By Jim O’Neill, Chairman, Goldman Sachs Asset Management

Sticking with my theme of trying to be pragmatic, the first week of 2012 closed with, on the one hand, a few highly interesting developments, and on the other hand, a sense of 2011 déjà vu, especially as it relates to Europe.

Following the tone of my Jan 3rd Viewpoint, I shall be watching the Monday evening close of the S&P very closely to firm up or reject my current biases. More on this below.

The US. Virtuous Improvements Starting or Another False Dawn?

Following an encouraging December manufacturing ISM index, December payrolls contained many positive signs as well as the complementary household survey reporting another drop in unemployment. For many obvious reasons, an improving job market in the US is vital to a number of related topics. This would include the political strength of President Obama and the mood of policymakers.  However, most importantly, an improving job market would create the conditions for some continued strength in consumption without requiring a further unsustainable decline in the personal savings rate.

Having been on the positive side of the cyclical arguments about the US since early last year, and then a bit baffled as to why so much momentum suddenly disappeared last Summer, this improving mood is not a surprise to me. A lot of ingredients are present for a more vigorous recovery than the consensus is currently forecasting, and indeed, considerably more than our current 2.2 pct GSAM forecast for 2012 GDP.  Many reliable coincident and short-term leading indicators are showing promising signs, including the ongoing trend in weekly job claims. Moreover, it seems to me that there are good signs on a couple of major structural issues that have hung over the US also. One is the housing market.  And, even without the continued promptings of some US policymakers, such as NY Fed President Dudley last week, a modest turn in the housing market in 2012 could contain a number of virtuous ingredients, including helping the fortunes of major US banks. The second is the changing dynamics of the energy markets, with more signs of deliverable and usable domestic oil and gas supplies, which could also be highly significant for further improving the US balance of payments current account.

Against all of this optimistic thinking, there are many reasons why the recovery could falter once more, including the possibility that some of the reported improvements are due to less inclement weather in late 2012 than usual, the fresh decline in the savings rate, and the more populist and familiar gloomy issues related to de-levering and the government’s fiscal affairs. Of course, there is the widespread belief that, at some point, the European mess is going to have much bigger negative consequences on the US than what is apparent so far.  But I am increasingly inclined to think that the 1997 parallel with the Asian crisis might be valid, i.e., due to easier overall financial conditions – for the US – the crisis might indirectly help the US recovery rather than harm it. If, however, the worst path for the Euro Area comes to pass, then it will hurt the US.  But at this point, those relying on that factor must perhaps even be hoping that this comes true.

Currently, it seems to me that the consensus is going to have to contemplate a year with close to or above trend growth for the US, and a repeat of December’s data pattern in January would probably cause that change.

Asian Signals Unclear.

Against the clearly better marginal signs in the US, the same cannot be concluded from Asia. While the December Chinese manufacturing (and services) PMI positively surprised, as I mentioned on the 3rd, it is conceivable that this might be distorted due to the early Chinese New Year coming up and businesses front-loading activities before the usual shutdown. I am sure that if the Shanghai stock market hadn’t opened the year in such a gloomy mood, I might not have given that theory as much credence, but the continuation of the weak December equity market performance suggests something doesn’t seem so good.  Another explanation is that the much-anticipated decline in Chinese consumer price

inflation is not going to happen.  A major client raised this possibility with me late last week. I am in the camp that CPI is heading down back towards 3 pct early this year, but if it reversed its late 2011 sharp drop and started rising back to 5 pct and higher, this would be quite an issue.

Data from other parts of Asia is quite mixed, with Japan looking quite disappointing again, and some softness in various internationally-exposed Asian economies. But against that, the most up-to-date and highly pertinent Asian trade data, that from Korea, strongly surpassed expectations. Korean exports rose by around 12.5 pct year-on-year last month,

nearly twice expectations. As I am fond of saying, unless they are trading with Jupiter, someone around the world is doing ok. The details that are available at this early stage, suggest that while their exports to Europe are weak, this is strongly offset by strength elsewhere, especially to other parts of Asia.

More Signs of Currency Reform in China.

In addition to a second speech from PBOC Governor Zhou about further capital account opening, over the weekend, Premier Wen has indicated that China will undertake more reforms including enhanced flexibility of the Yuan. This is both cyclically and structurally a key issue for all of us, and consistent with my ongoing assumption since last Summer that full convertibility – at least Chinese style – could be upon us by 2015.

And As For Europe?

Most of last week’s disappointments came from Europe predictably, although in terms of data, it has not all been one way. Indeed, quite a lot of the German data continues to positively surprise. While their highly volatile factory orders fell sharply in November, the December data to date has been better, including both auto sales and unemployment and, inline with the earlier reported better-than-expected December IFO, the latest German PMI positively surprised.

There was also a somewhat pleasant surprise with the release of the much better-than-expected December services PMI in the UK and combined with slightly better-than-expected manufacturing and construction PMIs, this raises the possibility that the UK is not as weak as the very grim mood. There is also more and more positive evidence emerging about auto construction in the UK, much of which is earmarked for export. Perhaps the UK is creeping down the path of underlying adjustment more than many realize?

