mam insights october 2012

Merlin Asset Management ● 20 Park Plaza, Suite 400 ● Boston, MA 02116 ● www.merlinam.com

An Economic and Market Commentary

by Michael Obuchowski, Ph.D.

Merlin Asset Management - Insights October 2012

Inside this issue

Introduction ................................ 1

Current Threats .......................... 1

More Global Risks and

More Global Response................ 2

Early Economic Indicators ........... 4

Lagging Economic Indicators....... 6

Summary .................................... 9

About NSAM ............................... 10

Special points of interest

US economy continues its slow consistent recovery

US leads global economies our of recession

Europe refuses to break apart and abandon euro

Central banks prepared to do whatever it takes for as long as it takes to protect and stimulate global economies

After posting solid returns in the first quar-

ter of 2012, US equity markets declined in

the second quarter, and staged a solid re-

covery from early June until the end of Sep-

tember. Despite the resulting excellent year-

to-date returns, investors and pundits con-

tinued to behave as if they were in the mid-

dle of a continuing recession. Many econo-

mists questioned the slowly but consistently

improving US economy, spreading fear and

doubt with their relentless pessimism. Most

of the financial media joined in, seemingly

abandoning objectivity and focusing on

sharing the pundits’ pessimism rather than

on presenting objective reporting. Despite

this widespread negativity, the equity mar-

kets continued to anticipate a US and global

economic recovery and continued to move

higher. During the last several months, it

became increasingly clear that the US once

again has become the driving force behind

the global economic recovery. Weak dollar

stimulated export and manufacturing in the

initial phase of recovery from the recent

deep recession. After several quarters of

stagnation, the housing recovery finally

started gaining steam. Together with steady

returns in the equity markets and a slowly

improving employment situation, consumer

confidence started its recovery from the

bottom of the recession. Anticipating im-

proving economy, the US equity markets

ended the quarter with solid returns, finish-

ing at 2012 highs. The S&P 500 Index ended

the quarter with a 6.35% return (16.45%

YTD). The Russell 1000 Growth Index fin-

ished the quarter with a 6.11% return

(16.80% YTD) and the Russell Top 200

Growth Index ended the quarter with a

6.41% return for the quarter (17.97% YTD).

With all the central banks focused on reaccelerating global

growth and preventing Europe from falling into another se-

vere recession, politics remained the most troubling and very

visible threat to the US economy. Despite the quickly ap-

proaching deadline, the political inaction in Washington will

result in big tax increases when 2001 and 2003 Bush tax cuts

expire by the end of the year. Dividends that attracted the

attention of many individual investors in this extremely low

interest rate environment would be taxed at their ordinary

income rates as high as 39.6%. Capital gains maximum tax

rate would increase from 15% to 21.2% for long term and 35%

to 40.8% for short term gains. There continues to be a signifi-

cant disagreement as to the probabilities of this “fiscal cliff”

actually happening. There is currently a consensus in Wash-

ington (which is something we have not seen in several years)

that the fiscal cliff would have a significantly negative effect

on the US economy and would likely send the US economy

back into another recession. For those reasons, the probability

of complete inaction in Washington is much lower now than it

was only a few months ago. Real action happening during the

lame duck session of Congress most likely depends on the

results of the upcoming elections. Regardless of the elections

results, the most likely outcome is a temporary “kick the can

down the road” approach early during the next session of

Congress retroactively applied to the beginning of the year.

Despite the low probabilities of inaction, investors cannot

ignore the chances that fiscal cliff might occur.

