iron harbor us economic outlook_march 2012

8/2/2019 Iron Harbor US Economic Outlook_March 2012

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View from the HarborUS Economic Outlook

March 2012

Portfolio: Based on our interpretation of

the fundamental trends in the US economy,

we have been assuming an aggressive risk

profile which favors a healthy exposure to

equities relative to bonds. At present, we

think that relatively modest equityvaluations are bounded to the downside by

steady earnings growth, improving

confidence, and easing credit standards.

More broadly, the current negative real US

rate regime should drive capital into higher-

yielding assets.

Economy: Although the last six quarters

have been a little bumpy, underlying

momentum suggests that the US has

regained its footing and is making

meaningful progress in its recovery. We

believe that the US economy is securely in

the middle of the Early Upswing, and will

likely remain in this phase through the first

half of 2013. We are very optimistic on US

prospects as the economy progresses

through the business cycle.

Housing: We are fairly confident that the

worst is over for the US housing market andbelieve conditions for a recovery are

decidedly favorable. The facts clearly reveal

that the elements necessary for a

sustainable recovery in housing are coming

together. The balance of risks to housing in

such an environment is firmly to the upside

and few in the market are paying attention

to what we believe to be a paradigm shift.

avelle Pierre, CFA

[email protected]

is Nicholson, [email protected]

ti Thapar, PhD

[email protected]

queline Hayot

[email protected]

Yun

ww.iharborcap.com

Sales price-to-rent near long term

averages

The US Economy: All Systems Go!

10

15

20

25

1988 1993 1998 2003 2008

Asking Sales Price to Asking Rent

Average since 1988

20

40

60

80

100

120

Jan-06 Jan-08 Jan-10 Jan-12

Conf. Board Consumer Confiden

UMich Sentiment

Strong gains in confidence will

support growth

Source: Conference Board, Reuters/University of Michigan

Index Value

Source: US Census Bureau, Our Calculations

Ratio



In the last ten years, investors have been

burned during the equity busts of 2001-2002

and 2008-2011 and have faced an environment

of sagging confidence and loss of dollar

primacy. It is perhaps natural for the global

investor to give pause at the idea of now

charging into dollar assets. This back-testedattitude, however, misses a few key

fundamentals of the US economy that are now

coming into focus. First, the US economy is

clearly the most balanced and growth-friendly

large developed-market economy. At a

reasonable valuation, this alone demands a

notable allocation.

Second, growth in the US has little

dependence on international trade in

comparison to other developed markets. In a

weaker European and Chinese economic

scenario, it is still realistic for US growth to

remain firm if the domestic economy is in a

favorable place. The converse is strictly not

true. The US shows notable strength in

innovation, connectedness to the global

markets via the English language and

immigration, and more favorable demographic

trends than other developed markets. For an

investor seeking long-term performance with adegree of prudence, we suggest a near-term

orientation to China-neutral Asian markets,

select value-based purchases elsewhere

around the globe, and a US equities core.

As we go deeper into US economic

fundamentals herein, the case for core US

exposure will become clear.

Iron Harbor, March 2012

The US Economy: All Systems Go!

…the US economy is clearly the most balanced and growth- friendly, large, developed-market economy



Underlying the global economic system are the

collective decisions by market participants to

put capital at risk in search of return, or to hold

back. The sum of these decisions, and the

supply and demand balance that results,

normally produces a seven- to ten-year global

business/investment cycle that can becharacterized in distinct phases which inform

price movements in different asset classes.

Where we are in the cycle. Our analytical

framework is based on five distinct phases of

the business cycle1:

Although the last six quarters have been a little

bumpy, and at times the economy’s

progression through the business cycle

appeared to have stalled, underlying

momentum suggests that the US has regained

its footing and is again making meaningful

progress in its recovery.

