  turning  points.       What  is  the  probability  of  our  returning  to  the  normal  of  the  last  twenty  years?    The  answer  to  the   question  certainly  rests  in  the  timeline  one  is  willing  to  wait  for  the  prior  normal  to  return.       Achieving  investment  outperformance  requires  an  ability  to  remove  oneself  from  the  day  to  day  flow  of   news  to  establish  perspective,  enabling  objective  thinking.    SummitVIEW  finds  few  voices  in  the  media   mainstream  that  speak  to  the  structural  deficiencies  prevalent  in  the  US  economy.    Most  voices,  or   talking  heads  in  a  pejorative  sense,  see  only  what  they  want  to  see,  the  cyclical  fantasy,  while  ignoring   underlying  structural  stresses.       For  example,  how  many  are  discussing  the  manipulation  of  accounting  standards  occurring  in  banks  that   hold  debt  collateralized  by  commercial  real  estate?    Since  Fannie  Mae  and  Freddie  Mac  are  the  buyers   of  last  resort  in  the  residential  mortgage  industry,  one  has  to  look  no  further  than  these  institutions'   balance  sheets  to  find  where  generally  accepted  accounting  standards  (GAAP)  have  been  loosened.    For   the  loans  on  commercial  real  estate  properties,  one  has  to  look  to  the  regional  banks  (see  quote  on  page   5  by  Elizabeth  Warren).       Another  reason  banks  are  not  lending  money  (besides  consumers  not  seeking  new  loans)  is  to  prevent   an  immediate  markdown  and  potential  collapse  of  the  banks'  equity  once  loan  values  are  reflected   accurately  on  their  books.    Cash  on  hand,  thanks  to  the  Troubled  Asset  Relief  Program  (TARP),  cushions   the  potential  equity  valuation  adjustment.       Which  brings  me  back  to  a  Muppet  like  conversation  referenced  in  the  February  SummitVIEW  (then   known  as  Headlines),  which  captures  the  spirit  of  the  Capitol  Hill  debate  on  how  to  handle  the  country's   structural  deficiencies  :   Patient:  Doctor,  Doctor,  it  hurts  when  I  do  this.   Doctor:  Well,  then  don't  do  it.   Next  month  SummitVIEW  will  lay  the  framework  for  the  US  based  investor  to  begin  to  develop  asset   allocation  strategies,  based  on  his  or  her  risk  tolerances  and  future  liabilities,  with  a  view  towards   systematic  and  sovereign  risks  and  future,  global  growth.   Please do not forward  


SummitVIEW   2   Risks  &  Opportunities      

Risks: Systematic Market Musings & Data Deciphering In  one  month,  the  U.S.  government  turned  in  a  deficit  that  in  other  times  in  the  not-­‐too-­‐distant  past,   was  what  was  incurred  in  a  full  year  (1990,  1991,  1992,  1993,  2002,  2003,  2004,  2005  all  come  to  mind).   The  fiscal  year  is  a  mere  five  months’  old  and  already  we  have  seen  Washington  rack  up  $652  billion  of   red  ink.  The  chamber  voted  62-­‐36  for  the  legislation,  which  would  also  extend  dozens  of  expiring  tax   cuts,  ease  corporate-­‐pension  requirements  and  heads  off  cuts  in  Medicare  reimbursements  to  doctors.   It  begs  the  question,  if  things  are  so  great,  why  the  need  for  this  additional  stimulus?     Oh  yes,  and  in  a  green  shoot  of  epic  proportions,  the  media  today  is  treating  the  news  that  there  were   “only”  30  States  with  rising  unemployment  in  January  as  a  really  good  thing  because  it  was  down  from   43  the  month  before  (never  mind  that  five  states,  including  some  biggies  like  Florida  and  California,   reported  new  highs  for  their  jobless  rates);  and  that  home  foreclosures  (as  per  RealtyTrac)  were  “just”   6%  above  year-­‐ago  levels,  which  was  the  slowest  pace  in  four  years.  (You  know,  you  can  reach  a  level  of   obesity  where  the  percent  increase  in  your  weight  from  a  year  ago  can  go  down  rather  dramatically   while  at  the  same  time  your  health  continues  to  deteriorate.)      

