March 2009 Issue: Key Points

This month's feature article takes an in-depth look at the progress we have made towards resolving the three problems that underlie the global economic crisis: (1) The previous engine of growth, the U.S. consumer (or, more broadly, the Anglosphere consumer), has reached her or his borrowing limit, and is now struggling to pay mortgage, credit card, and auto debt, while worrying about losing his or her job; (2) Thanks to high leverage and tight global connections, these credit problems have triggered a systemic crisis across the world financial system; and (3) The problems have been further accentuated by deep imbalances in world economy, which for too long has been characterized by Anglosphere countries like the U.S. issuing increasing amounts of debt to enable them to spend beyond their incomes, while other countries, most notably China (but also including Japan and Germany) financed this profligacy in order to facilitate the growth of their overly-export dependent economies. As a result, when American consumers finally hit their borrowing limit, the consequences exploded across the world with frightening speed, in the manner of those rare mass-cataclysms in complex systems known as "punctuated equilibrium" events.

We find that the middle class American consumer is becoming more anxious, angry and volatile. While they are still giving the Obama stimulus plan and budget the benefit of the doubt, the fact that they have slammed the breaks on spending has made financial asset valuations more uncertain, and will not make it any easier to resolve the financial system crisis. After presenting a short guide to the policy alternatives facing a government trying to sort out a failing bank, we conclude that there are major differences between small and medium size banks, and the megabanks at the center of the current crisis. Regarding the latter, we conclude that the U.K. has set an example for other countries, with its combination of wholesale funding guarantees and de-facto nationalization via government equity purchases. That said, we also believe that at least some wholesale funding should be converted into bank equity, and that both principal/agent and political logic indicate that far more management changes need to be made in nationalized banks than we have seen to date. In terms of international imbalances, we add new detail to our two principal scenarios. The essence of the cooperative scenario is a new era of investment led growth in the United States (focused on the transformation of the energy, and perhaps healthcare industries), consumption led growth in China, and maintenance of a relatively high level of global economic integration.

While there are some signs that the cooperative scenario could develop, there are also plenty of obstacles that may prevent its successful realization. Whether by accident or design, we believe that our conflict scenario could easily develop, which includes higher inflation, slower growth, decreased globalization, and the rise of competing Sinosphere and Anglosphere blocs and hinterlands, with the Eurozone caught in the middle. On balance, we conclude that so many things have to go right in order for the cooperative scenario to develop that the conflict scenario must be considered more likely. We conclude this month's update with a very detailed look at how these two scenarios could affect fundamental value drivers, investor behavior, and prices in a wide range of asset classes over the next two years.

Our product and strategy notes review a number of new studies that should be of great interest to subscribers who are financial advisers, as well as two papers that show how hedge fund size, inflows, and the aggregate amount of money invested in a strategy all affect realized returns. We also review new product launches around the world, new papers on the dynamics of commodity returns, and another paper on one of our favorite subjects, the role of foreign currency exposures in a portfolio.

| Letter from the Publisher | March 2009 Issue: Key Points | This Month's Letters to the Editor: Why Academic Research? and Why Not More Frequent Updates on Where Markets are Headed?; Why Not Currencies as an Asset Class? Is Your Use of Uncorrelated Alpha Strategies in some of your Models Inconsistent with Your Belief in Passive Investing? | Global Asset Class Returns | Uncorrelated Alpha Strategies Detail | Asset Class Valuation Update | Economic Update: Situation, Scenarios, and Asset Allocation Implications | Product and Strategy Notes: Two Interesting Papers on Commodities; News of Note for Advisors; Two Interesting Hedge Fund Papers; On the Product Front and Foreign Currency Bonds....Again | 2008-2009 Benchmark Portfolios - All Currencies |