A number of the obvious weak spots of Europe were disappointing PMIs but, to support my oft stated judgment that people shouldn’t exaggerate the global aspects of the deep crisis many are facing, as I had already mentioned on the 3rd, December’s global PMI rose to 50.8 from 49.7.

The real disappointment relates to the ongoing performance of many Euro Area financial markets, and certainly in recent days, the fresh weakness of European banks equity value.  Following the late 2011 generous ECB 3-year money market activities, this suggests that investors don’t believe the funding support is going to help the earnings capabilities of troubled banks.

In addition, the reported Spanish news that their budget deficit is around 2 pct higher than previously reported, together with plans to tighten fiscal policy, further highlights the questionable core cyclical tactic of many struggling Euro Area economies. I have some sympathies with this view. While it is so fashionable to regard the Euro Area crisis as a sovereign budget deficit and debt crisis, until the 2008 collapse and their own housing market reversal, Spain’s fiscal position was the strongest of the big 5 Euro Area economies. What Europe needs is more growth, and a European Monetary System that is credible and attractive to private sector investors.

It remains to be seen whether the changing of some key individuals on the ECB board will be relevant in this regard, but I am touch surprised that this is not receiving more commentary. While the replacement of Stark with Rasmussen at the start of 2012 was known, it was not expected that the leadership of the Economics research would shift away from a German head. It has been given to Peter Praet, the Bank of Belgium member, which may or may not be interesting. It certainly seems that President Draghi is going to do things his way.

So What About Markets?

There are two things which are potentially quite interesting about the markets, but we will need more evidence. In addition to the S&P 5-day rule (more below), there is some extremely tentative evidence that this weird risk on/risk off correlation between the Dollar and US economic news could be changing. The prevailing pattern since 2008 where the Dollar drops on better-than-expected US economic news and rises on disappointing news certainly didn’t pan out last week. If this is the start of the renewal of the more normal historic trend, this would be a fabulous development in my view, as it should make investment decisions more logical, if not easier.

As far as the 5-day rule I discussed as important for me at least, Monday’s close in New York will be the 5th day. After 4 days, the S&P closed up by 1.6 pct year-to-date, but given the fun and games since last Summer, this is easily reversible in a day.

I have found myself quite engrossed in analysis, discussion and debate about this somewhat odd rule in recent days, not least of which because Jose Ursua from the GS Economics, Commodities and Strategy (ECS) department devoted a daily commentary to the topic on Thursday, and subsequently explored it further at my prompting, as have a number of other poor souls including James Wrisdale, and another colleague from GSAM, Rob Hinch.

I first came across this notion from the Stock Market Almanac, and my 2012 edition has been more heavily turned over in the past couple of days than it normally would. It taught be two things many years ago.  One, that there is remarkable pattern historically that many major stock markets show very strong performance from November through April, and quite often, quite weak performance from May through October (hence the “sell in May” oft discussed notion). Any investor that stuck to this calendar investing pattern  would dramatically boost his returns. And two, when the S&P rises after the first 5 trading days of a new year, the market has a pretty good annual performance. In fact, the Almanac claims the success rate has been just under 87 pct since 1950. Jose studied a broader 5-day rule as well as the “January month” rule in his daily and showed that, for a number of markets, the January factors seemed to be quite powerful, albeit less than I had believed, and not enough to dismiss the superior importance of fundamental analysis.

While I certainly concur with the latter, in fact, the Almanac observation appears to be very strong on additional analysis; it is not useful when the 1st 5 days show a decline.  Historically, this appears to offer no concrete signs for the year.  In fact, those years are close to 50/50 as to whether the markets are up or down. (There have been 22 of them since 1950.) It is only really powerful when the S&P is up after the first 5 days. As I reported on January 3rd, 2011 was a real oddity, as it became just the 6th year out of 39 years when the rule didn’t work. What is especially interesting is that there have been no back-to-back years when the rule hasn’t worked. So if for some reason, the S&P is still in positive territory on Monday evening, I shall be most excited.

There is an even more important historical statistic that is exercising me, and millions of others, about a certain Red persuasion this weekend. United have not lost 3 consecutive competitive games since 1997, and those noisy neighbours have a chance to repeat that feat this Sunday afternoon.

Good luck.

Jim O’Neill

Chairman, Goldman Sachs Asset Management

Jim O’Neill, Chairman, Goldman Sachs Asset Management

Tomorrow, Wednesday, November 30 is the tenth anniversary of when I first mentioned the BRIC acronym when I published GS Global Economics Paper No: 66, “Building Better Global Economic BRICs.” As I am sure a number of readers now know, I am publishing a book to celebrate the anniversary. It is called “The Growth Map.” Any proceeds accrued to me from the book will be donated to the charity SHINE, Support and Help In Education “www.shinetrust.org.uk” that I am Chair of, and helped set up with some friends back in 1999.

In this week’s Viewpoints I decided to highlight some of the major observations involving the BRIC development over the past decade, as well as some key issues related to ongoing recent events.

The 2001 paper didn’t create a lot of attention at the time. It was not really until after the publication in 2003 of GS Economics Paper No: 99, “Dreaming With BRICs: The Path to 2050,” authored by Dominic Wilson and Roopa Purushothaman, that the theme really caught on. The fact that many large multinationals started to embrace the BRIC concept around this time and, of course, the happiness of the four BRIC countries themselves, helped give the theme such a push.