David  A.  Rosenberg,  Chief  Economist  &  Strategist,  Gluskin-Sheff,  March  11,  2010  

How to Handle the Sovereign Debt Explosion We  should  expect  (rather  than  be  surprised  by)  damaging  recognition  lags  in  both  the  public  and  private   sectors.  Playbooks  are  not  readily  available  when  it  comes  to  new  systemic  themes.  This  leads  many  to   revert  to  backward-­‐looking  analytical  models,  the  thrust  of  which  is  essentially  to  assume  away  the   relevance  of  the  new  systemic  phenomena.   There  is  a  further  complication.  Timely  recognition  is  necessary  but  not  sufficient.  It  must  be  followed  by   the  correct  response.  Here,  history  suggests  that  it  is  not  easy  for  companies  and  governments  to   overcome  the  tyranny  of  backward-­‐looking  internal  commitments.   Where  does  all  this  leave  us?  Our  sense  is  that  the  importance  of  the  shock  to  public  finances  in   advanced  economies  is  not  yet  sufficiently  appreciated  and  understood.  Yet,  with  time,  it  will  prove  to   be  highly  consequential.  The  sooner  this  is  recognized,  the  greater  the  probability  of  being  able  to  stay   ahead  of  the  disruptions  rather  than  be  hurt  by  them.     Entire  article  found  here.    It's  worth  a  read  -­‐  Mohammed  El-­‐Erian,  CEO  and  Co-­‐CIO,  PIMCO   Please do not forward  


SummitVIEW   3   Risks  &  Opportunities    

The Defining Moment of the Year Coming Up... ...A Peak in Leading Economic Indicators! At  the  heart  of  the  double-­‐dip  recession  vs.  sustainable  recovery  debate  is  the  consumer  and  whether  or   not  job  growth  will  come  back  strongly  enough  to  offset  consumer  deleveraging  in  the  years  ahead.  At   this  point  in  the  recovery  we  should  expect  to  see  the  yield  curve  begin  to  decline  as  short-­‐rates  rise.  We   do  not  suspect  this  will  happen  given  the  strong  disinflationary  trend  from  core,  and  the  Fed’s  outright   statement  to  keep  rates  low.  What  is  more  likely  is  to  occur  is  a  flatter  yield  curve  on  the  back  of  lower   long-­‐rates,  which  is  a  recipe  for  a  weak,  not  strong  equity  market  (&  and  economy  in  2011).            

Francois  Trahan,  Wolfe Trahan & Co.,  March  19,  2010  

Primary Trends The  primary  trend  towards  consumer  frugality,  liquidity  preference  and  deflation  has  not  vanished  just   because  of  the  impressive  bear  market  rally  in  risk  assets  that  has  occurred  over  the  course  of  the  past   year.   Japan  lost  its  AAA  rating  in  February  2001  and  over  the  next  three  years,  the  10-­‐  year  JGB  yield  still   ended  up  declining  almost  100bps  to  the  lows  two  years  later  and  the  yield  is  still  lower  today  than  it   was  at  the  time  of  the  downgrade.    Just  goes  to  show  that  not  even  the  rating  agencies  or  the  fiscal   largesse  is  a  match  for  sustained  below-­‐trend  economic  growth  in  a  post-­‐credit-­‐bubble-­‐collapse   economy  and  all  of  the  lingering  deflation  pressure  that  comes  with  it. David  Rosenberg,  Gluskin-Sheff,  March  17,  2010  