We believe that the US economy is securely in

the middle of the Early Upswing, and will likely

remain in this phase through the first half of

2013. While this phase can be thought of as a

sweet spot because of low interest rates and

excess production capacity – i.e., activity can

be robust without the threat of higher inflation –

growth typically continues on firm footing

throughout the Late Upswing. We are thus

very optimistic on US prospects over the next

several years.

Initial Recovery

Early Upswing

Late Upswing

Slowdown

Recession

Tracking the Global Business Cycle

1. As set forth by John L. Maginn, et al., Managing Investment Portfolios (New York: CFA Institute, 2007).

Early Upswing

Increasing confidence

Increasing household spending

Inventory builds

Falling unemployment rates

Short-term rates increase

Late Upswing

Confidence is high

Unemployment is low

Inflation pick-up, wages accelerate

Rapid economic growth

Restrictive monetary policy

Exhibit 1: Phases of the business cycle



The biggest known-unknown and the

primary risk to this outlook is the lingering

impact of the credit bust which introduces

unique factors to consider. On the upside,

the easing of credit underwriting standards by

banks, which we discuss below, is likely to

provide a very meaningful boost to theeconomy. Conversely, banks’ exposure to

commercial real estate loans is a source of

ongoing downside risk. Beyond the impact of

the credit cycle, there are other areas worthy of

close attention. We are keeping a close eye on

key input costs, which can undermine profits

and confidence. Gas prices, in particular, are

up 14% since the beginning of 2012 (Exhibit 2).

The role of commodities as a store of value

also bears consideration. Conservative

investors facing inflation-adjusted negative

yields seem to be rotating from debt

instruments to commodities. This could be a

factor driving inflation and in turn, pressing the

need for higher rates as the economy

progresses through the Early Upswing phase.

Although no two business cycles are the same,

the one outstanding difference between the

present cycle and every other post-WWII cycle

is the presence of an ongoing drag on final

demand due to credit cycle deleveraging.

From 1995 to 2007, the combination of low

concerns about financial distress, optimistic

future income expectations, and financial

deregulation, prompted US households to

leverage their balance sheets by assuming

increasing levels of debt. According to the

Federal Reserve, during that period the

financial obligations ratio rose from nearly 17%

to almost 19% per cent of disposable personal

Moving Past the Credit Bust

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

AAA Reg. Gas/Gallon

Exhibit 2: Gas prices making anunwelcome comeback

…the easing of credit underwriting standards by banks …is likely to provide a very meaningful boost to the economy

Source: AAA

$ per gallon



income. Since 2007 we have seen the

reverse: households have cut back on credit

and de-levered as financial distress concerns

increased and pessimism regarding future

income expectations increased. Over the

course of the recession and recovery, the

financial obligations ratio dropped to nearly

16% by 3Q2011—the lowest level since 1993

(Exhibit 3/4). At the same time, banks both

reduced the supply and increased the cost of

lending. These factors amplified the severity of

the

deleveraging cycle and are the primary

reasons the present recovery-expansion

process has been so lethargic. Of course,

everyone already knows this.

What many market participants have not yet

considered is the credit-cycle recovery and its

impact on how quickly the US economy moves

through the business cycle. The key to a

sustainable recovery in credit is dependent

upon households’ perceptions of their debt

levels and expectations of future income as

well as the health of the banking system. That

the academic literature is somewhat divided on

which factor plays the leading role in credit-

driven household demand is almost irrelevant

since both household debt levels and income

are improving. In the past four years,

households have made significant progress in

reducing debt levels, and low interest rates

15

16

17

18

19

20

Mar-80 Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 Mar-10

Financial Obligations as % Disp. Pers. Inc.

Exhibit 3: Households make progress onbalance sheets

1%

2%

3%

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

Int. Pymnts % of Disp. Inc.

Exhibit 4: Households interest paymentsare also at decade lows

Source: Federal Reserve

Percent

Source: BEA, Our Calculations



have reduced the cost of servicing household

debt.