The US equity markets and companies exposed to the US

economy have become one of the most interesting places to

invest. The continuing economic recovery combined with

highly accommodative stance of monetary policy in the Unit-

ed States that is likely to “remain appropriate for a considera-

ble time after the economic recovery strengthens” sets the

United States apart from the rest of the world. US economy is

primarily consumer driven and relatively insular—only about

10% of GDP is directly related to exports. Increased risks and

slow growth in Europe, slower growth in typically much fast-

er growing Asian economies and the resulting slowdown in

the increase in demand for commodities has limited effect on

the US economy when consumers are increasingly willing to

Introduction

Current Threats and Opportunities


Merlin Insights October 2012

The newly found decisiveness of the European Central Bank

(ECB) was shared by other central banks during the last few

months. Mario Draghi, ECB’s president’s statement that

“Within our mandate, the ECB is ready to do whatever it takes

to preserve the euro,” should have answered any questions

about central banks’ determination. If that was not enough, the

US Federal Open Market Committee’s statement “If the out-

look for the labor market does not improve substantially, the

Committee will continue its purchases of agency mortgage-

backed securities, undertake additional asset purchases, and

employ its other policy tools as appropriate until such im-

provement is achieved in a context of price stability.” eliminat-

ed any remaining doubts. Open-ended commitments of central

banks will assist in the recovery of the global economy and

lower the risk of another recession in the near term. Continu-

ing central banks actions brought the VIX volatility index back

towards its Q1 lows (see Figure 2). Despite US economists’ and

media conviction about the impending collapse of Europe and

the unavoidable exit of Greece and the other Club Med coun-

tries from the Euro zone, nothing like that happened and the

probabilities of such events happening are extremely low. In

fact, the real risks of an uncontrolled collapse were present

more than a year ago when the EU was caught by surprise and

the politicians seemed to be completely unprepared for quick

and decisive actions designed to rescue the European econo-

my. It certainly took a couple of years longer that it should

have taken, but the stability measures implemented in Europe

successfully limited the probabilities of a tail risk event – at

least for the time being. The latest ECB program enabled the

More Global Risks and More Global Response

Figure 2. CBOE SPX Volatility Index. Source: CBOE, Bloomberg.

spend their money. Real estate was a popular investment be-

fore the recession. Despite the recovery in real estate, more

investors realize the risks of investing in a highly cyclical

assets with limited liquidity. Understanding that interest

rates will eventually move higher made fixed income in-

vesting increasingly risky. The US Treasuries, previously

thought of as investments with nearly riskless return are

increasingly described as investments with “returnless

risk”. One of the areas of interest from investors selling out

of real estate in the cities was farmland. Until recently,

farmland was considered to be attractively priced in many

areas of the US. After gains in the 1970s, the value of agri-

cultural land was basically flat between 1981 and 2001.

Between 2001 and 2011, the average value for land in Iowa

increased from $1,926 to $6,708 per acre – a 248% increase

during a period time when the S&P500 Index price

changed only 9.45% (total return for the S&P500 Index was

32.83%). The rapid rate of increase in land value (32.46%

increase in 2011 was the largest increase ever) has led to con-

cerns of farmland becoming the next speculative bubble. The

recent government energy policy changes that led to increase

in farm income are considered to be the primary reason for

increase in farmland value with nearly 40% of US corn crops

going to biofuel production. Any changes to energy policy

that would lower the use of corn for ethanol production could

have dramatic negative effects on farm income and price of

farmland. With food prices increasing because of the diver-

sion of corn to fuel production and the abundant natural gas

increasingly substituting other fuels in energy hungry indus-

tries, energy policy changes are certainly not impossible. In

addition, a possible glut of supply of sugar from Brazil (Brazil

is the second largest producer of ethanol and uses sugar to

produce it) might result in the United States importing etha-

nol from Brazil, directly affecting the need for corn ethanol.

Figure 1: Average value per acre of Iowa farmland. Source: Iowa State

University Extension and Outreach Land Values Survey.

3 Merlin Asset Management ● 20 Park Plaza, Suite 400 ● Boston, MA 02116 ● www.merlinam.com


ECB to buy unlimited amounts of debt of struggling Europe-

an countries. Such purchases are expected to lower their bor-

rowing costs and to regain market access. Despite official

denials, Spain is likely to be the first country to ask for a Eu-

rozone bailout under this program. Spanish government has

instituted ambitious changes in the recently announced 2013

budget with focus on liberalizing the economy and cutting

government spending rather than increasing taxes. There are

signs of progress—the unexpected increase in tax revenues

was the first welcomed sign that Spain’s reforms are begin-

ning to move their economy in the right direction. Even with

some positive signs, the cost of borrowing and the amount of

money that Spain will need in the near future makes the Eu-

rozone bailout of Spain very likely.

The only Eurozone country that is following on a path of

drastically increasing taxes and refusing to cut spending is

France under newly elected Francois Hollande. So far, the

first reaction of French businesses are suspension of invest-

ments in the country, layoffs and closures.

