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The Market (and Life's) Twist and Turns

(February 2, 2012)

Dear Subscribers and Readers,

This time last year, I was expecting 2011 US real GDP growth to surpass 3% easily. As the year progressed, we ratcheted down our projection; and we were still too optimistic. Indeed, most economists overestimated 2011 US real GDP growth in the beginning of the year. This year, we may witness a similar story—but with a twist. The latest IMF update suggests that 2012 US real GDP growth may only be 1.8%; and for 2013, 2.2%. Deleveraging or not, this is significantly below the structural trend (1% population growth + 2% productivity growth). While I don't think this year will be smooth sailing (I expect the European Sovereign Debt Crisis to return with full force in 2H 2012), I believe a 1.8% real GDP growth projection for the US, and 3.3% for the world this year may be too pessimistic, especially given the aggressive easing policies of the Federal Reserve, the ECB, the Bank of England, and most of the world's central banks. Indeed, Goldman's latest Global Leading Indicator reading (published yesterday) is showing increasing signs of positive momentum.

Just as important, WTI crude oil prices—a major contributor to the US current account deficit and overall inflation—has actually declined since the beginning of the year. The March 2012 WTI contract (shown in the below chart courtesy of futures.quote.com) has declined from nearly $105 a barrel in the beginning of this year to $97.42 a barrel as I am typing this:

Chart Image

Not only does a lower oil price directly add to the “bottom line” in US real GDP growth, it also enables the Federal Reserve to implement a QE3 policy as fears over potentially higher inflation erode. Meanwhile, another important energy source for the US, natural gas, has resumed its decline in price, after spiking to $2.70/MMBtu over Chesapeake's January 23rd announcement to curtail its production. As I am writing this, March 2012 natural gas is trading at $2.39/MMBtu, as shown in the following chart (courtesy of futures.quote.com):

http://app.quotemedia.com/quotetools/getChart?webmasterId=101374&snap=true&chscale=1y&chtype=AreaChart&chwid=560&chhig=200&chfill=cce5e5e5&chfill2=7d7d7d&chln=7d7d7d&chpccol=ff0000&chfrmon=false&chton=false&chpcon=true&symbol=/NG:NMX

To paraphrase Forrest Gump, life is really like a box of chocolates. If you had told me five or ten years ago that the March 2012 NYMEX natural gas would be trading below $2.40/MMBtu a month before expiration, I would have hauled you off to the insane asylum (this contract traded at nearly $14/MMBtu during the summer of 2008!). Now that so much of the pessimism has been baked into the 2012 forecasts, I would not be surprised if US real GDP growth this year actually surpasses 3%--Black Swan event in the Euro Zone notwithstanding. For now, we need to keep an eye on Portugal. I expect the market to correct sometime this month over fears of a Portuguese default; but overall, I expect 2012 to be an up year, although I am also expecting some difficulties in the Euro Zone in the second half of this year.

Signing off,

Henry To, CFA, CAIA

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