Monthly market commentary by David E. Nelson, CFA, Chairman of the Investment Policy Committee, Legg Mason Capital Management: "We believe 2008 could be a very different kind of year than 2007. The big surprise to investors could be a global growth slowdown. If we’re right, 2008 may reward very different investment strategies than 2007 did."
Expectations of a 2008 slowdown in U.S. GDP16 growth are widespread and fairly well discounted in the market, in our judgment. Some sectors — notably consumer discretionary and financials — are priced for recession, or nearly so. On the other hand, sectors such as energy, materials and industrial commodities are priced as though strength in emerging market economies will power them through any slowdown in the U.S. relatively unscathed.
To the extent that proves not to be true, these groups could be vulnerable to disappointment because investor expectations currently are so elevated. We think a global slowdown is more likely than many now seem to believe. Clearly, the U.S. is slowing, as is the U.K. Japan is not growing very fast, and the strength of the euro is likely, in our opinion, to cause a slowing of growth in Continental Europe. If the developed economies — which account for roughly 70% of world GDP — slow, that leaves it to the developing economies to pick up the slack. But most developing economies’ customers are in the developed world. Not only that, but the Chinese central bank has been tightening credit conditions for nearly 18 months in an effort to slow China’s torrid growth rate and ease inflationary pressures. We expect them to continue to tighten until they achieve the result they want. China has been the marginal consumer of a wide range of industrial commodities. As an example, ISI Group’s Francois Trahan told us in a recent meeting that he estimates China will consume more copper in 2007 than the U.S. and Japan combined. That’s a lot of copper. Even a modest falloff in Chinese demand could have a very material effect on the pricing of a number of industrial commodities, as well as the price of oil.
So, as is often the case with us, we find ourselves increasing our investment in areas such as financials, where fear and loathing are rampant, and underweighting or avoiding areas where optimism seems to us to be excessive or unjustified. We do not do this arrogantly, but with humility, recognizing that we could be wrong or early, but mindful that historically the most gut-wrenching decisions for us have also been the most profitable. Benjamin Graham said it better than we could, so we’ll leave you with his admonition: “Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it — even though others may hesitate or differ. (You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.)”
Read the complete commentary
Expectations of a 2008 slowdown in U.S. GDP16 growth are widespread and fairly well discounted in the market, in our judgment. Some sectors — notably consumer discretionary and financials — are priced for recession, or nearly so. On the other hand, sectors such as energy, materials and industrial commodities are priced as though strength in emerging market economies will power them through any slowdown in the U.S. relatively unscathed.
To the extent that proves not to be true, these groups could be vulnerable to disappointment because investor expectations currently are so elevated. We think a global slowdown is more likely than many now seem to believe. Clearly, the U.S. is slowing, as is the U.K. Japan is not growing very fast, and the strength of the euro is likely, in our opinion, to cause a slowing of growth in Continental Europe. If the developed economies — which account for roughly 70% of world GDP — slow, that leaves it to the developing economies to pick up the slack. But most developing economies’ customers are in the developed world. Not only that, but the Chinese central bank has been tightening credit conditions for nearly 18 months in an effort to slow China’s torrid growth rate and ease inflationary pressures. We expect them to continue to tighten until they achieve the result they want. China has been the marginal consumer of a wide range of industrial commodities. As an example, ISI Group’s Francois Trahan told us in a recent meeting that he estimates China will consume more copper in 2007 than the U.S. and Japan combined. That’s a lot of copper. Even a modest falloff in Chinese demand could have a very material effect on the pricing of a number of industrial commodities, as well as the price of oil.
So, as is often the case with us, we find ourselves increasing our investment in areas such as financials, where fear and loathing are rampant, and underweighting or avoiding areas where optimism seems to us to be excessive or unjustified. We do not do this arrogantly, but with humility, recognizing that we could be wrong or early, but mindful that historically the most gut-wrenching decisions for us have also been the most profitable. Benjamin Graham said it better than we could, so we’ll leave you with his admonition: “Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it — even though others may hesitate or differ. (You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.)”
Read the complete commentary