After the initial success of the long awaited European action,

one of the most significant issues affecting investors contin-

ued to be the effect of the European slowdown on China and

countries dependent on the demand for industrial commodi-

ties. There was ample evidence of a slowdown in Chinese

economy during the last several months. At the same time,

very few observers doubted the commitment of the Chinese

government to maintain GDP growth above 7% . Their efforts

to shift the Chinese economy from completely dominated by

export towards a consumption-based economy made inter-

pretation of data coming out of China very difficult and pro-

vided plenty of ammunition to those expecting a “hard land-

ing” (which is typically defined as under 7% GDP growth).

The economic slowdown also questioned assumptions that a

shift to consumer consumption will quickly result in reaccel-

eration of economic growth and support for other economies

that will need to satisfy the growing internal demand in Chi-

na. There were some bumps in the road when the initial im-

plementation of the policy resulted in higher salaries, infla-

tionary pressures and lower profits that negatively affected

investments. After the failure of those initial policies focused

only on raising living standards, the recently announced $154

billion infrastructure investment program will likely be much

more successful in helping to stabilize and reaccelerate Chi-

na’s economy towards the end of 2012.

One of the major beneficiaries of China’s increasing focus on

domestic consumption is Germany. The demand from China

helped Germany to recover quickly from the recession and to

avoid slipping into another one despite the crisis in many

European countries. Germany has an export oriented econo-

my which is unusual for a developed European country. At

the same time, due to scarce natural resources, Germany also

depends on imports, particularly in the energy sector. In

2011, German exports for the first time exceeded 1 trillion

euros, with imports reaching 902 billion euros. With growing

demand from developing countries, the German export pro-

pensity (ratio of exports to the gross domestic product)

reached 41.3%, the highest level ever. In 2011 China was Ger-

many’s fifth largest export country and the second largest

import country. After growing at 19% annual rate between

1991-2008, according to some estimates, China might become

Germany’s top export customer by 2016.

China is also increasingly important to the United States. As I

presented in my last Commentary (see Economic and Market

Commentary April 2012), despite the common perception

that the United States is mainly an importer of Chinese

goods, China is Unites States’ 3rd largest export market

(behind Canada and Mexico) and continues to be the fastest

growing one, with $103.90 billion in US exports to China in

2011.

There are certainly valid reasons to believe that China’s move

away from exports will negatively affect demand for com-

modities in the short term and negatively affect the econo-

mies of countries dependent on commodities exports. In the

long term, the more reasonable future rate of increase in com-

modities demand is likely to follow a much healthier and

more sustainable path.

Figure 3. Germany’s major trading partners. Source: The Federal Statistical Office.

https://www.box.com/s/47a9a0733b8f21359c46

https://www.box.com/s/47a9a0733b8f21359c46



In my last commentary, I concluded that the run up to the

elections was going to happen within the context of an im-

proving economy. The matrix of early economic indicators

and a number of other indicators that I have been following

closely since 2008 allowed me to take an objective look at the

current state of the economy and provided an unbiased guide

to the most likely path of economic developments. Despite the

anemic GDP and headline grabbing unemployment numbers,

the US economy continued to improve.

It is always interesting to review the indicators and what their

patterns might suggest about the future. The first of the lead-

ing economic indicators that I have been following since 2008

was the Core Crude Goods Producer Price Index. The CCG

Index provides insight into the earliest stages of capital goods

production and is especially sensitive to turning points in the

economic activity, as we can see in Figure 4. It proved to be an

important indicator of changes in future industrial produc-

tion, suggesting the bottoming of the recession the recession

in the early 2009. The pattern was even more interesting dur-

ing the last two years, indicating a recovery early during both

years and then slowdown in the second half of each year. At

the same time, the overall level remained close to the 2008 and

2010 highs with the latest pattern suggesting a continuation of

the economic recovery.

The Primary Metals Index captures the raw materials being

ordered by large manufacturers and it proved to be an im-

portant indicator of changes in future industrial production.

At its current level of 27003 (see Figure 5), the PMI is has been

falling since the end of 2011’s peak of 32055, pointing to a de-

cline in raw material orders. Nevertheless, the current level is

just slightly above its pre-recession peak in 2008, suggesting a

level of demand consistent with continuing growth in indus-

trial production.