There were three essential arguments I made in the 2001 paper:

Firstly, I simply pointed out that if on a relative and absolute basis the strong growth of the four BRIC countries¾Brazil, Russia, India and China¾continued at the same pace, by 2010 they would become a much larger part of the world economy. In the most optimistic of the scenarios I considered, I suggested that their combined share of GDP could rise from the then 8pct to around 14pct. In the event, their share has risen to around 18-19pct. I suggested that China might get close to the size of Germany. In the event, it has sailed past Japan and has already become not far off twice the size of Germany. I suggested Brazil might get close to the size of Italy, and it actually crept above them to be the seventh largest economy last year. The collective nominal growth of the BRIC economies was close to $10 trillion creating more than three times their 2001 size of around $ 3 trillion.

Secondly, because of their relative shift, I argued that the BRIC countries should become more central to global economic policymaking, suggesting each of them, certainly China, should become part of the G7/G8-type groupings. Of course, while this hasn’t happened quite this way, the G20 was placed at the front of global co-ordinated policymaking primarily to bring the BRIC countries into the centre. It took the global credit crisis in 2008 for this to happen, but it has, and this is probably one of the better things that have happened since. Despite many issues about the operational effectiveness of the G20, its legitimacy is greater than that of the G7/G8.

Thirdly, another key¾and currently still very topical¾point of the paper was my argument that since France, Germany and Italy were all now part of a monetary union with no independent monetary policy, why didn’t they agree to represent themselves collectively in the G-meetings and indeed at the IMF? Amongst other things, it would demonstrate to many that their commitment to a permanent monetary union was rock solid. This is one of the BRICs that still needs to be built. In hindsight, this lack of bold vision and leadership was, and has been, symptomatic of the weaknesses in the structure of EMU, many of which, of course, escalate by the day. If EMU is to survive in the future, then the Euro zone must start to act collectively as one. Perhaps this is now where we are headed, and certainly the increasingly vocal call for a new, stronger fiscal framework from German Chancellor Merkel shows what they would like. As I will discuss more below, while there is plenty of debate about the role of true Euro-denominated bonds, more and more Euro policymakers are moving towards this ultimate goal. Merkel is now openly suggesting a revised Treaty to accommodate it, and following her joint meeting with Sarkozy and Monti last week, a specific proposal looks like it is going to be presented by December 9. If this is where the Euro Area is ultimately headed, with a central Finance Ministry-type entity, then it should be relatively straightforward for all remaining Euro members to combine as one when it comes to their representation in the IMF and at G7-type meetings. If so, this would allow for the eventual reduction of the G20 towards something more like a G9 which is what I argued for back in 2001. The four BRIC countries would join the Euro Area, together with Japan, the US and still probably Canada and the UK. Of course, there would be questions about the legitimacy of the latter two and perhaps it might eventually be just a new G7 without them. The existing G20 could serve as a broader umbrella group but would not be as central as it currently has become.

Looking Back and Forward With the BRICs.

As I said, the BRIC economies combined have grown to around $13 trillion and are poised to overtake the size of each of the US and the EU in coming years. Over the decade, they have created the equivalent of close to seven new United Kingdoms or at least of the 2001 size. China alone has added slightly more to world GDP than the US, around $ 5.5 trillion probably by the end of this year.

In the decade ahead, the BRIC countries will probably create at least another one of their current self, i.e., grow by around $12-13 trillion in nominal $ terms, assuming that they collectively grow at somewhat softer rates. If they grow by similar degrees as the last decade, their contribution in nominal $ could be closer to $20 trillion. China seems likely to grow by more modest rates, perhaps in the 7-8pct range, but India could accelerate. This could be especially true if India persists with what looks like some sudden passion for policy reform. In what I would describe as the most interesting economic news of last week, on Thursday the Indian government appears to have decided to allow majority foreign ownership of their domestic retail businesses. This is obviously huge news for the world’s biggest retailers given India’s fabulous demographic but it is probably even more important for Indian agricultural productivity and supply chains which is why policymakers have finally decided to take this step. More of these kinds of decisions and India will possibly finally succeed in achieving China-style GDP growth rates.

Another major consequence of the BRIC story has been the desire of other large-population emerging economies to get into the “club”¾something itself we recognized back in 2005 when we thought of the “Next 11” idea. Many of these countries before and after have wanted some of that BRIC “magic”. These days, at GSAM, we regard four of them¾Indonesia, Korea, Mexico and Turkey¾as sufficiently large and important to be considered “Growth Markets” along with the BRICs. Going forward, it is quite likely that others may become this differentiated, perhaps at some stage including part of Africa and the Middle East. I discuss aspects of this in the book. I spent last Friday in one of the non-BRIC Growth economies, visiting Istanbul to present my views of the world for a major client. I was literally in and out, but what a remarkably vibrant city Istanbul is these days. I cannot understand why continental European countries are not more eager to embrace this country, especially as it would seem like an obvious credible “model” for some of the dramatically changing nations in Northern Africa and the Middle East.