At the same time, the housing market,

employment growth, wage and salary earnings,

and consumer confidence have each stabilized

and in some cases are showing modest

improvement. In this context, we believe that

the balance of risks is to the upside for each

the US economy, US asset markets (except for

Treasuries), and the US dollar in the near and

medium term. The storm is dissipating.

We are fairly confident that the worst is overfor the US housing market and we believe

conditions for a recovery are decidedly

favorable. Household formation has bottomed

out and is again rising at the same time that

starts and permits have stabilized. The ratio of

median US sales-to-rent prices is back near

the 20-year average and vacancy rates, while

at historically high levels, are beginning to

move lower. Foreclosure and delinquency data

looks favorable, but there can be meaningful

differences between states which are not

reflected in the headline numbers. Another

indicator that we have closely monitored is the

rate spread between jumbo and conforming

mortgage loans. This spread suggests that

private financing channels are now healthier

than at any point during the past five years.

We remain excited about the trend in

construction jobs growth which has now been

positive for five consecutive months and is near

its best year-on-year growth rate since October

2006! Residential construction job growth, in

particular, is making remarkable progress andis one more reminder that that this sector of the

economy has not been permanently impaired.

This growth gives us more confidence that

demand is again picking up and soon will be

more fully reflected in new residential

construction figures.

As we mentioned earlier, commercial real

estate (CRE) will likely continue to be a source

of broad uncertainty going forward. Anecdotal

evidence suggests that banks are being

somewhat more aggressive in writing down the

carrying value of CRE assets. Moreover,

delinquency rates have moved steadily lower

Housing: On the Mend

…the balance of risks is to the upside for each the US economy,US asset markets (except for Treasuries), and the US dollar in

the near and medium term



Figure 1. Housing: On the Mend

-20%

-15%

-10%

-5%

0%

5%

10%


NFP Construction % YoY SA (LHS)

0%

1%

2%

3%

4%

5%

1970 1975 1980 1985 1990 1995 2000 2005 2010

Total Households % YoY

Avg % YoY since 1990

Avg % YoY 1965-1985

10

12

14

16

18

20

22

24

26

1988 1993 1998 2003 2008

Asking Sales Price to Asking Rent

Average since 1988

0

1

2

3

Jan-00 Jan-03 Jan-06 Jan-09 Jan-12

Jumbo/Conforming Spread

Household formation rebounding from multi-decade low could create stepwise change in housing activity…

…at the same time that sales price to rents are near

the 20-year average.

Construction jobs growth is making steady progress and suggests demand is again picking up.

Private financing channels are now healthier than at anpoint during the past five years.

Source: Census Bureau

Percent

Source: Census Bureau

Ratio

Source: BLS Source: Banxquote

Percent



for the past twelve months and vacancy rates

have shown modest improvement though they

remain near historically high levels. This

recent data has been encouraging, but risks

still remain.

Finally, we are cautiously optimistic that there

will be a policy-driven boost to the recovery as

policymakers have communicated a renewed

interest in providing assistance to underwater

homeowners through loan modification and

principal reduction. There is, perhaps, ongoing

risk for home prices in the near term as

illustrated by the December S&P/Case-Shiller

data. Beyond the near term, however, the facts

clearly reveal that the elements necessary for a

sustainable recovery in housing are coming

together. The balance of risks to housing in

such an environment is firmly to the upside and

few in the market are paying attention to what

we believe to be a paradigm shift.

In the context of the ongoing recovery, we are

devoting some time to developing a better

understanding of what will be the “new

equilibrium” in housing. From 1970-2000, US

residential fixed investment benefited from

relatively high household formation led by thebaby-boomers. By 2000, the boomer effect on

household formation and home purchases was

winding down and the data is quite startling.

From 1970-2000, household formation was

increasing 1.7% a year (Exhibit 6). Since

2000, household formation has been running at

1.1%; approximately two-thirds the growth rate

of the earlier period!