Another Leg Down We  are  not  the  only  ones  who  see  the  prospect  of  another  leg  down  in  home  prices.  The  banks  seem  to   have  given  up  any  hope  that  we  would  see  a  rebound  at  any  time  on  the  horizon,  which  explains  for   example  why  it  is  that  BoA  is  now  more  fully  engaged  in  principal  write  downs  and  expect  to  see  other   lenders  follow  suit.  It  is  the  right  thing  to  do.  It  will  speed  up  the  process  of  price  discovery  at  the   expense  of  revealing  just  how  much  more  downward  price  pressure  there  is  going  to  be  in  the  market   for  residential  real  estate.   Never  before  have  new  home  sales  gone  on  to  make  a  new  cycle  low  after  a  recession  ends  —  until   now.  In  fact,  in  practically  every  other  cycle,  housing  is  the  first  sector  to  bottom  and  lead  the  economy   out  of  the  downturn.     Please do not forward  


SummitVIEW   4   Risks  &  Opportunities     That  said,  without  the  traditional  credit-­‐sensitive  sectors  leading  the  economy  into  the  upturn,  as  has   traditionally  been  the  case,  then  it  is  hard  to  believe  we  are  going  to  see  a  sustainable  recovery.  Already   we  are  seeing  capital  spending  slowdown  as  companies  opt  for  cash  and  liquidity  as  opposed  to  new   investments  and  the  export  story  is  going  to  grow  old  very  soon  with  Europe  moving  back  into  recession   and  equity  markets  in  Asia  pointing  to  a  moderation  in  growth  there  as  well.  Not  to  mention  what  the   stronger  U.S.  dollar  is  going  to  do  in  terms  of  a  competitive  roadblock  for  U.S.  producers.    

David  Rosenberg,  Gluskin-Sheff,  March  25,  2010  

What Does Greece Mean to You? (in letter addressed to his kids)   It's  all  connected.  We  built  a  very  unstable  sand  pile  and  it  came  crashing  down  and  now  we  have  to  dig   out  from  the  problem.  And  the  problem  was  too  much  debt.  It  will  take  years,  as  banks  write  off  home   loans  and  commercial  real  estate  and  more,  and  we  get  down  to  a  more  reasonable  level  of  debt  as  a   country  and  as  a  world.   And  here's  where  I  have  to  deliver  the  bad  news.  It  seems  we  did  not  learn  the  lessons  of  this  crisis  very   well.  First,  we  have  not  fixed  the  problems  that  made  the  crisis  so  severe.  We  have  not  regulated  credit   default  swaps,  for  instance.  And  European  banks  are  still  highly  leveraged.   Why  is  Greece  important?  Because  so  much  of  their  debt  is  on  the  books  of  European  banks.  Hundreds   of  billions  of  dollars  worth.  And  just  a  few  years  ago  this  seemed  like  a  good  thing.  The  rating  agencies   made  Greek  debt  AAA,  and  banks  could  use  massive  leverage  (almost  40  times  in  some  European  banks)   and  buy  these  bonds  and  make  good  money  in  the  process.  (Don't  ask  Dad  why  people  still  trust  rating   agencies.  Some  things  just  can't  be  explained.)    

John Mauldin,  Millennium  Wave  Advisors,  March  26,  2010  

Warren Issues Warning on Commercial Mortgages Elizabeth  Warren,  head  of  the  Congressional  Oversight  Panel  for  the  Troubled  Asset  Relief  Program,  said   that  by  the  end  of  the  year,  about  half  of  commercial-­‐property  mortgages  in  the  U.S.  will  be  underwater.   "They  are  [mostly]  concentrated  in  the  midsized  banks,"  Warren  said.  "We  now  have  2,988  banks  -­‐-­‐   mostly  midsized  -­‐-­‐  that  have  these  dangerous  concentrations  in  commercial  real  estate  lending."  She   added  that  the  economy  likely  will  not  return  to  normal  for  several  years  as  it  strives  to  resolve  this   issue. CNBC,  March  29,  2010  

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SummitVIEW   5   Risks  &  Opportunities    

U.S. adds $600 million to foreclosure-crisis fund A  special  fund  that  helps  U.S.  states  prevent  residential  foreclosures  will  get  an  extra  $600  million,  the   Obama  administration  said.  The  funding  will  go  to  North  Carolina,  South  Carolina,  Ohio,  Oregon  and   Rhode  Island.  The  money  is  on  top  of  $1.5  billion  previously  allocated  to  California,  Nevada,  Arizona,   Michigan  and  Florida.      