The Core Capital Goods Order Index is considered to be one

of the best indicators of business investment spending. Tech-

nically known as the New Orders of Nondefense Capital

Goods Excluding Aircraft, it provides a broad overview of

business investing, while controlling for the volatile aircraft

orders and defense spending that is rarely highly correlated to

economic activity or expectations. Unlike the other indices,

after leveling off since the middle of 2011, it has declined in

the last few months to the level last seen nearly two years ago

(see Figure 6). Unless the decline is just part of this year’s vol-

Figure 6. Core Capital Goods Order Index (New Orders of Nonde-fense Capital Good Excluding Aircraft & Parts). Source: US Census Bureau, Bloomberg.

Figure 5. The Primary Metals Index (US Durable Goods New Orders) since 3/31/2006. Source: US Census Bureau, Bloomberg.

Early Economic Indicators

Figure 4. Core Crude Goods Producer Price Index. Source: Bureau of Labor Statistics, Bloomberg.



atility and the index rebounds in September (with monthly

lag, the latest data is for August 2012), it will be very difficult

to be optimistic about continuing business investment spend-

ing.

When selecting the Baltic Dry Index in early 2008, I expected

that it was going to be a useful indicator of global economic

activity. The BDI provides an assessment of the price of mov-

ing raw materials by sea. It covers 26 shipping routes world-

wide and is a composite of the Baltic Capesize, Panamax,

Handysize ansd Supramax bulk carrier indices. To my sur-

prise, instead of being an index of global economic activity,

the BDI proves to be a very sensitive measure (BDIY is calcu-

lated daily) capturing economic activity in China. Consider-

ing China’s efforts to refocus on domestic investments and

consumption., is certainly an interesting question whether

BDI will remain so in the future. The pattern of recovery in

2009 and decline in 2011 and 2012 (see Figure 7) seems to

mirror closely the recent slowdown in Chinese economy. The

BDI will be an important index to monitor in the future to

help evaluate the effects of China’s new economic stimulus.

The first four indicators presented above showed a consist-

ently improving economy since early 2009 with leveling off

and declines in 2011 and 2012. The first three indicators di-

rectly tap into early stages of manufacturing. Although man-

ufacturing represents only approximately 11% of the US

GDP, it has the highest direct multiplier effect of any sector

in the economy. United States will benefit from the abun-

dance of natural gas (that for the time being cannot be ex-

ported due to lack of export facilities) making energy de-

manding manufacturing increasingly attractive despite high-

er relative labor costs. Despite these positive developments

that should help manufacturing growth in the future, the

declines in early indicators are worrisome and bear close

attention for any signs of further deterioration or recovery.

The last two indicators have only recently started presenting

a more positive pattern are both related to real estate. The

Architecture Billing Index (ABI) is a leading indicator of

commercial construction activity, capturing approximately

nine to twelve months lag time between architecture billings

and construction spending. The ABI is derived from a

monthly “Works-on-the-Boards” survey sent to a panel of

the American Institute of Architects member-owned firms.

The ABI is a diffusion index and a level of above 50 repre-

sents an increase in architectural billings. Figure 8 illustrates

how, after recovering from the catastrophic decline in early

2009, the index crossed 50 in late 2010 and remained range-

bound close to the breakeven 50 level in 2011 and 2012.

Based on this index, it appears that there is some hope for

commercial construction activity, or at least no evidence of

declining demand for architectural work.

The Private Housing Authorized by Building Permits Index

(BPI) provides information about expectations for residential

real estate activity based on the issuance of building permits.

Finally this is one indicator where there is no question that

the latest seasonally adjusted BPI of 801,000 (Figure 9) is a

great improvement from the 513,000 bottom reached in

March of 2009. Despite the consistent increase during 2011

and 2012, it is important to remember that the BPI is still far

from its peak of nearly 2 million permits issued per month in

April 2006 and less than half of the 10 year median of season-

ally adjusted monthly permits.

The BPI is an important indicator to follow because of its

long history of reliability as an economic indicator and large

direct and indirect multiplier effects. By some estimates, con-

struction of 1,000 single family homes generates directly

2,500 full time jobs and nearly $100 million in wages. The

Figure 8. The Architecture Billings Index. Source: American Institute of Architects, Bloomberg.

Figure 7. The Baltic Dry Index since 3/31/2006. Source: Baltic Ex-change, Bloomberg.



As expected in an election year, we have been hearing a lot of

politically-driven rhetoric rather than objective analyses of

available economic data.