Source: Federal Reserve, CB Richard Ellis

Percent Percent

6

8

10

12

14

16

18

0

2

4

6

8

10

Mar-00 Mar-04 Mar-08 Mar-12

CRE Delinq. Rate (LHS)

US Office Vacancy Rate (RHS)

…the facts clearly reveal that the elements necessary for a sustainable recovery in housing are coming together

Exhibit 5: Keep a close eye on CRE loans

1947 -

Present

1947 -

1970

1971-

2000

2000 -

Present

Household

Growth YoY 1.75% 2.13% 1.69% 1.12%

Exhibit 6: Household growth slowing

Source: US Census Bureau, Our Calculations



Although the dramatic decline in household

formation had been fundamentally changing

housing’s role in the US economy, the collapse

certainly accelerated this change. Again

looking at the period 1970-2000, residential

fixed investment and the large array of housing

services comprised, on average, 18.4% of real

GDP. Since the housing bust, that contribution

has been 15%; housing is unlikely to be aspowerful a force in our economy as it had been

previously. Nevertheless, we expect a

meaningful uptick in household formation as

the economy progresses through the business

cycle. A resulting stepwise change in housing

activity could quickly create a virtuous cycle of

wealth-effect induced consumer spending,

business optimism and investment, asset price

increases, and wage growth.

Payrolls Steadily Coming Back. The latest

US employment numbers are solid, even

beyond the oft-cited non-farm payrolls and

weekly unemployment claims. First, state and

local government payrolls are declining at

much slower rates and are much less of a drag

on headline numbers. Second, both weekly

hours and real wage growth are advancing

convincingly. Third, job openings and temp

payrolls are showing steady progress. To be

sure, there are a few data series that require

careful attention such as the number of “part-

time workers for economic reasons” and “jobs

hard to get”; neither of which have shown really

meaningful progress. Over the next several

months, it is possible that the recent trend in

payroll expansion may slow a bit, but the

overall pick-up in the labor market is a deepenough story to make us fairly confident

regarding the likely trend over the upcoming

quarters. The primary beneficiaries of the labor

market pick-up will be personal income and

confidence.

What the Numbers Reveal

A resulting stepwise change in

housing activity could quickly create a virtuous cycle of …consumer spending, business optimism and investment …and wage growth.

…the overall pick-up in the labor market is a deep-enough story to make us fairly confident regarding the likely trend over the upcoming quarters



Figure 2. Payrolls Advance Convincingly

Growth in aggregate hours underlines US payroll trends…

…and the government sector is much less of a drag

in recent data.

Temp help payrolls trending lower at same time payroll expansion continues means that…

…companies are hiring. This is for real!

Source: BLS

Percent

Source: BLS

Ratio

Source: BLS

Percent

Source: BLS

Percent

90

92

94

96

98

100

102

-10%

-8%

-6%

-4%

-2%

0%

2%

4%


Index Total Aggregate Hours % Chng YoY (LHS)

Index Total Aggregate Hours (RHS)

Index Value

-6%

-4%

-2%

0%

2%

4%


NFP Total Government % YoY SA

Total Payrolls % YoY

-30%

-20%

-10%

0%

10%

20%

30%

-6%

-4%

-2%

0%

2%

4%


Payrolls % YoY

Temporary Hires % YoY -60%

-40%

-20%

0%

20%

40%

2000

3000

4000

5000


Job Openings (LHS)

Job Openings % YoY Chng (RHS)



Understanding income trends. A data series

we closely track is personal income published

by the Bureau of Economic Analysis. In order

to have a better understanding of the

consumer-centric US economy, it is important

to first understand what is going on with

income because it drives confidence and

consumption. As we have noted previously,

real disposable personal income growth has

been collapsing: year-on-year growth was

negative for most of 2H2011. There is no way

around that data point; it is bad from every

angle. Yet, there is something going on with

personal income that portends good things for

consumption. A deeper dive into the BEA data

reveals that the main contributor to the collapse

in disposable personal income has beenshrinking government transfers to individuals.

