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JAForlines Global: Can There Be A “Great Rotation Without Reflation?”

Past performance is no guarantee of future results. The material contained herein as well as any attachments is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies, opportunities and, on occasion, summary reviews on various portfolio performances. Returns can vary dramatically in separately managed accounts as such factors as point of entry, style range and varying execution costs at different broker/dealers can play a role. The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts are inherently limited and should not be relied upon as an indicator of future results. There is no guarantee that these investment strategies will work under all market conditions, and each advisor should evaluate their ability to invest client funds for the long-term, especially during periods of downturn in the market. Some products/services may not be offered at certain broker/dealer firms.


New York, February 5, 2013, Advisor Update®
January was a good month for risk assets and a bad one for government bonds. JFG benefited by a mix of “spread” bonds (corporate or emerging market) and equities with little government bond exposure. We continue to believe that equities will do better than bonds this year even after this run-up, but sector and region selection will be very important. For example, many US sectors are at 2007 highs while EU regions continue to be well below that. On a risk-adjusted basis, Japanese equities and certain emerging market regions/sectors are more attractive than most US or EU sectors.

From a macro perspective, the picture remains mixed. Not surprisingly, political issues are at the top of the problem list. Citizen resistance to governments in Spain and Italy, and of course, the US (fireworks to come later in the spring on budgets, deficits and sequester), are major contributors to uncertainty. This is illustrative of the point we hammer home to Advisors and Fiduciaries all the time: in an “unbalanced world” (emerging market countries growing faster than developed countries) government and policy makers feel compelled to manipulate central bank balance sheets, currencies and to the extent possible, their treasury yield curves. Note that the two largest developed economies that can do all three –US and Japan– are in far better position to control their own economic destiny. If they do manage to reflate assets and boost growth above the anemic levels of the last five years, history tells us that inflation is not far behind.

Inflation’s “canary in the coal mine”–commodity prices–shows we’ve had two attempts to break out from the effects of the terrible 2007-09 recession. Those effects, lack of global demand from deleveraging and high structural unemployment, are still with us, which is why inflation is so tame. Could QE3 and its counterparts in the EU and Japan make the difference this time?

We get a lot of questions on Quantitative Easing (QE) and its effects on asset prices. We would emphasize that such aggressive measures have not been attempted before on a global scale. So the after effects are not fully understood, even by so-called experts in the economics profession. And we fully expect that some of the holdings we own now will have to change as the effects become more transparent.

In the meantime, having exposure to sectors and low inflation regions where companies are producing high cash flows is part of our strategy. Another is anticipating currency manipulation as part of an investment thesis. A great example is Japan. What makes their equity market so attractive right now is that it is cheap on a relative basis and the government is finally committed to a lower Yen. Would Japanese equities be otherwise attractive? No, but this is illustrative of the macro-dominated investing world we inhabit AND the importance of tactical agility.

Please email us your comments, questions, etc.

John Forlines III

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