The most obvious target of political spin is the data related to

employment. The official headline unemployment measure is

the U-3 (total unemployed, as a percent of civilian labor

force). The U-3 rate has declined significantly from its reces-

sion high and very recently dropped below 8% for the first

time since January 2009.

A necessary part of the continuing decline in unemployment

is jobs creation. Based on the average population growth and

the average Labor Participation Rate for the last 10 years, it is

necessary to add approximately 150,000 jobs every month

just to keep up with natural workforce growth. This number

might be significantly lower with a decline in the Labor Par-

ticipation Rate that has been observed for the last 10 years.

Of course there are many interpretations of the reasons of the

decline in the Labor Participation Rate (see Figure 12). Some

argue that naturally retiring baby boomers will continue to

shrink the labor force and help the unemployment numbers

drop even faster. Others argue that the primary reason for a

declining Labor Participation Rate is that many people give

up searching for work and leave the civilian labor force tem-

porarily until the job prospects improve. According to the

Bureau of Labor Statistics, the number of Persons Not in the

Labor Force increased by 3.08% during the last 12 months. At

the same time, the number of Persons who Currently Want a

Job increased by 8.4%, with a 0.24% decline in those Margin-

ally Attached to the Labor Force, and an astonishing 22.66%

decline in the Discouraged Workers subcategory. These data

suggest that retiring individuals might be the primary reason

for the Labor Participation Rate decline, although it is possi-

ble that decisions to retire might have been precipitated by

Lagging Economic Indicators

Figure 11. U-3 US Unemployment Rate Total in Labor Force. Source: Bureau of Labor Statistics, Bloomberg.

World Bank estimates that every $1 invested in the housing

sector generates an economy-wide multiplier effect of $5-$12.

Many argue that a recovery in housing combined with rising

equity markets has a positive effect on the consumer confi-

dence, fueling a positive feedback loop of increasing consum-

er spending driving acceleration in the economic recovery. In

fact, regardless of which of the consumer confidence surveys

one looks at, they all show solid recovery in late 2011 that

largely continued into 2012 (see Figure 10).

Figure 9. Private Housing Authorized by Building Permits Index. Source: US Census Bureau, Bloomberg.

Figure 10. University of Michigan Survey of Consumer Confidence Sentiment. Source: University of Michigan Survey Research Center,



the perceived lack of job opportunities.

It is clear (see Figure 13) that after the horrific jobs losses cul-

minating in a net loss of 741,000 jobs in January 2008, jobs are

being added again. At the current level new jobs are outpac-

ing the population growth and are contributing to lowering

the unemployment. The Federal Reserve Bank of Atlanta

created an online “Jobs Calculator” designed to answer a

question of how many net jobs need to be created to achieve

a specific unemployment rate in a specific amount of time.

The calculations are based on the current economic data and

a set of assumptions related to employment analysis (with

Labor Participation Rate being the most important variable).

In the last Commentary, I pointed out that even without a

change in Labor Participation Rate and using the latest (at

the time) four week average monthly change in payroll em-

ployment of 214,500, the model estimated the expected un-

employment rate by the November elections to be approxi-

mately 7.59%. The recent decline to 7.8% should not have

been a surprise.

Many argue that the U-3 is too conservative of a measure and

that we should use a more liberal measure to fully evaluate

labor underutilization, not just strict unemployment. The

most liberal alternative measure from the Bureau of Labor

Statistics is the U-6: Total unemployed, plus all marginally

attached workers, plus total unemployed part time for eco-

nomic reasons, as a percent of the civilian labor force plus all

marginally attached workers. The U-6 rate is always higher

than the U-3 and provides a better picture of the labor utili-

zation trends. The spread between these two measures typi-

cally widens during the periods of prolonged high unem-

ployment due to economic contraction. Because the U-6 in-

cludes all marginally attached workers who are not counted

in the civilian labor force and are not included in the U-3

unemployment, the U-3 vs. U-6 spread can better illustrate

changes in unemployment than either of the measures alone.

As we can see in Figure 14, despite the decline in U-3 and U-

6 measures, the U-3/U-6 spread stayed close to its high

throughout 2010 and most of 2011. The U-3/U6 spread has

only started declining at the end of 2011 and continued its

decline in early 2012, supporting other data suggesting the

long awaited improvements in the labor market.

