April 19, 2011

REVIEW OF THE PROGRAMS

This May we will celebrate ten years of Vega Capital Group. We would like to take this opportunity to thank our loyal clients. We have been through the most difficult times in the past several years — the trust you put in us is very much appreciated. As usual, we would appreciate the referrals from our satisfied clients.

First, let's review the events that either have influenced the markets in the first quarter of 2011, or might influence the markets in the next several months (yes — our time horizon has been reduced significantly). The totality of the world and economic events, often contradictory, require a careful analysis, and based on it — fine tuning of the portfolios, both Equities and Fixed Income.

Let's start with the macro picture. There is no doubt that the U.S. economy is stable, unemployment is decreasing (very, very slowly), and overall health of the financial system and major financial institutions has improved. There is also no doubt that U.S. Dollar is in significant trouble, no consensus on the deficit reduction can be reached, and U.S. political bodies are playing games with no serious decisions.

If, however, you look deeper into the world economic picture, one can come up with the conclusions that the world economy is divided into three distinct qualitative classes: America, Euro Zone and Emerging Markets. The world global output has risen close to 5% in 2010 — nobody has expected such a rapid recovery at the end of 2008. Looks wonderful on the surface, but let's take another look into that number. All three "economies" are heading in different directions, with different growth prospects and very contradictory policy choices.

In our opinion, the Fed's monetary policies are implicitly devaluing the U.S. dollar. Consider the following: when the Fed purchases U.S. Treasury securities, it artificially drives down the yield on those same securities, intentionally overvaluing them. At the same time, yields around the world have been rising, as international central banks follow tighter monetary policies. As a result, rational investors are evermore incentivized to look abroad for less manipulated, higher rates of return. Indeed, from the date of Fed's Chairman Bernanke's Jackson Hole, WY speech in late August 2010 through March 31, 2011, the U.S. Dollar Index declined more than 8%.

What does a weak dollar means? Commodities will benefit greatly (and we observing that in the price of oil; unrest in North Africa and Middle East contributes even more into rising oil prices). We continue to hold significant positions in the oil-industry-related companies, and added additional exposure to other commodities (gold- and silver-exploration companies). With tensions in the Middle East and Africa pushing oil well above $100 a barrel for the first time in two years, should we invest in oil and oil related stocks? The math is very compelling: the word produces 84.4 million barrels of oil a day, and it consumes roughly the same amount (US Energy Information Administration). There is no room for error, unrest, shutdowns, or embargoes. The demand for oil continues to increase in India and China, and other fast-growing economies. We remain very bullish on the oil sector.

There is no question that interest rates will have to rise in the nearest future. How will that impact your bond portfolio (for those of you for whom we manage this asset class)?

Which bonds will hold up best when rates rise again? In essence, the answer is surprisingly simple — the longer the duration the greater the price sensitivity. Another issue facing bond investors today is whether to hold bonds until maturity or sell them early. We remain cautious in our Vega Safety portfolio where we continue to favor short- and medium-term bonds over longer maturities.

Fight in U.S. Government

It is clear that without addressing the issues of entitlements, the budget will never be balanced. Here again, the arithmetic and demographics are very simple: people in rich countries are living longer. The key figure is the ratio of workers to pensioners, known as the support ratio. This ratio is deteriorating steadily. In 1970, this support ratio in the U.S stood at 5.3, in 2010 — at 4.0, and in 2050 it is estimated to be 2.6. Another very troubling problem is with the employees who will underestimate the size of the pension pot they need and overestimate the investment returns they will achieve.

Inflation

It is coming (or it is already here). We are positioning the portfolios for the upcoming inflation: short duration for bonds, and significant exposure to the dollar-sensitive assets.

Japan

The main question everybody has is whether the tragedy in Japan will give the new boost to the economy or it will stagnate Japanese economy for many years to come. Despite the devastating effect of the earthquake, the tsunami and the nuclear disaster, the economic consequences are likely to be limited, both for Japan and on a global scale.

You should expect to see more trading in the portfolios as we adjust to the ever-changing situation in the markets.

As always, we appreciate your business. Do not hesitate to call us with any questions you might have, and refer us to your friends.

Vega Capital Group Team.