June is the month for mid-year revisions to economic forecasts by the major international financial organizations and other forecasters.  The Organization for Economic Cooperation and Development (OECD) released its new forecasts Wednesday, predicting that the deep global recession is nearing a bottom. It’s projections of world real GDP growth of -2.2% for 2009 and +2.3% for 2010 represent the first upward revisions in OECD’s growth projections since June of 2007.  In remarks last week, the First Deputy Managing Director of the IMF, John Lipsky, said he expects that his institution will be revising its projections “modestly upward, mainly with regard to 2010.”  The sister organization of the IMF, the World Bank, took a contrary stance at the beginning of the week, setting back global equity markets with a downward revision of its projection for the global economy this year to -2.9%, coupled with strong negative comments on the effects of the global credit crisis on developing countries.

We are in broad agreement that a turning point in the global economy is likely in the coming months.  This follows a period of particularly sharp contraction (“falling off a cliff”) in the six-month period to March of this year.  A recovery appears to be already underway in many of the emerging-market economies.  Among the advanced economies, the United States and Japan appear likely to begin to recover in the course of the second half, driven by what the OECD characterizes as “massive policy stimulus and progress in stabilizing financial institutions and markets.”  Continued balance-sheet problems for consumers, aggravated by further increases in unemployment, will likely put a damper on the pace of recovery in the US.  Continued heavy deflationary forces will continue to be a challenge to policy makers in Japan, following what was probably that country’s most severe recession in its post-war history.

While there are some “green shoots” also appearing in the euro area, the eventual recovery looks likely to lag that in the US and Japan.  External demand for the region’s exports has collapsed; and tight financial conditions, rising unemployment, and financial-sector problems have constrained domestic demand.  Positive growth probably will not appear until the fourth quarter of this year at the earliest. 

There is broad agreement on the positive economic outlook for the Chinese economy, which appears to be on course for strong growth.  The World Bank raised its 2009 forecast for China from 6.5% to 7.2%.  The OECD expects 7.7% growth for China this year and 9.3% in 2010.  We would not be surprised to see Chinese economic growth top 8% this year and be close to 10% in 2010.  The government’s fiscal stimulus of $590 billion, along with sizable monetary stimulus, has clearly been successful in helping the economy ride out the global recession.  This is quite an achievement in a year in which world trade growth is on track to register a 16% decline.  In May there were notable advances in urban fixed investment (largely government-sponsored), real estate investment, and retail sales.  Industrial production accelerated to an 8.9% rate.  Declining exports have been a depressing factor in the first half.  This trend should reverse with the expected recovery in the global economy.

Global equity markets, as is often the case, anticipated the end of the global financial crisis, the coming recovery and advanced strongly in recent months after bottoming in early March.  International investors’ appetite for risk evidently returned to more normal levels as fears of “worst-case scenarios” lessened substantially.  The very rapid pace of the advance in equity markets over the March through May period has been followed by a modest 6% pullback in global equities since early June.  Markets clearly had gotten somewhat ahead of themselves.  While risk appetite seems to have moderated in this period, there are no indications that it has turned negative.  Investor flows into equity markets, particularly emerging markets, are continuing.  Cumberland’s equity portfolios remain fully invested.

China’s strong performance on the economic front is reflected in its equity markets.  The MSCI Index for China is up 28% year-to-date through June 23rd.  An important reflection of the continuing strength of China’s market is the fact that this index drew back only -1.8% thus far in June while the MSCI Index for Emerging Markets dropped by -6.4%.

We utilize three ETFs to provide exposure to the Chinese market.  The first is the iShares FTSE/XINHUA China 25, FXI.  This ETF is by far the most popular China ETF, and therefore is the most liquid, an important consideration.  It invests in just 25 ultra-large-caps, mostly government-sponsored Chinese firms.  It is heavily concentrated in the financial sector (45.5%) and has 0% in the technology sector.  The second is the SPDR S&P China, GXC.  It has reached an adequate level of liquidity, with net assets of $315 million (although much less than FXI’s $9.2 billion).  It provides considerably more diversified exposure to China than FXI, investing in some 130 firms, mixing large caps and small caps.  It also has a high exposure to financials (32%) and includes some tech exposure (8.1%).  Thirdly, we also use the Claymore/AlphaShare China Small Cap, HAO.  Here we have to limit our position because the net assets of this fund are only $70 million.  We are attracted by the differences in its sector exposure as compared to the previous two ETFs, including 16% exposure to information technology and only 7.7% to financials.

China’s strong performance is an important positive factor for other economies in the region, including Hong Kong (iShares MSCI Hong Kong Index Fund, EWH), Taiwan (iShares MSCI Taiwan Index Fund, EWT), and Singapore (iShares MSCI Singapore Index Fund, EWS), all of which we are overweighting in our International, Global Multi-Asset Class, and Emerging Markets ETF portfolios. China’s huge appetite for commodities is also boosting the markets for commodity-exporting economies, including Australia (iShares MSCI Australia Index Fund, EWA), Canada (iShares MSCI Canada Index Fund, EWC, and the Claymore/SWM Canadian Energy Income Index, ENY), Brazil (iShares MSCI Brazil Index Fund, EWZ) and Chile (iShares MSCI Index Fund, ECH).

Thus far we have not seen any evidence of a reemergence of the previous speculative excesses in China.  Valuations continue to look relatively attractive.  The price-to-trailing 12-month earnings ratio is 14.5, still below its 10-year average of 15.9%, whereas the same measures for Korea, Hong Kong, India, and Brazil are now all higher than their 10-year averages.  Nevertheless, as the last 12 months have amply demonstrated, the Chinese market, like other emerging markets, can be highly volatile and requires careful monitoring.