There are several interesting measures closely related to the

changes in unemployment that are less controversial and

more informative than the payroll numbers or information

obtained from the household survey. One of the measures

that I follow closely is the Average Weekly Hours worked

(see Figure 15). Current level of average weekly hours (just

below 2007) suggests that existing employees are unable to

provide more working time and are reaching limits of

productivity improvements. As a results, it is likely that com-

Figure 13. US Employees on Nonfarm Payrolls Total Monthly Change. Source: Bureau of Labor Statistics, Bloomberg.

Figure 14. U-3 and U-6 Unemployment and U-3/U-6 spread since 1994. Source: Bureau of Labor Statistics, Bloomberg.

Figure 12. US Labor Participation Rate since 1949. Source: Bureau of Labor Statistics, Bloomberg.



panies will have to increasingly focus on hiring new employ-

ees.

Throughout the recession we have heard that for unemploy-

ment rates to decline, the Initial Jobless Claims have to remain

below the magical number of 400,000. This weekly measure is

volatile and is frequently subject to large revisions. It is best

interpreted as a four-week moving average (See Figure 16).

Despite all the noise in the financial media (and these days

also among politicians) every time the Initial Jobless Claims

do not match the average expectations of the economists

(which is exactly every week), it is obvious that the pattern is

strongly supportive of continuing declines in unemployment.

One of the most socially relevant areas of unemployment is

the situation of those already unemployed. Those unem-

ployed for a longer period of time typically have a much

more difficult time finding jobs. With that in mind, one would

expect the difference between the average length of unem-

ployment and the median length of unemployment to be al-

ways positive. An increasing average vs. median unemploy-

ment spread suggests a shift in the distribution towards

longer periods of unemployment, as one might expect during

a recession. Despite the decline in the median length of unem-

ployment, the mean length of unemployment remains very

high at 39.8 weeks. The percentage of unemployed for 27

weeks or more remains stubbornly high at 41.5% and the

spread between the mean and median remains close to its

recent peak (See Figure 17). It is important to note that the

methodology of length of unemployment collection was mod-

ified in early 2011. Prior to January 2011 the Current Popula-

tion Survey (CPS) accepted unemployment durations of up to

two years. Any response of unemployment duration greater

that two years was coded as two years. Because nearly 11% of

unemployed persons have been looking for work for two

years or more in the fourth quarter of 2010, the CPS started

Figure 15. Average Weekly Hours of Production of Nonsupervisory Workers on Private Nonfarm Payrolls. Source: Bureau of Labor Statis-tics, Bloomberg.

Figure 16. US Initial Jobless Claims. Source: Department of Labor, Bloomberg.

Figure 17. Mean vs. Median US Unemployment Duration. Source: Bureau of Labor Statistics, Bloomberg.

Figure 18. Employment Diffusion Index 1 Month. Source: Bureau of Labor Statistics, Bloomberg.



An interesting picture is emerging from the overview of the

economic indicators. Since the bottom of the recession, the

lagging indicators have gradually turned positive and con-

tinued their consistent improvement. The leading economic

indicators started rebounding in early 2009. After the initial

sharp rebound, the early indicators illustrated the extreme

volatility of the global economic environment over the last

two years. It looks like the early economic indicators might

be more sensitive to the extremes of an economic cycle. They

might be less useful during the actual periods of expansion

or contraction.

The majority of consumer related indicators, whether con-

sumer sentiment or housing suggest steady improvement

and even potential acceleration in economic growth. Current

levels of housing related economic activity are still historical-

ly quite low. There is a significant growth potential in that

part of the economy. Despite decline in the unemployment

rate and steadily declining new unemployment filings, struc-

tural unemployment among those who have been out of

work for a long period of time remains at dangerously high

levels.

Investors do not like lack of certainty. It is typically associat-

ed with volatile or declining markets. The expectations of

continuing albeit slow global economic recovery supported

by all central banks helped advance the US equity markets

in 2012. So far these expectations prevailed, despite the unu-

sually large number of unresolved issues facing global econ-

omy. We are close to the point where we will know the win-

ner of the presidential election and the balance of power in

the US Congress. Regardless of investors’ preference, just

knowing the outcome is likely to be positive for the equity

markets. The upcoming elections will affect the path of re-

solving issues related to the “fiscal cliff”, once again provid-

ing clarity regardless of the preferences for a particular out-

come.

