Municipal securities continue to provide yields in excess of Treasuries, despite their tax-favored status. For tax-exempt accounts, we continue to see opportunities in corporate debt, both investment grade and the highest quality non-investment grade, as well as in select international sovereign debt issues.
Despite the natural volatility of the stock market, three themes unfolding over the next decade should benefit equity investors: innovation in technology, healthcare and energy; the rise of developing nations and their demand for consumer goods; and global expansion of trade in goods and services.
It is our view that inflation should be moderate over the near term. However, we recognize that portfolios of different investors have different sensitivities to sharp increases in inflation. To that end, the discussion here centers on methods to hedge unexpected inflation in those specific portfolios.
We believe one of the most important economic developments to monitor is whether the U.S. economy can wean itself off government stimulus before bond vigilantes take the matter into their own hands. In short, we are in the midst of a cyclical recovery that could be overshadowed at some point by the longer term structural challenges.
The combination of an enhanced European-level policy response, fiscal austerity and structural reform at the national level, plus a more broad-based and secure economic recovery, should bring normalization to the Euro-area sovereign debt crisis by 2012. But if one or more of these expectations is not realized, the crisis may intensify.
We recently have taken an increasing interest in housing and housing-related investment opportunities. While we cannot state with certainty when the recovery will come, we see a road towards redemption and investment opportunities while the market gradually improves.
Euro area countries need to coordinate their economic policies better to prevent macroeonomic imbalances. The proposed set of policy indicators would identify such imbalances and indicate action to be taken if thresholds are too high or low. But this system has structural problems related to timing, response and proactive planning.
Heightened market volatility is emerging as the new framework for investment decisions. Suggestions for succeeding in this environment include focusing on a dual-asset allocation approach, taking into account a greater number of worst-case scenarios, assessing liquidity and leverage carefully, and looking for volatility-related opportunities.
Behavioral finance theory offers some compelling explanations for financial crises, including the most recent one. Supplementing standard finance theory with behavioral and psychological criteria can help clarify investors' decision-making processes and explain the influence of behavioral biases in stock market crashes.
Aggresive government policies may jump-start the U.S. economy, but longer-term risks remain. We suspect investors will be happy to say goodbye to the last decade during which investment returns in most asset classes were far below historical norms. As we begin this new decade, we are optimistic about one important issue: equity prices are not at the extreme “bubble” levels that they were a decade ago—due to the dot.com era—and that alone, we believe, portends better returns in the coming decade.