Everyone knows that the government gravy

train is drying up. What most observers have

not considered is that the main reason

disposable personal income has been recently

negative is because government transfers to

individuals have declined faster than wage and

salary growth has increased. The good news

is that wage and salary growth has solid

momentum and is increasing at its fastest pace

since last April. If job growth broadens as we

expect, disposable income should also begin

again to move higher. So, it is not enough to

simply look at disposable personal income and

note that it has been negative; the real story is

that wages and salaries have been rapidly

expanding and that jobs growth is the key to

the ignition. Households are already

communicating this sentiment.

-4%

0%

4%

8%

12%

16%


Gov't Transfers % YoY (LHS)

33.7

33.9

34.1

34.3

34.5

34.7

-8%

-6%

-4%

-2%

0%

2%

4%

6%


Real Wage Growth YoY (LHS)

Avg Weekly Hours (RHS)

Exhibit 7: Government gravy train isdrying up…

Exhibit 8: …but wage growth will soon

kick-in.

Source: BEA, Our Calculations

Source: BEA, BLS



Confidence: “10% hard work and 90%

delusion”. US households are more confident

now than they have been at any point over the

past twelve months. Prior to the recent pick-up

in jobs numbers, wage and salary growth, and

the stunning rally in US equities over the past

three months, we believed that there was a risk

of a false bottom and households were

deluding themselves. We now believe that the

improvement in confidence has legs and is

communicating a significant turn in household

sentiment that could ignite the virtuous cycle of

greater demand – jobs growth – wage

expansion – greater demand.

As one would expect during the Early Upswing

stage of the cycle, confidence is steadily

increasing and consumers are borrowing and

spending more. Data from both

Reuters/University of Michigan and the

Conference Board confirms the general trend

in confidence. Moreover, both surveys show

expectations to be improving relative to present

conditions. While we appreciate the fickle

nature of households and consumers, they are

better positioned now than at any point in the

last four years to unleash a torrent of pent-up

demand into the US economy. Better sentiment

combined with a continued expansion in

consumer lending by US commercial banks

could be the catalyst for a powerful andenduring expansion. Very few market

observers are considering the inflationary

consequences of such an expansion.

20

40

60

80

100

120


Conf. Board Consumer Confidence

UMich Sentiment

…[households] are better positioned now than at any point in the last four years to unleash a torrent of pent-up

demand into the US economy

Exhibit 9: Households are feeling good

Source: Conference Board, Reuters/University of Michigan

Index Value



Inflation Concerns. Inflation expectations as

measured by both the Cleveland Fed and the

University of Michigan remain at multi-year

lows and are little changed since 4Q2011.

Nonetheless, there is trouble in the form of

core CPI brewing in this economy which

expectations do not yet capture. Core CPI has

been trending higher for the past 15 months

and is now at 2.3%. The rise in core inflation

should make it increasingly difficult for the

FOMC to justify its current interest rate outlook

given its 2.0% inflation target. Of course, it is

always possible that the recent trend in core

either reverses or moderates over the next

several months. This, however, is an unlikely

scenario because the largest component of

core inflation is owners’ equivalent rent, the

rent paid to oneself as an owner-occupant. It

has also been steadily rising and is now at

seventeen-month highs. The law of supply and

demand will eventually drive lower rental prices

and owners’ expectations of for what their

home would rent as additional rental capacity

comes on line. New construction, however,

takes time. This makes it extremely unlikely

that core inflation will magically start to

moderate within the next few quarters.

