I started the year with a bias for developed market equities over emerging market equities. Year-to-date, developed equity markets have outperformed emerging markets by roughly 4%. I had two main reasons for favoring developed market equities. Emerging market equities looked expensive relative to their developed market counterparts and I felt that emerging market inflation would be a more persistent problem than the market was discounting. Now, however, these major rationales for broadly favoring developed markets no longer hold.

I continue to hold a negative long-term view of US Treasuries. That said, given the anemic state of the economic recovery and the growing risk aversion in market places, Treasuries may not necessarily sell-off in the near-term after a US debt downgrade. My view on Treasuries has a longer-horizon and is based on low real yields and a deteriorating fiscal picture. Finally, even if US debt is ultimately not downgraded in the coming weeks, investors need to realize that the US fiscal situation is an ongoing chronic problem that is unlikely to be fully addressed in the near term.

At an emergency meeting Thursday, European leaders backed a rescue plan for Greece that was generally in line with what the market had been led to expect. Ultimately, I believe the news supports the case for risky assets such as equities and hurts the case for more risk-averse investments such as the US dollar and US Treasuries. I think that the risks facing the Italian market are more than adequately reflected in the valuations, as the country currently trades at just 9 times forward earnings and 0.8 times book value, one of the lowest valuations among developed countries.

While the recent June non-farm payroll report offered yet another reminder of the fragile and sluggish nature of the current recovery, we continue to believe that equities offer better prospects than fixed income. A combination of high margins, low inflation and some top-line growth will continue to support stocks. For the most part, the largest companies are cheaper, more profitable and more diversified than their smaller counterparts. In fact, US and global mega-cap companies remain one of the few unambiguously cheap asset classes, trading at roughly a 15% discount to the broader market.

This week, our first call focuses on the ongoing drama over the US debt ceiling and its implications for the US Treasury Market. While the clock continues to tick towards an August 2nd deadline for raising the debt ceiling, Congress and the White House are still nowhere near a compromise. Next, heres a quick update regarding our view of China. While we remain, for now, neutral on China, and hold a negative view of emerging markets in general, our stance on China is starting to shift to a more constructive, or positive, view.

The ongoing challenges facing the consumer ? a weak labor market, anemic wage growth, too much debt and a stagnant housing market ? have been well documented. To our thinking, these issues are not likely to be resolved in the near-term. Yet despite the long litany of problems, investors continue to favor US retailers. We believe this enduring faith in the willingness and ability of the US consumer to spend is misplaced.

While Washington debates raising the debt ceiling and cutting spending to achieve $1 to $2 trillion of savings over the next decade, it?s worth pointing out that these savings may never materialize because the existing official budget numbers are too optimistic across several fronts.

In a recent mid-year update to our 2011 outlook, we noted how equity market volatility is likely to rise further in light of continued near-term weak economic growth. Already, spring?s unusually placid markets have given way to heightened volatility. The most recent cause has been anxiety over Greece, but investors are not at a loss for things to worry about. This is a sharp departure from just eight weeks ago. In April, the VIX Index, which measures implied volatility on S&P 500 options, the ?fear index? hit its lowest level since early 2007. Investors had a blindly optimistic world view.

This week, our attention first turns to European banks. Since February, the sector is down more than 15% versus a 3% drop for global developed markets. Back in February, our thesis was that European banks were not taking adequate account of the ultimate hit they were facing due to write downs on European sovereign debt. While we are still advocating a negative outlook for European banks, we believe that much of core Europe now appears very cheap, and is reflecting a lot of bad news. In particular, we continue to believe German equities look attractive for long-term investors.

While many market watchers on Thursday focused on the higher-than-expected latest weekly domestic initial jobless claim data, we believe the key figures released Thursday were the Chicago Fed National Activity Index and Purchasing Managers Index (PMI) figures for Germany. The US initial jobless claim applications in the week ended June 18 increased 9,000 is clearly another sign of the decelerating recovery. Still, that the May Chicago Fed National Activity Index came in at -0.37, well below expectations of -0.05 but above April?s -0.56 reading, is especially important.

While we believe the recent economic slowdown represents a deceleration rather than a reversal of the global recovery, there are certain events that we believe could turn the current fragile recovery into a failed one. In particular, we believe investors should pay careful attention to events in the Middle East. Why? We believe that the most serious risk to the global economy is another spike in energy prices. While the events that began in Tunisia earlier this year were both unexpected and unprecedented, the world is now aware of the political fragility of large parts of the Middle East.

Last month, we described why we believe that over the long term, there?s a case for the outperformance of equities. But what does the slowing recovery mean for equities? While we have been arguing that the summer is likely to be characterized by higher volatility, we believe that absent a dramatic economic slowdown, equity markets still appear reasonable. The fact that equity valuations reflect much of the bad news should help cushion the near-term downside for stocks. And long-term, equities still appear to better reflect the world?s risks and worries than their pricier cousin, bonds.

On Tuesday, the Commerce Department said retail sales in May fell less than expected. If you look behind the numbers, however, the new retail data clearly shows a deceleration in consumption.

The recent recession has been, and will continue to be, very different from the typical post-World War II recessions. Since there are so few recent examples to guide us, it?s important not to draw conclusions about the current recovery just by examining the last 50 years or so. Taking a longer-term perspective is key and that?s precisely what economists Carmen Reinhart and Kenneth Rogoff do. While the book came out in 2009, it is especially relevant to today?s investors as it helps put the effects of the recent credit crisis in the right historical context: a very long-term one.

