While the worries about growth in the emerging economies will drive money flows, we believe that the growth in many of those regions remain on track.  This is not a repeat of the 1997 Asian economic crisis!  Current account deficits and capital flight in the 1990’s lead to plunging currency values in the developing world which crushed domestic demand, drove growth down to recessionary levels and decimated stock markets in the region.  But those economies are in far better financial shape today with higher levels of domestic savings, substantial foreign exchange reserves to defend their currencies and continued expansion of the domestic economies.  Buying all emerging markets may not make the most sense since some are more impacted by these changing fund flows than others.  China can finance their growth with local funds and is coming off a period of slower growth, with stock valuations down sharply. It stands out as our top pick among the developing markets.

Moreover, PMI (Purchasing Manager Index) surveys from the US, Eurozone and China offered some good news about the outlook for the world economy. The headlines from all three surveys strengthened in August and to levels that surpassed consensus forecasts. Forward looking elements concerning manufacturing new orders were particularly upbeat (see chart below).  The re-stocking of raw materials and the destocking of finished goods which was evident in the details of all of these surveys also bodes very well for the global growth outlook in the period ahead  a synchronized pick up in global growth has been a rare phenomenon in recent years.  Recent data from important leading indicators in the US, Europe and China suggests that there is upside to the global growth outlook .Sustained Recovery: ISI Surveys

Although the global financial picture may not be as dire as the headlines might suggest recently, stock markets in the developed economies are pricing in a much better picture.  Price gains of stocks in the S&P500 are outpacing profits by the fastest rate in 14 years as the bull market extends beyond the average length of rallies.  The benchmark gauge for U.S. equities has risen 14 percent relative to income over the past 12 months to 16 times earnings. Valuations last climbed this fast in the final year of the 1990s technology bubble, just before the index began a 49 percent tumble.

The rally that started in March 2009 has now outlasted the average gain since 1946.  Combined profit at S&P500 companies surged 37 percent in 2010, 19 percent in 2011 and slowed to 2.3 percent last year.  The last time gains in stocks outpaced profit expansion by this much was in 1999, when equity valuations surged 19 percent in a year to 30 times reported profit.  That bull market ended the following year, with the S&P 500 tumbling 49 percent from March 2000 through October 2002 as the dot-com bubble burst.  Similarly, in 1987, prices rose so fast that valuations increased 43 percent through August, about twice the pace of the year before. That month marked the peak in a five-year rally, followed by a 34 percent loss through December 1987.

Given the sharp gains for U.S. stocks this year we have been reducing stock positions in that market recently, taking profits in the Financial Services and Information Technology sectors.  Our internal Asset Mix Indicator also suggests that we reduce stocks back closer to a neutral position, at least in the short-term.  The details of the indicator are shown below.  The indicator currently stands at +1 (in a range of -10 to +10), slightly above a neutral, benchmark level of 0 but well below the +5 level at the market lows last October or the +7 level at the market bottoms in March, 2009 and September, 2010.Asset Mix Positive but a bit Over-Extended

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