Economy

Ø The world economy has continued to slow during the last few months. The next several quarters are likely to be weak for three reasons. First, fiscal policy will continue to be restrictive as plans to trim excessive federal budget deficits continue to unfold. Second, private sector demand looks gloomy because households will continue to deleverage from high debt levels while unemployment remains a problem. Third, the uncertain future of the Euro-zone debt situation remains a major setback to future economic growth.

Ø The U.S. economy expanded at an annual rate of 2.5% in the third quarter. (See U.S. Real GDP Growth Rate Chart). The average consensus for economic growth for the remainder of 2011 in the U.S. is 1.7% growth in Real Gross Domestic Product (GDP). The consensus of economic research is projecting a lower U.S. real GDP growth rate in 2012 of 1.5%.

Ø International developed market economies, particularly in the Euro-zone, have been stuck in a slow growth mode in 2011, with the aggregate Euro-zone economy growing at a 1.7% rate. Consensus among economic forecasters is for a greater probability of a decline in this growth rate going into 2012.

Ø Emerging market economies meanwhile remain relatively more robust. China has been a big driver of global growth, with real GDP growing at a 9.3% rate so far in 2011. Other areas of stronger growth include the other Asia-Pacific economies at a 7.3% rate and Latin America growing at a 4.3% rate. While these numbers look comparatively better, there are risks of downward revisions depending on if the recent downtick in leading economic indicators is confirmed in future reports.

 

U.S. Housing

Ø U.S. new housing starts had a good third quarter and are up 10.2% from their September 2010 levels.

Ø According to the National Association of Realtors, existing home sales fell about -3.0% month over month in September, but are up over 11% from the level of September 2010.

Ø The median existing-home price for all housing types was $165,300 in September 2011, down 4.1% from September 2010.

 

Currency

Ø Currency markets have gone through a bout of risk aversion in the third quarter of 2011 as the sovereign debt crisis in Europe has sparked a flight to safe-haven assets.

Ø The U.S. Dollar has been one of the main beneficiaries of this risk-aversion trade. The U.S. Dollar Index, a leading benchmark for the trade-weighted international value of the U.S. Dollar, rose roughly 7% in the third quarter.

Ø The uncertain future of the Euro-zone economy and the continued inability of policymakers there to implement a long-term, viable solution to the debt problems continue to be a support for the value of the U.S. Dollar.

Ø Due to the seemingly unresolvable differences that exist among the current Euro-zone member countries, some analysts have begun to question the viability of the European Economic and Monetary Union (EMU) itself and whether a breakup of the EMU remains in the cards.

Ø The one factor that could impact the U.S. Dollar to the downside would be renewed easing policies from an already stretched Federal Reserve. While the recent “operation twist” implemented by the Fed seems to be a more conservative compromise to a full-blown third round of quantitative easing (QE3), the risk to the U.S. Dollar would stem from further unexpected monetary stimulus by the Fed.

 

Debt

Ø The current fiscal situation in the U.S., while not as bleak as what currently exists in Europe, is certainly not a rose garden by comparison. Many long-term, structural spending problems remain embedded in the ongoing U.S. federal budget deficit figures. Any failure of the U.S. Congressional “super committee” to pass meaningful long-term budget cuts could spark fresh doubts about the risk-free status of U.S. Treasury Bonds.

Ø Despite the plethora of problems surrounding the unsustainable nature of current U.S. Federal Government spending programs, the yield on long-term U.S. Treasury debt has continued to make fresh, all-time lows through the end of September, 2011 with the 10-year Treasury bond yielding roughly 1.8%.

Ø Fears over what is going on in the Euro-zone in the short-term and the possibility of a global recession are dominating any long-term worries over the sustainability of U.S. fiscal policies. As many leading global economic indicators continue to deteriorate, the flight to perceived safety assets will persist and U.S. Treasury Bonds will continue to receive a bid, driving down yields further.

 

Unemployment

Ø The unemployment rate in the United States was reported at 9.1% as of September 2011. While slightly better than prior months, the September employment report continued the trend of weak jobs growth as only 103,000 jobs were added compared to the roughly 250,000 needed just to keep up with population growth. (See U.S. Unemployment Rate trend chart below)

Ø The U.S. Labor Department’s U-6 measure of unemployment, which includes discouraged workers and those working part-time but seeking full-time work, was at 16.5% in September. Some economists prefer this measure and call it the “real” unemployment rate because it includes those who have given up on finding a job and those who want full-time jobs but cannot find them.