As it relates to the BRIC politics, Philip Stephens wrote a very interesting op-ed in last Friday’s Financial Times entitled “BRICs without Mortar.” He points out that the four countries are not natural political bedfellows, highlighting some of their bilateral issues and many of their differences. I would agree with many of his points, but I don’t think this means they are not increasingly relevant for the world and, as discussed above, they should be more and more central to optimal global economic policymaking. I never suggested that they should operate alone as a political club, and other than highlighting the inadequacies of the current G7, etc.,  the purpose of such a club¾-especially now South Africa is included¾seems a bit limited. However, by the end of this decade, the BRICs and the other four Growth Markets collectively will be not far off the size of the G7.  The BRICs collectively will be bigger than the US. So, from an economic perspective, the BRICs will be contributing lots of mortar.

Against this background, it seems inevitable that the current world monetary system is likely to evolve differently with, at a minimum, the role of the RMB becoming more important, and as I discuss in the book, perhaps other changes might occur.

By Chris Weafer, Chief Strategist at Troika Dialog.

 The weekly equity funds flow report from EPFR Global showed a big jump in new investment into emerging market funds for the week ended Wednesday. A total of $3.5 bln was invested into all EM funds compared to $1.0 bln the week before.

Russia dedicated funds reported their first week of inflows since early July, directly raising $56 mln in the current week compared to a loss of $54 mln the week earlier. However, on an aggregate basis when taking into account

By Marcus Williams. The exchanges of the emerging markets bloc of Brazil, Russia, India and China are forming an alliance to help deepen their liquidity and offer investors pooled exposure to their markets. This initiative was announced at the 51st AGM of the World Federation of Exchanges (WFE) in Johannesburg yesterday. The initiative brings together BOVESPA from Brazil, MICEX from Russia (currently merging with RTS Stock

By Andrei Skvarsky.

HSBC, Europe’s largest bank, has launched an emerging markets fund onto the London Stock Exchange.

The Irish-domiciled HSBC MSCI Emerging Markets Exchange Trade Fund will replicate the performance of the Morgan Stanley Capital International (MSCI) emerging markets index, which tracks the performance of major companies in countries such as Brazil, Russia, China and India, according to www.fundweb.co.uk, a website run by British magazine Fund Strategy.

The ETF will use physical replication of the index and has a total expense ratio of 0.6%

By Jim O'Neil, Chairman of Goldman Sachs Asset Management.

In the past week, we have experienced remarkable turmoil in financial markets, which have brought back memories for many people of the darkest days of late 2008. Are direct parallels to 2008 valid ?

Many other questions also come to mind.  Are current market valuation levels correct in assuming that most of the G7 and Europe are set for multiple years of Japan-style weak growth? And unlike Japan, will it carry high unemployment and social unrest? Are my beloved BRICs and Growth Markets set to keep the world above water, or are they doomed also?  And of course, how do investors make money?

I am afraid I don't have all the answers. I thought I would reflect back on the past couple of weeks, review the major news flow this week, and offer a few perspectives against my own underlying judgment about the long term path for the world economy. I shall also give a flavor of the intense daily discussions we have been holding amongst the CIOs and senior portfolio managers across Goldman Sachs Asset Management (GSAM), which has been extremely stimulating.

Generally speaking, collectively, we remain quite sanguine about the world.  We think that the markets are excessively worried about the US and, while there is less agreement amongst us about Europe, we are impressed by the policy response. In terms of equities, while aware of the risks, we believe that there are very attractive valuations on offer, including in the US financial sector. In fixed income markets, while there is little value, the strength of the US and European policy response has been such that markets have momentum from the policy support, at least for now. On currencies, we find it difficult to be attracted to any of the major currencies, but continue to find attraction in some in the Growth Markets. The increased rate of CNY appreciation this week is highly interesting and pertinent in this regard.

US STOCKS, US AND GLOBAL FINANCIAL CONDITIONS

At the lows of Monday of this week, the S&P had lost more than 200 points since the highs of late July, and around 265 points from the highs at the end of April and start of May. Understanding why a move of such power has occurred, and what its implications are, seem critical for thinking about the US going forward and maybe the rest of the world too. Much of the decline occurred between August 1st, post the weak July ISM release, and August 8th, the first trading day after the S&P downgrade.

As discussed by many analysts on Wall Street, the degree of weakness prevailing earlier this week would be consistent with a stronger degree of evidence of economic weakness and a high probability of recession. However, this is in contrast to the most recent economic evidence, which includes some better-than-expected releases. For example, the fresh decline in weekly US job claims, to 4-month lows, is particularly striking, along with evidence of a continued pick up in auto sales. In the GS Global Leading Indicator (GLI), the change in US weekly job claims is one of the more powerful components and has a good statistical track record in foreshadowing changes in the US stock market.

With the weakness of the financial sector, in particular, and despite the clear message given from the FOMC meeting after their "easing" this week, US markets appear to be assuming Japan-style multi-year weak growth, and have concluded that trend growth in the US is significantly impaired.

There are many differences between the US and Japan, and although the post-crisis recovery in the US has been quite disappointing so far, it is not at all clear to us that direct comparisons are valid. The US has much better demographic dynamics and its policymakers are still quite flexible.  Under this Federal Reserve, overall financial conditions are kept extremely accommodative.