 

The  Washington  Post,  March  30,  2010  

China warned of growing "land loan" threat The  Guanyinxia  forest  stretches  up  to  the  mountains  north-­‐west  of  the  big  central  Chinese  city  of   Chongqing.  Most  is  protected  land.  “Our  purpose  is  mainly  preservation  –  not  to  make  money,”  says  Liu   Siyang,  Communist  party  secretary  of  the  government  bureau  that  manages  the  forest.   Yet  the  same  forest  has  a  double  life  in  the  commercial  world.  It  has  been  used  as  collateral  by  a   company  controlled  by  the  local  government  forestry  bureau  to  help  secure  a  Rmb300m  loan  it  took  out   last  year  from  a  state-­‐owned  bank,  which  was  then  spent  on  infrastructure  projects  in  Chongqing.   Finally,  the  local  governments  can  make  up  for  losses  at  their  investment  companies  by  selling  land.   Yet,  as  the  Guanyinxia  forest  indicates,  not  all  of  the  land  used  as  collateral  is  commercially  viable.  And   the  volumes  could  become  huge.  Stephen  Green,  an  economist  at  Standard  Chartered  in  Shanghai,   estimates  that  the  collateral  used  to  back  loans  issued  to  these  investment  companies  is  equivalent  to   three  times  all  the  land  sold  over  the  past  five  years.   “It  is  hard  to  see  how  this  game  can  continue  without  an  unhappy  ending,”  says  Mr.  Green.   “If  land  values  fall  or  the  market  stagnates  .  .  .  this  game  can  never  be  brought  to  a  successful  close.”    

Geoff  Dyer  in  Chongqing,  China,  Financial  Times,  March  28,  2010  

Art  Cashin  of  UBS  summarized  the  above  best  by  saying,  "Kind  of  like  borrowing  against  Yosemite  or   Mount  Rushmore."            

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SummitVIEW   6   Risks  &  Opportunities    

Opportunities: New Normal Investments U.S. Apparel Retailers Map an Expansion to the North The  border  crossings  underline  a  wider  dilemma  facing  CEOs  in  many  industries.  Many  feel  the  economy   is  still  too  fragile  to  take  big  ambitious  risks,  but  they  still  need  to  restart  growth.  Canada  offers  a  baby   step:  a  way  to  expand  internationally,  but  in  a  market  that's  closer  and  more  familiar  than  Europe  or   Asia.      

 

The  Wall  Street  Journal,  March  29,  2010  

Yield! The  complex,  multi-­‐layer  system  of  government  in  America  is  slowly  shifting  from  extreme  “free   spending”  to  austerity.  And  American  households  are  in  the  early  in  the  process  of  “right  sizing”  their   debt  levels  to  their  modestly  growing  income  streams.   We  believe  these  fundamental  shifts  in  government  and  household  behavior  will  dampen  economic   growth,  and  constrain  private  fixed  capital  formation  in  the  United  States.    We  expect  US  corporations   will  increasingly  allocate  cash  flow  to  dividends  and  share  repurchases.  And  we  are  also  likely  to  see   elevated  M  &  A.  activity.   We  believe  a  high  –  perhaps  an  uncomfortably  high  –  percentage  of  future  total  returns  from  large  cap   US  equity  portfolios  will  come  from  current  yield  rather  than  price  appreciation.  (emphasis  added)   US  households  are  not  just  sitting  still  and  wringing  their  collective  hands  about  their  often  stressed   financial  situation.  They  have  slowly  changed  their  behavior  and  are  now  working  to  lower  their  debt   service  payments  by  chipping  away  at  the  amount  of  debt  outstanding.    But  it  is  a  very  slow  process.   Household  debt  peaked  at  $13.85  trillion  in  mid  2008,  and  was  down  to  $13.54  trillion  at  year-­‐end  2009.   This  translates  into  an  average  pay  down  of  roughly  $18  billion  per  month  over  the  past  18  months.   Americans  have  paid  down  debt  by  lowering  their  monthly  cash  outlays  to  96%  of  their  disposable   personal  income  –  this  “spend  rate”  is  even  with  that  of  1999  on  the  way  up  and  1947  on  the  way  down.   Our  guess  is  this  ratio  trends  “flat–to-­‐down”  for  the  foreseeable  future.    