Ø The most recent measure of the unemployment rate for the Euro-zone nations stood at 10.0%. Spain’s unemployment increased to 21%, while Switzerland has one of the lowest rates at 2.8% (Non seasonal Adjusted).

Inflation and Commodities

Ø The annual inflation rate in the United States was reported at 3.9% ending September 2011. The inflation rate refers to a general rise in prices measured against a standard level of purchasing power. The average inflation rate in the U.S. since 1914 has been 3.38%. (See the U.S. Inflation Rate chart below)

Ø Commodity prices took a hit in the third quarter. Declining macroeconomic fundamentals and a sharp fall in risk appetite from investors combined to more than offset any worries about global supply shortages for commodities in general.

Ø Going back to July of 2008, commodity markets have become increasingly correlated with other markets, particularly equity markets. As the financial crisis in Europe has roiled equity markets, commodity markets have fallen in lockstep.

Ø The twin forces of declining economic fundamentals and investor risk aversion are two trends that appear to be persisting over time, and as such, indicate further declines for commodity prices in general.

Ø Despite the weakness in broad commodity markets, gold remains an outlier. Even though it has pulled back from the all-time high of $1,888 it set in August of this year, it remains elevated from a historical perspective both in the short term and long term as it still trades north of $1,600 per ounce.

 

REIT (Real Estate Investment Trusts)

Ø The global REIT markets have not been immune to the recent tumults of financial markets. However, ultra-low interest rates and persistently strong credit-quality in the commercial REIT universe have been supports to REIT markets in general.

Recent Changes to the Portfolios

Compass EMP Funds – Compass EMP Multi-Asset Balanced Fund / Compass EMP Multi-Asset Growth Fund /

Compass EMP Alternative Strategies Fund

• The expansion of market volatility in the third quarter saw the number of positions engaged in downside hedging increase.
• Prior to June 30, 2011, 6 positions in the Commodity asset class were short and 14 were long. Ending September 30, 2011, that changed and 17 positions were short and only 3 positions remained long (Gold, RBOB Gasoline, and Sugar).
• Prior to June 30, 2011, 4 of the world stock markets held in the Equity Hedge L/S asset class were short while 8 remained long due to the upward trends of the global stock markets. Over the third quarter, all 12 markets held in the Equity Hedge L/S asset class converted to a short position due to the large increase in market volatility to the downside in late July and early August.
• Prior to June 30, 2011, 6 of the 7 positions in the Currency L/S asset class were held long with only the Yen being a short position. As of September 30, 2011, that has changed and 6 of the 7 positions are now short, with only the Yen being held as a long position. This is due to a flight-to-quality for the U.S. Dollar after market fears of a financial crisis in Europe.

 

Ø While earnings reports for REITS in the last quarter have come in generally positive, investors’ expectations are for reduced demand in the future, particularly in sectors that are most sensitive to economic cycles.

Ø The hotel sector was the worst performing sector for REITs in the last quarter due to its sensitivity to the economic cycle, even despite a strong corporate environment and solid group booking rates for 2012.

Ø Despite the challenging economic environment that REITs are dealing with, opportunities abound for companies that have a strong balance sheet and the ability to make acquisitions at favorable prices.

Ø The free standing retail sector was among the best performers in REITs due to their generally low debt levels and the defensive nature of their cash flows.

 

Note: Strong asset class diversification and a long-term objective are highly recommended.

Because of the diversification of multiple low correlating asset classes and multiple markets, the Compass Efficient Model Portfolios performance is not expected to completely track with any particular broad stock or bond market index over any given time frame.

Higher and Lower Performing Asset Classes (Represented by ETFs or In-House Strategies held in the Compass EMP Funds or Separately Managed Accounts) The short-term performance below indicates the asset classes that were the higher and lower performers over the last 12 months. Depending on the asset allocation model, the Compass Efficient Model Portfolios may invest in Exchange Traded Funds or liquid futures strategies that represent the following asset classes. “L/S” represents Long/Short hedging strategies.

Last Quarter 1 year Higher Performing Asset Classes	Lower Performing Asset Classes	Higher Performing Asset Classes	Lower Performing Asset Classes
Global Bond Hedge L/S	Int’l Emerging Market Stocks	Managed Futures	Int’l Emerging Market Stocks
U.S. Core Bonds	U.S. Small Cap Stocks	U.S. Core Bond	International Dev. Mkt. Stocks
Commodity L/S	International Dev. Mkt. Stocks	International Bonds	International Real Estate
Global Currency L/S	International Real Estate	Commodity L/S	U.S. Small Cap Stocks

 

 

 

(c) Compass EMP Funds

www.compassempfunds.com