1%

2%

3%


Cleveland Fed 5yr Expex

Cleveland Fed 10yr Expex

-1%

0%

1%

2%

3%

4%

5%


Core CPI

Owners Equivalent Rent % YoY NSA

Exhibit 10: Expectations do not capturethe risk of inflation

Exhibit 11: Core is unlikely to quicklymoderate

Source: Federal Reserve Bank of Cleveland Source: BLS



Beyond the immediate signs of actual inflation,and perhaps more important, is the fact that

conditions exist for inflation to make a

substantial return. First, manufacturing

capacity (78.6) is now at 96% of its 2007 levels

and again very close to its forty-year average

of 80.4. There is much less slack in this

economy in 2012 and any unanticipatedincrease in demand from improved consumer

confidence, jobs growth, and income growth

could ignite price pressures. Second, the

Chicago Fed National Activity Indicator

(CFNAI), which provides a useful gauge on

future and current economic activity andinflation, suggests that US growth is again

modestly above trend. The CFNAI three-

month moving average is at its best level in

twelve months. Finally, we are keeping tabs on

the relationship between M2 and the velocity of

money in the US economy; we believe this will

likely be the single most important factor inforecasting the speed at which the US

economy progresses through the business

cycle.

0

1

2

3

4

60

65

70

75

80

85

Mar-00 Mar-03 Mar-06 Mar-09 Mar-12

Cap. Util. Qtrly SA (LHS)

Avg. Cap. Util. (LHS)

Core CPI (RHS)

-5

-4

-3

-2

-1

0

1


Chicago Fed NAI 3mma

Exhibit 12: Activity indicators illustratebroad momentum…

Exhibit 13: …which is captured in capacity data.

Source: Federal Reserve Bank of Chicago

Index Value Index Value Percent

Source: Federal Reserve, BLS



Most market observers are aware that M2

has been expanding at its fastest pace in

more than twenty five years, courtesy of the

Fed. The exponential growth in M2 is believed

by many to have the potential to drive inflation

beyond the control of the Fed. What this logic

has so far failed to capture is the M2 growth isonly half of the story.1 The other critical factor

to consider is the velocity of money through the

economy. Two tangible determinants of

velocity are bank credit standards and loan

growth. To use an example, credit standards

and loan growth act as a dam that regulates

the huge reservoir of M2. Over the past

several years, the Fed has injected a massive

supply of money into the US economy, but US

bank lending standards have been exceedingly

tight; the banks were damming up the supply of

M2 and preventing it from entering into the US

economy. The velocity of money in the

economy depends upon the speed with which,

and the degree to which, banks ease credit

standards—similar to a dam gate release.

There is a huge reservoir of money supplywaiting to be released and banks’ willingness

to lend will determine how fast that supply hits

the economy.

Bank Standards Easing. We monitor the

Senior Loan Officer Survey as a means of

gauging credit availability and demand. Of

particular interest to us are credit standards

and demand for mortgage loans and consumer

loans. The trends in credit standards and

demand for mortgage loans, as one would

expect, have been steadily improving. The

percentage of banks indicating easing as

opposed to tightening standards for prime

loans is more favorable than any time in the

past two years.

M2 Supply is Only Half the Story

1. In fact, the Conference Board recently replaced M2 as a leading indicator noting the difference between the observed relationshipbetween real M2 and general economic conditions.

2. Banks’ reluctance to lend is one of the reasons that Treasuries outperformed equities in 2011. Banks parked QE1 & QE2 related

money supply back into bonds instead of increasing lending.

…[the] exponential growth in M2 …is only half the story. The other critical factor to consider is the velocity of

money through the economy.



Figure 3. Money Supply and Bank Balance Sheets

The increase in money supply following QE1 and QE2 was previously held on US Bank balance sheets…

…and is now being released in the form of

consumer loans….

Source: Federal Reserve Source: Federal Reserve, Our Calculations1

Source: Federal Reserve, Our Calculations

0%

3%

6%

9%

12%

10%

15%

20%

25%

30%


Treasuries & Cash as % Total Assets (LHS)

M2 % YoY (RHS)

-20%

-10%

0%

10%

20%

30%


C&I Loans % YoY

Consumer Loans % YoY (adj.)