Douglas  Cliggott,  US  Equity  Strategist,  Credit  Suisse,  March  19,  2010  

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SummitVIEW   7   Risks  &  Opportunities    

Rocking-Horse Winner Even  though  the  government’s  fist  has  been  successful  to  date  in  steadying  the  destabilizing  forces  of  a   delivering  private  market,  investors  are  now  questioning  the  staying  power  of  public  monetary  and  fiscal   policies.  2010  promises  to  be  the  year  of  choosing  “which  government”  can  most  successfully  substitute   the  governments’  fist  for  Adam  Smith’s  invisible  hand  and  for  how  long?  Can  individual  countries  escape   a  debt  crisis  by  creating  even  more  debt  and  riding  another  rocking  horse  winner?  Can  the  global   economy?     The  answer,  from  a  vigilante’s  viewpoint  is  “yes,”  but  a  conditional  “yes.”  There  are  many  conditions  and   they  vary  from  country  to  country,  but  basically  it  comes  down  to  these:   1. Can  a  country  issue  its  own  currency  and  is  it  acceptable  in  global  commerce?   2. Are  a  country’s  initial  conditions  (outstanding  debt,  structural  deficit,  growth  rate,  demographic   balance)  moderate  and  can  it  issue  future  public  debt  as  a  substitute  for  private  credit?   3. Can  a  country’s  central  bank  be  allowed  to  reflate  via  low  or  negative  real  interest  rates  without   creating  a  currency  crisis?   In  today’s  marketplace,  prudent  lending  must  be  directed  not  only  towards  sovereigns  that  can  escape  a   debt  trap,  but  ones  that  can  do  so  with  a  minimum  of  reflationary  consequences  and  currency   devaluation  –  whether  it  be  against  other  sovereigns  or  hard  assets  such  as  gold.  Investment  strategies   should  begin  to  reflect  this  preservation  of  capital  principal  by  positioning  bond  portfolios  on  front-­‐ends   of  selected  sovereign  yield  curves  subject  to  successful  reflation  (U.S.,  Brazil)  and  longer  ends  of  yield   curves  that  can  withstand  potential  debt  deflation  (Germany,  Core  Europe)  (emphasis  added).  (Editor's   note:    Gross  added  Canada  to  this  mix  in  a  follow-­‐up  to  this  piece  while  on  Bloomberg  Radio.)     William  Gross,  PIMCO  Co-­‐Chief  Investment  Officer,  Investment  Outlook,  April  2010  

For Brazil, It's Finally Tomorrow How the country of the future has at last made it—and what remains to be done   For  the  past  century,  Brazil  has  been  a  land  of  great  potential—but  few  results.  With  runaway  inflation   and  stratospheric  national  debt,  the  country  was  too  much  of  a  mess  for  anyone  to  take  it  seriously  on   the  world  stage.   How  times  have  changed.   Consider  this:  In  the  face  of  the  worst  global  economic  crisis  since  the  Great  Depression,  Brazil's   economic  output  dipped  a  tiny  0.2%  last  year,  and  is  expected  to  grow  as  much  as  6%  this  year.   Please do not forward  


SummitVIEW   8   Risks  &  Opportunities     Everyday  Brazilians  have  been  too  busy  buying  washing  machines,  cars  and  flat-­‐screen  televisions  to   even  notice  the  downturn.   Brazil  is  already  the  biggest  economy  in  Latin  America  and  the  10th-­‐biggest  in  the  world.  By  2050,  it  will   likely  move  into  fourth  place,  leapfrogging  countries  including  Germany,  Japan  and  the  U.K.,  according   to  a  study  by  Goldman  Sachs.    (The  entire  article  is  available  here.)    

Paulo  Prada,  The  Wall  Street  Journal,  March  29,  2010

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Approved SummitVIEW Apr 2010