asset management

Market Letter (Apr 01, 2011)

Markets today:
Labor Markets: Mar Non-farm payrolls surprised on the upside (↑216K vs. ↑190K [est] & ↑194K [Dec]) as private
sector job creation remained strong (↑230K vs. ↑206K [est] & ↑240K [Jan]) and in line with the recent ADP print
(↑201K). Payrolls for the prior 2 months were revised up by 7K: Feb (194K; ↑2K) and Jan (68K; ↑5K). Payroll
employment grew by 1.5mn (or 115K/month) from its recent low seen in Feb’10, as private sector job creation
(↑1.8mn or 138K/month) was partially offset by the 320K jobs lost in the government sector during that period.
Goods-producing sector added 31K jobs (vs. ↑73K [Feb]), as construction came in flat (vs. ↑37K) and factory
payrolls moderated (↑17K vs. ↑32K). Mining-related jobs however rose (↑15K vs. ↑4K). Job creation accelerated
in service-providing sector (↑199K vs. ↑167K) reflecting sequentially higher numbers across most heads: Wholesale
trade (↑14.1K vs. ↑13.6K), Retail trade (↑17.7K vs. ↓7.8K), Financial services (↑6K vs. ↓3K), Professional/business
services (↑78K vs. ↑44K), Temporaries (↑29K vs. ↑23K), and Education/health (↑45K vs. ↑41K). Leisure and
hospitality moderated (↑37K vs. ↑48K), while transportation and warehousing came in flat (↑22K) post its Feb
spike. Job losses in Government got extended (↓14K vs. ↓46K), all of which in Mar was at the Local level.
Average workweek remained unchanged at 34.3hrs as expected. Average hourly earnings also came in flat ($22.87),
but trailed expectations (↑0.2%) once again. Its YoY gain exhibited a similar pattern (↑1.7% vs. ↑1.9% [est]), while
lagging the headline CPI (↑2.1%) for the same period.
Household Survey reported a fractional drop in unemployment rate to 8.8% (vs. 8.9% [Feb] & 8.9% [est]) as
employment (↑291K vs. ↑250K) rose faster than the expansion in labor force (↑160K vs. ↑60K), which in turn
pushed the number of unemployed to 13.542mn (↓131K); 6.1mn or 45.5% (↑1.6%) of whom have been jobless for
27+ weeks. 2.4mn remained marginally attached to the labor force, of which the share of discouraged workers stood
unchanged at 921K. The broadest measure of unemployment/under-employment (U-6) edged down further to
15.7% (↓0.2%). And among the employed, the number of involuntary part-time workers held steady at 8.4mn. Both
Civilian labor force participation (64.2%) and Employment-population ratio (58.5%) also held steady during March.
Manufacturing: Mar ISM/PMI dipped (61.2 vs. 61.4 [Mar]), but beat expectations (61.1) to signal continuing
th
expansion in the nation’s manufacturing sector for a 20 straight month. 15 of the 18 industries that comprise the
sector reported growth during the month. Production rose (69 vs. 66.3), while New Orders (63.3 vs. 68), Backlogs
(52.5 vs. 59) and Exports (56 vs. 62.5) plunged. Employment expanded at a slower pace (63 vs. 64.5). Inventories
jumped up to a strong build from a weak draw (57.4 vs. 48.8). Prices Paid accelerated further in the 80’s (85 vs. 82).
Fedspeak: NY Fed’s Dudley said the recovery was still tenuous and still far from the mark on Fed’s dual mandate;
that the unemployment rate was much too high and the coast was not completely clear. Noting that the recent rise
in inflation was not due to monetary policy, he saw no reason to pull back from stimulus. However, Philly Fed’s
Plosser noted that an exit from stimulus may be warranted should the economy witness a stronger rebound. He
commented core inflation did not matter. Dallas Fed’s Fisher felt the Fed may be doing too much now, suggesting
that the stimulus could come off. Richmond Fed’s Lacker expressed satisfaction over economic recovery and said it
would not surprise him if the Fed acted on inflation in 2011.
NY: Stocks opened higher following better-than-expected payroll data, and went on to post impressive gains through
much of the session before paring a large chunk of their gains in late afternoon selling of Tech (semis), but only to
rebound and close on a strong note. Averages ended well off their day’s highs. Industrials and Financials led, while
Tech and Telecom lagged. Trading remained very light. Treasuries sold off at the open on stock strength and Fed
Presidents’ comments, but rallied back after Dudley’s remarks. Dollar rolled over after Dudley statement. Crude
rallied on dollar weakness. Grains rose further. Precious metals pared their intra-day losses, but still ended in red.
Copper was noticeably weak. VIX plunged at the open, but recouped bulk of its losses amid choppy trading.

