Before heading to Turkey for the IMF annual meetings, let’s do a little reckoning of views and where things are going (from a big picture standpoint). Also, what are the themes that seem to be shaping this next IMF meetings this weekend, in terms of the debates going on and the agendas put together by the investment banks.

Our views over the last few months were centered around a few fundamental ideas. Based on those ideas we structure the portfolios we had started to manage a few months ago.
– with the worst of the crisis behind us, oversold markets together with impressive and globally coordinated fiscal and monetary stimulus had to drive markets higher and economies to show a short-term effect
– credit would gradually come back, making spreads narrow towards previous levels, with better balance sheets outperforming (be it companies or countries)
– though there had been serious wealth destruction (including some institutional destruction), the main tenets of the US economy and its capacity to generate productivity growth were not yet affected by the crisis (though current policy initiatives increase distortions)
=> portfolios have had equities rising back from 15% to 25-30%, with overweights in Asia and best EM countries, specifically countries with better productivity growth and balance sheets; and, on the fixed income side significant exposure to US high grade and secured loans in high yield (which were trading cheap relative to unsecured). Same ideas should have led to a higher allocation to technology (due to balance sheets).
– the fiscal and monetary expansion used to respond to the crisis is undermining the value of the main currencies (USD, EUR, GBP, JPY) vis-à-vis the currencies of the rest of the developed countries and best EM currencies
– at the same time and same idea, medium term inflation fears have resuscitated, despite short-term denials due to the so called excess capacity
=> portfolios have had inflation protection through higher allocations to commodities (energy, materials and agriculture), staying in the short-end of most fixed income curves, with a higher than average allocation to EM currencies, as well as inflation linked instruments globally. As I said before, part of the rally in equities and commodities has to do with dollar concerns.

Enough marketing, what now?
The economic stabilization and recovery is showing up in the data. The question is whether it is a lift due to policy or the beginning of a sustainable cyclical upswing. We continue to believe what we wrote in this blog back in December, G7 growth will underperform for some time, with higher inflation. However, the apparent strength of the recovery most likely has more to do with stimulus than with sustainable fundamental drivers. Thus, we are now more cautious than 2-3 months ago. Though there is a debate about exit strategies, we do not believe monetary policy will be withdrawn fast enough to avert an increase in inflation expectations (though one Fed official recently hinted at a swift and drastic hike whenever they go back to hiking, most likely designed as a credibility acquisition strategy). Our moves to more conservatism would come from reductions in duration and exposure in high grade in the US, in favor of international fixed income (unhedged, including inflation linkers), and no serious reductions on other areas (especially not in Asia, not in commodities). Marginal changes and reallocations happen all the time.
Is the impressive performance of most markets during the 3rd quarter to be repeated during the quarter starting today? Not likely. The real question is whether we get something much worse than the stall being prognosticated by many people. I doubt it, though the probability of a scare in markets is not negligible, and the portfolios are designed accordingly.

These are some of the debates for this weekend in Istanbul
– growth expectations and sustainability in general, and for regions is the obvious, but should be a result of understanding most of the other debates
– monetary policy is clearly up there, especially in terms of the exit strategy for G7, the fate of the US dollar, etc.
– whether convergence trends would resume, especially in Central Europe
– Chinese growth, how sustainable it is and what is the next phase if its currencies strengthens, commodities rise and the world becomes a bit more protectionist
– Turkey is obviously a topical issue this time around, together with other countries that are using the crisis as an opportunity to push reforms forward
– for some, whether Argentina is this time serious about re-appearing in the capital markets (it is over-represented in some agendas, and investors will be looking for clues on the IMF attitude towards Argentina)

Though not explicitly in the agendas, I think the broader issue of EM having passed an impressive test like nothing before, and whether that can be the foundation for a more durable structural convergence of some countries (thus outperformance of those currencies and spreads broadly speaking), will be part of the discussions.

If I do not write from Istanbul, will do right after early next week.

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