PRIME Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12

Tightened

considerably 1.9 1.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Tightened somewhat 15.1 9.4 3.6 13.0 3.7 3.8 5.7 4.2 0.0

Unchanged 79.2 79.2 87.3 83.3 94.4 92.5 86.8 91.7 94.3

Eased somewhat 3.8 9.4 9.1 3.7 1.9 3.8 7.5 4.2 5.7

Eased considerably 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Eased - Tightened -11.3 0.0 5.5 -9.3 -1.8 0.0 1.8 0.0 5.7

…as lending standards begin to ease.

1. In 1Q2010, FASB Rules 166 & 167 changed how banks treated off-balance sheet special purpose vehicles (SPVs). In March, 2010,banks began to bring these SPVs back on to balance sheets and consumer loans recognized as assets on balance sheets ballooned.

Our adjustment for this increase affects year-on-year growth from March 2010 – March 2011.

Credit standards for approving applications from individuals for prime mortgage loans



On the consumer lending side, the surveys

indicate softer demand among somewhat

easier standards. The takeaway is that banks

are loosening lending standards. If US activity

continues to gain momentum, as we expect, a

gate release of M2 by the banks could send the

US economy quickly into overdrive and force

the Fed to increase policy rates well before the

end of 2014.

Based on our interpretation of the

fundamental trends in the US economy, we

have been assuming an aggressive risk

profile which favors a healthy exposure to

US equities relative to bonds. In upcoming

weeks, we will more fully discuss the factors

driving these allocation decisions. While our

investment process is firmly rooted in

fundamental analysis, we do pay attention to

valuations. At present, we think that relativelymodest equity valuations are bounded to the

downside by steady earnings growth,

improving household and business confidence,

and easing credit standards. More broadly, the

current negative real US rate regime should

drive capital into

higher-yielding assets. Thus, while absolute

valuations are reasonable, relative valuations

compared to bonds are even more reasonable.

As we have seen over the last few months,

investors have been well-compensated for

going into cheap US equities in advance of

clearer positive economic data. Nonetheless,

the US equities trade has now been de-risked,

and while valuations are a bit less compelling

on an absolute basis, they are highly

compelling versus interest-rate instruments. In

addition, risk hedging instruments like VIX

futures and put options are now priced for low

volatility, which creates a unique opportunity to

construct long-term return portfolios with

dampened downside volatility profiles. For allof the reasons stated above, we believe

skepticism about the US economy and equities

are unwarranted, and we recommend fairly

aggressive positioning on this theme even in

fairly conservative portfolios.

Conclusion and Valuation

Note

…we believe skepticism on the US economy and equities are unwarranted, and we recommend fairly aggressive positioning on this theme …



Iron Harbor Forecasts

Note: * represents forecasted values.

Gravelle Pierre, CFA is the Founder and Chief Portfolio Manager of Iron Harbor.

[email protected]

Chris Nicholson, CFA is the Senior Portfolio Strategist of Iron Harbor

[email protected]

Aditi Thapar, PhD is a Clinical Assistant Professor of Economics at New York University.

Her research focus is on Macroeconomics, Monetary Economics and Applied

Econometrics. Her most recent research paper, “Using Private Forecasts to Estimate the

Effects of Monetary Policy”, was published in the Journal of Monetary Economics, 2008.

She serves as Head of Global Economics of Iron Harbor.

[email protected]

Jacqueline Hayot is the Chief Operating Officer of Iron Harbor.

[email protected]

2011 2012

Q3 Q4 Q1* Q2* Q3* Q4*

Real GDP 1.8 2.8 3.0 2.9 2.9 2.7

Core Inflation 2.5 1.9 2.3 2.3 2.4 2.4

Federal Funds

Rate 0.1 0.1 0.1 0.1 0.1 0.2

Unemployment 9.1 8.7 8.4 8.3 8.2 7.9

iron harbor us economic outlook_march 2012

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