In 2008, the reason why the world fell into a quick and deep recession was because a large and quick unintended tightening of overall US and OECD financial conditions. As of yet, this is not the case in 2011. In fact, if we close the week where the S&P is trading as I write, we will have witnessed the tiniest of tightening in overall US financial conditions.

Despite all the gloom, the S&P will have recovered to trade close to 2 pct of its close last Friday.

As part of ensuring recovery,  I am presuming that a rising goal of US policymakers will be to try and encourage US companies to use the huge amounts of cash they are holding for investment and job creation, preferably at home. I assume there will be further efforts along these lines despite the challenges of the fiscal deficit.

 STRONG EUROPEAN POLICY RESPONSE

In last week's Viewpoint, I discussed three major issues that seemed to be troubling the world and markets, one of which was the US. The biggest of the three was the Euro Area, the third being China, which I will discuss below.  It is impossible to not be concerned about the Euro Area as the contagion  has spread to Italy, Spain, and now France. Greek-style financing problems in all three of these countries would make the problem quite considerable and extend way beyond Europe.

However, just as the Fed responded quickly and appropriately to the sudden undesired tightening of US financial conditions, Europe's policymakers have responded to the problems facing the latest Club Med countries. The controversial move by the ECB to purchase Italian and Spanish bonds has so far had a powerful impact.

While there is considerable debate about exactly how eager the ECB has been to embrace these purchases, the impact has been quite considerable.  10-year Italian yields have fallen back below their "breakout" of the late Spring, and Spanish yields are back to lows of the year. Many analysts are suggesting that this is only going to be temporary as when the market realizes how little the ECB has actually bought, then it will be a sign of how uncommitted the ECB really is. While this is one interpretation, I am not sure it is the correct one. The opposite is just as rational. Perhaps, in fact, the ECB hasn't had to buy that many in order to turn the trend.  Moreover, perhaps they are more focused on better timing and tactics in terms of their intervention. Time will tell.

Either way, despite the obvious opposition from a number of participants and a conservative Germany, the policy response was forthcoming.  And that is all one can ask for.

The bigger issue of the week in the Euro Area, however, became the sudden attention on France that, in many ways, appears to be a byproduct of the S&P downgrade of the US. Many US commentators seem quite irritated by the fact that France has a higher credit rating, especially when they perceive a country with a bloated government sector and an economy with weak trend growth. Whether this was the exact spark or not - France's massive exposure to Italy is probably more the underlying cause - the attention has certainly been on France and its financial institutions. Friday's news of a flat GDP in Q2  was seized upon by French skeptics, although dismissed as temporary by others, including most analysts

France has survived the week intact, with all the credit rating agencies reiterating their support for a AAA rating.

We now have news of another Sarkozy-Merkel meeting next Tuesday. This is likely to be a rather important affair and its outcome may determine European sentiment for the week.

The battle lines of the meeting are drawn. The conservative Germans seem to be protesting at any move Merkel makes towards European gestures. Despite the publicity all these comments get, it shouldn't be ignored that opposition forces are encouraging Merkel to be pro-European and, German leaders, like other country's leaders, have to sometimes do just that, lead. As I am fond of reminding people, Chancellor Kohl wasn't advised to swap West Marks for East Marks at 1 to 1, but he did.

The chorus of voices rising in support of closer fiscal union in the Euro Area and, as part of it, a true Euro bond, is getting louder. The most articulate argument in favour of a Euro bond was provided by the think tank, BRUEGEL, in 2010.  The idea of a common bond, backed by a stronger EU institution that will ensure stronger fiscal discipline, is rising. What the EU has to say about this topic in September is probably just as important, if not more so, than the national approval of the recent EFSF proposals. Analysts will be searching for any clues about this topic from the Sarkozy-Merkel meeting also.

On top of everything else, there is the matter of a fresh short sales ban imposed on the equity of financial companies by troubled Euro Area countries, which is obviously not going to permanently solve anything. But it does prove how determined policymakers remain to put up a fight.

SHOULD WE ALL BE BUYING EUR/CHF?

I mentioned in last week's Viewpoint that both the Yen and Swiss Franc were now at ludicrous valuations and that I doubted either would be close to those levels come September. Well, the Franc has already experienced a significant correction primarily over the last two days. Justifiably alarmed by the speed and size of the Franc's acceleration, Swiss National Bank (SNB) policymakers have indicated that they are prepared to undertake extraordinary measures to reverse this overvaluation.

They have suggested measures to introduce negative interest rates, which they temporarily did in the 1970's, and the more intriguing option of announcing a direct, albeit temporary, peg to the Euro. Many people talk of a 1.15-1.20 peg as being the area they would consider.  Such a step would require them to add persistent excess liquidity until the Franc was in this range against the Euro. Given the likely damage the Franc's strength will eventually cause, it seems to me a policy worth considering, especially given that all other efforts have not succeeded.

When I thought about the idea on Thursday morning, I thought it would be a rather smart thing for the ECB, and perhaps the entire G20, to support! Given how the Franc has played a central role in "risk off" behavior, perhaps a collective G20 effort to bring it closer to fair value might be good for everyone else as well as Switzerland.  By the way, the GS estimate of fair value for EUR/CHF is 1.44.