This proprietary and confidential document is a market commentary meant for informational purpose only and not an advice or solicitation or an offer to enter into any transaction.

Marco Polo Asset Management 75 Broad Street, New York

 asset management

Close: Dow (12377, ↑0.46%); S&P (1332, ↑0.5%); NASDAQ (2789, ↑0.3%); R2K (847, ↑0.4%); VIX (17.52, ↓1.5%);
10yr (3.448, ↓2bp); 2/10 (265, -----); FN4.0 (80, ↓2bp); EUR (1.4227, ↑0.5%); DXY (75.85, -----); CRB (360.9, ↑0.4%);
Oil (108.16, ↑1.4%); Ngas (4.33, ↓1.30%); Au (1428, ↓0.8%); Ag (37.76, ↓0.3%); Cu (4.242, ↓1.4%).

Macro Outlook:
Sequentially better job creation in the private sector and stability seen across various cuts of unemployment are
certainly encouraging. The pace of job growth during Q1 has also edged up to 159K/month (↑20K). Nonetheless,
today’s employment report is somewhat similar to the last one in some ways, when it comes to growth outlook. For
instance, flat hours worked would call for a significant pickup in productivity to deliver on growth expectations. But
we see no obvious catalysts for this in the near term. On the other hand, corporate margins are getting squeezed as
input costs, notably energy, have been on the rise in the face of limited pricing power. Businesses have shown
reluctance to build inventories and invest in capex. Therefore productivity may not get much of a lift at this stage.
On the personal consumption side too, higher energy costs could cap discretionary spending as income growth has
been weak, so much so that consumers had to draw down their savings. We see Q1 GDP centered at 2.75%.
Click here to access our top global macro calls for 2011.

Portfolio Strategy:
Risk assets have shown great resilience while facing serious headwinds from MENA political crisis, Japan earthquake,
peripheral European debt issue, the end of Fed’s QE2 in June and concerns over government shutdown in
Washington DC. To this list we should also add the risk of below-trend growth in the US during Q1 and Q2. Of
course, the market is not unaware of any of these. For instance, even as assets rallied, trading volumes remained
thin, participation from Financials was lackluster, and price action was outsized to almost any piece of news (or
speech for that matter). From a macro perspective, leading indicators and ISM indices have either peaked or in the
process of doing so. While absence of wage inflation is the foundation on which the Fed’s easy money policy rests, it
also spotlights the elevated level of slack in labor markets. And despite job creation, consumer sentiment has
plateaued and is currently at levels last seen in Mar’10, telegraphing clearly that it is not just jobs, but rising incomes
that make consumers feel good. Housing has double-dipped and home prices continue to deflate.
That being said, US equity valuations are not too expensive by historical comparison, as multiple-expansion has been
relatively steady. Sure there are sectors that are a bit rich after the heady bull-run, but the broad market does offer
some interesting opportunities here. Cyclicals still look appealing, but may not be compelling anymore. On the other
hand, Staples may merit consideration, not only to navigate uncertainty but also to benefit from their pricing power
in fast growing global markets. The current commodities-led rally is not over yet. In fact, it has formed a strong base
from which it can grind higher. Within commodities, Ag plays will endure as they have become thematic and the
speculative bid for oil would hold as MENA unrest cannot be wished away anytime soon, certainly not in one
quarter. Commodity-indexed currencies remain biased to the upside, while Yen and Euro are to concede significant
ground to the dollar. Precious metals are well-entrenched to benefit from exogenous shocks and unintended
consequences of economic policies. Our macro arguments do not suggest inflation to be a major concern at this
stage. Treasury yields are unlikely to take flight, but offer useful range trades. However, with corporate balance-
sheets in such fine shape, better relative value can be found in corporate credits. We expect spreads to remain
stable, credit environment robust and defaults fewer. By mid-March, we had also begun to rotate out of our
underweight allocation to EM. Given how well that had worked, this process may well have more room to run in Q2.
Bottom line: We expect growth to moderate and inflation to stay low, against the backdrop of numerous headline
risks. Our portfolio strategy is to stay consistent with these expectations, while favoring select risk assets.

– Shiva Ganapathy (See marcopoloam.com for more)

This proprietary and confidential document is a market commentary meant for informational purpose only and not an advice or solicitation or an offer to enter into any transaction.

Marco Polo Asset Management 75 Broad Street, New York