On Wednesday, the Federal Reserve Board released its latest Beige Book report, which provided more color on the recent slowdown and indicated the recovery is likely to be anemic and uneven. According to the report, which is a summary of anecdotal information from each Federal Reserve Bank on its district?s current economic conditions, ?economic activity generally continued to expand since the last report,? though it did slow somewhat in four of the 12 districts. In particular, ?some slowing in the pace of growth? was noted in the New York, Philadelphia, Atlanta, and Chicago districts.

Call #1: Maintain Underweight US Retailers. Last week, the main monthly gauge for manufacturing activity and May?s non-farm payroll report both came in weaker-than-expected and both confirmed that the economy is experiencing a dramatic slowdown. Call #2: Neutral Emerging Market Bonds. The other implication of a slower global economy is that bonds should do better relative to stocks. Given what appears to be a case of extreme over valuation, we would still advocate a negative view on US Treasuries, but we are now changing our view of emerging market bonds from negative to a neutral stance.

This week, our attention turns to the recent slowdown in the global economy and what it means for investors. Over the past month, both equity and commodity markets have staged a modest retreat. One potential cause of the slowdown is the lagged impact of higher commodity prices, which have historically acted as a drag on growth. Late last year, we advocated an overweight to Australian equities, which we then reiterated in early April. Since the initial call, iShares MSCI Australia Index Fund (EWA) has gained around 6.5%. We are now changing our view to neutral for a number of reasons.

With global equity markets up over 100% from their 2009 lows, many investors are questioning whether it is time to lower their strategic allocation to stocks. While there are no shortages of risks facing global equity markets, overall we find that most markets are fairly valued and arguably already reflecting some of the risks ? particularly higher inflation and interest rates ? that are likely to challenge the global economy. We believe that over the long term, equities are still likely to produce higher nominal (inflation-adjusted) and real returns than other financial assets.

The federal government is limited by law as to the amount of debt it can issue. Currently the debt ceiling is 14.3 trillion, an amount that was exceeded last Monday. Fortunately, the government can operate and pay its obligations through various accounting mechanisms. These mechanisms will allow the government to continue to function and avoid defaulting on its existing debt through early August, after which point the government could theoretically default on its Treasury obligations, something that has never happened in US history and would obviously be catastrophic for financial markets.

The news in Europe continues to be mixed. On the plus side, the core countries in Europe continue to post strong economic growth. We had more evidence of that this week with solid GDP results from both Germany and France. The problem of course remains the periphery, particularly Greece. Greek debt was downgraded again and markets are now convinced that Greece will need to restructure. US market volatility has been its lowest since 2007, with the VIX Index ? which measures implied volatility on S&P 500 options ? hitting a four year low of below 15 in April. We believe this is too low.

Friday Congress and the White House agreed to cut $39 billion in federal spending to avoid a shutdown. The agreement would fund the government for the remainder of the fiscal year, which ends on September 30th. In other words, after weeks of partisan debate, Congress and the White House were able to reach an agreement on 1% of the federal budget. What remains to be settled are three more serious and contentious issues: the imminent breach of the federal debt ceiling, the 2012 budget, and the long-term solvency of the three main entitlement programs Social Security, Medicare, and Medicaid.

While we remain underweight emerging markets in general, one emerging market is looking particularly cheap. While we would be concerned about having a long-term overweight to Russia given that country?s political situation, from a short-term perspective the market looks interesting. We first mentioned Russia as a possible play in early February ? since then the benchmark index is up nearly 7%, but Russia still looks cheap trading for less than 6x earnings. Also unlike China or India, which are negatively impacted by higher oil prices, Russia is a natural beneficiary of the spike in crude.

As Europe continues to muddle along, much of the bad news has been discounted in with the exception of the banks, which are likely to continue to remain under pressure. S&P cut Portugal?s rating two notches as its parliament rejected the government?s new austerity measures, prompting Prime Minister Jose Socrates to resign. Meanwhile Moody?s downgraded 30 small Spanish banks with mostly negative outlook following the earlier sovereign debt rating downgrade. However, despite the banking issues, Spain has been able to continue financing its debts.

Last week, world equity markets suffered their sharpest correction since August of 2010. Unrest in the Middle East and sovereign debt issues in Europe are contributing to the spike in volatility, but last week?s sell-off was primarily driven by the earthquake in Japan and related concerns over the safety of its nuclear power plants. The events in Japan are unlikely to detract from global growth, or change the market dynamics favoring equities. In fact given the recent flight to safety and accompanying drop in nominal bond yields, we reiterate our preference for equities over bonds.

Call #1: Underweight European equity market (with emphasis on banks) Call #2: Overweight developed (with preference for large/mega cap) vs. emerging markets. Year-to-date, emerging markets are down roughly 1.5% while developed market mega caps are up roughly 5%. Our view is reinforced by the recent market volatility and growing unrest in the Middle East. In this type of environment, large, quality companies are likely to prove more resilient.

The overall economy is demonstrating impressive resiliency to higher oil prices ? as evidenced by the recent strength in the ISM manufacturing and services surveys ? but investors should not be too complacent when it comes to the consumer sector. Even though labor markets are staging a slow-motion recovery, the US consumer still faces multiple headwinds, including anemic wage growth, too much debt, and a still fragile housing market. Oil crossing the $100 threshold will not help.

Recently, silver prices have benefited more than gold from the economic rebound. The relative gap between gold and silver suggests that it may be time for a pause in silver?s run. One of the many ironies of markets last year was the extent to which inflation occupied investors? attention, despite its near universal absence. While inflation has recently accelerated in emerging markets and a few developed ones, inflation was and is still largely absent in the developed world. Yet, record low inflation did not stop investors from worrying about it.