Needless to say, just the mere talk of these ideas has caused EUR/CHF to recover by around 7 pct, which in itself is a sign of how many people have been using the currency pair as a global bearish hedge.

Watching what the SNB says and does next week will be almost as interesting as the Sarkozy-Merkel meeting, and possibly more lucrative.

CHINA TO THE RESCUE?

The third issue I raised last week was China, ahead of the slew of monthly data that we were due, including the all-important CPI. It was as important as expected.  While the year-on-year CPI came in at the highest end of expectations at 6.5 pct, many analysts are now convinced that we will see a sharp reversal by year-end and beyond. Many expect August CPI to be less than 6 pct, and by year end, for inflation to be back to less than 5 pct. This all makes sense to me, and I can't emphasize how critical this is to the Chinese outlook, especially because of their importance to the rest of us.  This is fundamentally good news.

It is interesting to see so many media commentators highlight the surprisingly large monthly trade surplus for July - yet another sign of how alarmist everyone wants to be.  But, they failed to mention that the year-to-date surplus is just more than $180 bn or approximately 2.1 pct of GDP on an annualized basis. It is remarkable how few people still realize how much the underlying surplus has declined.

Anyhow, given the better outlook for the CPI from here, and perhaps realizing once more both their need to be more dependent on themselves for growth and not the G7, Chinese policymakers have suddenly allowed a faster speed of CNY appreciation and have stopped talking so hawkishly about monetary policy. This is just what the doctor, and more importantly the world, would recommend, and needs.

As I said last week, it is my belief that the next big global equity rally will start from a shift in Chinese policy, and I continue to think the same. It is most interesting to have seen the local "A" share market quite resilient all week.

All in all, what a week.  But for those that can look through the August fog (and there actually is quite a bit of that too where I am right now), there are quite a few hopeful signs. We are far from out of the woods especially given the Euro Area complexities, but it seems to me that things are not as bleak as many still think.

And for good measure, despite the horrible events that occurred on the streets of England this week, the Premiership is back. Hopefully, that will help put a week to forget, both here and in the global markets, to the memory of the past.

By Chris Weafer, Chief Strategist at ING in Moscow.   Investors continue to add new money to emerging market (EM) equity funds but retain a strong bias towards the relative safety of EM Balanced funds rather than trying to pick one or more individual countries. With the exception of some unusual flows in Taiwan, and net flows into China, activity in most other country-dedicated funds was unusually light. Russia funds attracted net new money for the first time in three weeks, albeit the amount was also very modest.   Greece and US data helped sentiment. The weekly equity fund flow analysis from EPFR Global showed that, for the week ended Wednesday July 6th, investors added a total of $1,355 mln, of 0.18% of AUM, to EM funds. That was down on the $2,464 mln invested for the previous week. But that total was distorted with an exceptional inflow of $2,093 mln into Taiwan funds. Stripping out what have been very unusual flows into and out of Taiwan funds (-$526 mln this week) the total for EM – ex Taiwan this week is $1,889 mln versus $371 mln for the week prior. Given that we are in the usually quiet summer period, that is a useful net increase that better reflects the gains in most global markets as investor sentiment improved after the Greek debt threat was reduced and US growth indicators improved.    Investors switched from Taiwan to China. Asia funds attracted the greatest volume of new money, totalling $634 mln and equal to 0.26% of AUM. China funds attracted $355 mln (0.4% of AUM), their best week since end April as investors were not put off by the disappointing PMI Manufacturing report and prospects for further rate rises. In terms of % of AUM, Philippine funds attracted the most new money equal to 12.4% of AUM and Malaysia funds reported new money equal to 7.5% of AUM. At least some of the money invested into China funds came from the $526 mln taken out of Taiwan funds (4.6% of AUM). Elsewhere in Asia, India funds reported redemptions of $82 mln, their tenth straight week of redemptions, and Korea funds added $55 mln.   Little interest in LatAm. Fund activity in Latin America was very light last week with a net total of $7 mln redeemed from all regional and country funds. Brazil funds lost $7 mln and Mexico funds lost $24 mln.   Russia reversed a losing streak. In EMEA, Russia funds reported a net inflow of $14 mln (0.07% of AUM) for the week. That relatively small sum was at least better than the $188 mln and $298 mln redeemed by investors over the previous two weeks respectively. Turkey funds attracted a net $2 mln only last week. EMEA theme funds reported a net inflow of $3 mln while East Europe regional funds lost $5 mln. Taking Russia’s share of the flows into and out of the bigger thematic and regional EM funds, the total available to fund managers was increased by approximately $55 mln to almost $70 mln.

By Chris Weafer, Chief Strategist at ING in Moscow.

Russian funds attracted more new money than any other emerging market (EM) dedicated country fund in the 1st Qtr and although suffered redemptions in the past two months, the funds are still well ahead for the 1st half-year.

The big theme within the EM asset class, however, is the continuing shift from country specific exposure to the relatively safety of GEM Balanced funds. Investors want to stay exposed to the fast growing and fiscally safe emerging economies but are reluctant to make specific country bets.