One very interesting development in the US has been slowly

gaining attention. For the first time in a generation, manufac-

turers of energy-intensive products find that it is less expen-

sive to be located in the United States. The increasing availa-

bility of cheap natural gas (combined with lack of export

facilities) is rapidly changing the United States into the most

profitable place in the world to make chemicals and fertiliz-

ers. Natural gas accounts for nearly 70% of the cost of manu-

facturing fertilizer and 25% of the cost of making many plas-

tics. After many years of moving fertilizer plants to lower

cost countries, an Egyptian company announced plans to

build a $1.4 billion fertilizer plant in the United States. Some

economists question the size of the natural gas related in-

crease in the economic output, but even the lowest estimates

suggest 1% contribution to GDP over 10 years. Such a contri-

bution would not significantly affect unemployment, but it is

likely to have a significant effect on the manufacturing indus-

tries‘ global competitiveness. It remains to be seen whether

the abundance of natural gas will affect the price of oil

which trades globally and is much easier to transport.

Europe provided many reasons for investors to worry about

the future and many economists are still pessimistic about

the prospects of united Europe. It is clear that the push to-

wards closer fiscal cooperation, the pan-European banking

supervision and eventual Eurobonds will take time, but it

will keep moving forward. Considering the number of coun-

tries (and politicians) involved, Europe is making a rapid

progress.

There is growing evidence that Chinese economic growth is

stabilizing and picking up momentum. China and the other

“Growth Markets” will increasingly influence the rate of the

global economic growth. Even if growth slows down in

many parts of the world, secular trends that include consum-

er strength in emerging markets, global demand for technol-

ogy innovations, and infrastructure build out will continue to

benefit well positioned and well managed companies.

Regardless of the level of optimism, it is clear that the global

economy is still fragile. The aggressive central bank policies

combined with excess liquidity will eventually affect eco-

nomic growth and will likely boost prices of risky asset clas-

ses. Many of the investors who remain on the sidelines or

moved their investments to fixed income instruments will

eventually have to decide on coming back to the equity mar-

kets or risk increasing opportunity costs and potential rising

inflation threatening the value of their fixed income assets.

Summary

accepting reported unemployment durations of up to five

years. This change was phased in over the first four months

of 2011. Because of this change, the estimates of mean dura-

tion of unemployment using the five-year limit were higher

than using the two-year limit. It is likely that the actual peak

of mean duration of unemployment was higher than 40.9

weeks.

Another interesting measure of employment is the Diffusion

Index of Employment Change (Figure 18). This index rep-

resents a percentage of industries (within the 347 industries

with private nonfarm payrolls) with increasing employment,

plus on-half of the industries with unchanged employment.

Diffusion Index of 50 indicates an equal balance between

industries with increasing and decreasing employment. De-

spite its volatility, it has remained above 50 since early 2010,

suggesting continuing improvement in nonfarm payrolls.



1. The S&P 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. It is a

market-value weighted index with each stock’s weight in the Index proportionate to its market value. The Index is one

of the most widely-used benchmarks of U.S. equity performance.

2. The Russell Top 200 Growth Index measures the performance of the especially large cap segment of the U.S. equity

universe represented by stocks in the largest 200 by market cap that exhibit growth characteristics. It includes Russell

Top 200 Index companies with higher price-to-book ratios and higher forecast growth values. The companies also are

members of the Russell 1000 Growth Index. The Russell Top 200 Growth Index is constructed to provide a comprehen-

sive and unbiased barometer of this larger cap growth market. The Index is completely reconstituted annually to en-

sure new and growing equities are included and that the represented companies continue to reflect growth characteris-

tics.

3. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe.

It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The

Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap

growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and

that the represented companies continue to reflect growth characteristics.

4. The indices referred to herein are unmanaged and therefore do not have any transaction costs, advisory fees or similar

expenses to which a client account would be subject. It is not possible to invest in these indices. The indices are for

comparison purposes only. Performance for all indices includes the reinvestment of dividends.

5. There is no guarantee that the matrix of economic indicators (or each indicator individually) can accurately predict

profits or losses in the markets. The matrix of indicators discussed herein is not intended to determine investment de-

cisions. Other indices or economic indicators may reflect differing or contrary results. There is always the potential

for gains as well as the possibility of losses.

Disclosures

mam insights october 2012

Economy & Finance

us economy

global economic recovery

us equity markets

global economies

slow consistent recovery

global risks

global response

reaccelerating global