Investors returned to EM in the 2nd Qtr. For the 1stQtr, the EM asset class suffered a sizeable outflow of money. Across all EM funds the net redemption was $18.4 bln for the quarter. That turned 180 degrees at the start of April and, through the 2nd Qtr the total aggregate new money flow into EM funds was $11.8 bln.

Still a net redemption of $6.6 bln for the half year but a credible performance given the over $170 bln transferred into the asset class in 2009 and 2010 and the backdrop of global uncertainty for most of this year. The EM Balanced Funds category picked up$10.1 bln in the 2nd Qtr to balance the $9.0 bln redemptions of the1st Qtr. That left a net $1.1 bln of new receipts for the 1^st half.

BRIC is dead for fund

By Andrei Skvarsky.

BRIC and its younger rival CIVETS, as groupings of nations, are losing relevance for investment strategists, who are increasingly taking a country- or sector-based approach, according to a US consultancy.

Whilst Brazil, Russia, India and China have similar growth patterns, as do the CIVETS countries – Colombia, Indonesia, Vietnam, Egypt and South Africa, - they have different investment opportunities, Kevin McPartland, principal of emerging markets research and advisory firm TABB, argues in a report.

McPartland also says it is time for the BRICs “to move over as the CIVETS are the next wave of emerging financial markets with prospects on a par with what the BRIC nations began to experience a decade ago”. The CIVETS nations saw inflows of $10bn in 2010 and nearly each of them posted double-digit equity returns last year. 

HSBC Global Asset Management has launched a fund investing in its self-coined CIVETS concept which seeks to curry favour of investors who fell for Goldman Sachs' BRICS whizz.

The HSBC GIF CIVETS fund targets returns by investing in a diversified portfolio of equities from the CIVETS countries - Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa.

The fund also has the ability to invest up to 25% in non-CIVETS nations which have similarly attractive demographics, such as Mexico, Nigeria, Philippines, Thailand, Malaysia and Saudi Arabia.

The fund will be run by Douglas Helfer,  current manager of HSBC's Russian equity fund, who will work alongside co-managers Basak Yavuz and Andrew Brudenell.

The term was coined by the group back in 2009 and is one of a number of acronyms currently circulating in the market to identify the next potential BRIC countries. Jim O'Neill of Goldman famously came up with BRIC to identify Brazil, Russsia, India and China. South Africa was recently lumped on.

Goldman Sachs guru Jim O'Neill cosied up to Russian state lender VTB boss Andrei Kostin at the US bank's BRICs conference yesterday in London.

Andrei Kostin - VTB

More than 600 clients from around the world, including a significant delegation from Russia, attended the event.

Jim O’Neill, inventor of the BRIC acronym, interviewed  Kostin and discussed why Russia deserved to be a part of the BRICs.

The duo agreed the financial infrastructure in Moscow will continue to improve substantially as part of the government's determination to establish Moscow as a significant financial hub and that Russia's role as part of the BRIC countries will be vital in creating future global growth.

Jim O'Neill - Goldman Sachs

O’Neill remains convinced that Russia would continue to be one of the fastest-growing economies in the world and its aggregate performance over the decade was as he had envisaged in 2001 when he created the BRIC concept.

"Russia continues to earn its place in BRIC, and in fact this year has been the best performing equity market in the EM universe. Moreover, the ruble continues to strengthen, and it is notable that, as of today, the ruble is the only EM currency that would meet all IMF criteria to join the SDR," O'Neill said.

He also emphasised the favourable and competitive state of the Russian financial industry and the stimulating impact the 2014 Winter Olympic Games and the 2018 Football World Cup in Russia will have on opening up new avenues of growth.

By Jim O'Neil, Chairman of Goldman Sachs Asset Management.

Now that the Royal Wedding is out of the way, my thoughts turn to the month of May. Those of us obsessed about a certain sport have a lot of exciting season-end issues to think about.  Well, at least those of us that support a particular team, today’s result not withstanding.

May is also the beginning of a (sometimes) historically challenging month for equity markets, with the infamous British phrase, “Sell in May and go away, come back on St. Legers Day” familiar to some of you. Historically, looking back at the post World War 2 environment, if you had only invested in the major Western markets from November 1st until April 30th, and avoided equities from May 1st until October 31st, you would have considerably enhanced your returns. This was true in the US, Canada, Japan and most of Europe, not just the UK.

According to the Stock Market Almanac, from 1950 to 2009, the average return from investing in the DJIA from November 1st through April 30th would have been 7.4 pct. In contrast, from May 1st through October 31st, the average return was a mere 0.4 pct. For UK markets, the May-November return is even weaker.

Those of us that have been around a long time are occasionally sensitive to bouts of superstition. So, even though I tend to find the glass more half full than empty, I find myself wondering if there is anything that could happen this month that can trip up the rally.

Before I turn to the fundamentals, let’s look a bit closer at the May-October market specifics. While the return over time is lower than from November-April; it is influenced by the typical size of decline when they occur rather than the total frequency.  In fact, a study of the current Almanac from 1950-2009 revealed that  36 years of those years actually delivered positive returns from May-October, 7 of which were double digit. Of the 23 negative return periods, 11 were double digit. The double digit negative return periods outnumber the double digit positive periods by four.

If you look at the period more closely, the 1960’s and 1970’s were the worst decades, with as many negative periods as positive ones in each of those two decades.  The past two decades were less negative. Indeed, if you study the 2000-2009 period, all three of the large negative May-October periods were identifiable with clear macro causes (e.g., the 2001-2002 technology bubble and subsequent recession and the 2008 global credit crisis.)  Moreover, in two of the three circumstances of negative May to October periods, the previous November to April were negative also.

It is also worth pointing out another dominant through time.  Typically, the 3rd year of a Presidential term of office has been a year when May- October returns have been positive.  So in fact, while there is no denial of the historical facts, it also seems pretty explainable in terms of macro economic circumstances. Therefore, in my view, it is best to watch the most useful coincident and lead indicators. In other words, focus on the fundamentals.

So what could go wrong?

CHINA CHALLENGES

No doubt influenced by the price of their A share market, I found myself worrying somewhat about China this week. Before any of you get over excited, this is against the background of me thinking that a “happy slowdown” was in the process of being achieved in China. I entered this year strongly of the opinion that Chinese policymakers would be planning for a period of softer overall GDP growth, in which “quality” was more important than “quantity”.  In this environment, less dependence on exports and investment would go hand in hand with more domestic, private consumption.  In addition, I believed that there would be greater policy focus on the environment and efficient use of energy. These expectations were confirmed with the release of their latest 5-year plan a couple of months ago, and were symbolized by the citing of a 7 pct “target” for the next 5 years.

Amongst the challenges to making this critical shift is the need to keep inflation under control.  This is partly due to global circumstances, but also because of China’s own remarkably strong growth.  Today, inflation is higher than policymakers’ desire and need to help facilitate this adjustment.

A month ago, it seemed to me that most published data was starting to show signs of a slowing economy and a possible peaking in the commodity-related inflation pressures. Certainly, key lead and coincident indicators suggested to me that this was likely. Both the GS China Financial Conditions Index (FCI) and the GS China Economic Lead Indicator have suggested slower growth ahead for some time. The last batch of monthly data, however, published nearly two weeks ago suggests that growth has  not apparently slowed that much and CPI inflation rose to 5.4pct, with fears of more increases to follow. Linked to this, as I discussed last week, it appears as though policymakers are searching for additional ways to tighten monetary policy further, including allowing a faster pace of RMB appreciation.

All of this seemed perfectly sensible to me.  However, this past week, the China A share market suddenly gave up half its rally year-to-date suggesting something is upsetting local confidence. I hope this is temporary.  If I simply look at reliable indicators that have served me well in the past, I find myself slightly worrying that China runs some risk of slowing things too much.  I am sure my concerns will turn out to be temporary. Certainly today’s April PMI release showing some softening in both activity and import prices are a renewed turn for the better.

MORE GLOBAL  ISSUES

Moving on from the China-specific issues to thinking about potential problems elsewhere.  Of course, any further loss in the momentum of global recovery would be interesting. Today’s Korean export data came through stronger than expected suggesting that global trade continues to improve. The publishing of the monthly PMI and ISM surveys around the world this week will be as important as every month. However, some softening  wouldn’t be overly troubling, as we have risen so much in recent months, and any softening would simply add to the inclination of most Western monetary policymakers to be extremely slow in tightening monetary policy, if at all, and certainly in the US.

What would concern me more would be evidence of continued creeping inflation and inflation expectations.   In this regard, stronger ISM and PMI surveys might be slightly more challenging than softer ones, especially if they were to lead to more companies thinking they have pricing power. This past Thursday, I hosted an internal “CIO call” with most of the CIO’s of our various investment teams at GSAM. Some of those involved in managing equity investments reported anecdotes of companies raising prices. If this were to spread, then policymakers in the US and elsewhere wouldn’t find it quite so easy to remain as docile as they have been. In this regard, watching for any signs of this trend spreading is also likely to be important, possibly more so than the monthly PMI and ISM surveys. My own suspicion is that if commodity prices were to ease, then such anecdotes would quickly follow.

Bringing the issue back to China, the more I look at where China appears to be headed “strategically” as well as cyclically, I can’t see the case for so much bullishness on commodity prices. Moreover, if commodity prices were to ease, I can’t really see the case for fears about inflation around the world.

Ultimately, it seems to me that the global equity rally will end when policymakers decide they have to tighten monetary policy considerably.  This may happen in a May or a November, but it looks to me as though it isn’t likely to be this May, or perhaps this November either. In this regard, developments in China both directly and indirectly might be more relevant than many perceive. We shall see.

Meanwhile, I shall turn my attention to the other highly exciting issues of May...

By Andrei Skvarsky.

Citigroup, the world’s biggest financial services company, has promoted Adrian Faure to head of equities for Asia excluding Japan and Brent Robinson to head of research for the region as part of an overhaul of its global equities trading team.

Faure, who will be based in Hong Kong, was chief researcher for the region and Robinson his deputy prior to their new appointments.

Bloomberg cited Faure as saying Citi would focus on China, Russia, Brazil, South Africa and India in its emerging markets business.

London-based business daily City A.M. said Andy Thompson has become Citi’s head of equities for Europe, the Middle East and Africa (EMEA).