In a historic shift last week, the Federal Reserve removed all mystery about its plans for interest rates, declaring its intent to maintain the current “exceptionally low” target of near zero percent for the key federal-funds rate “at least through late 2014.”  The surprising announcement of the extension of this policy—from a previously anticipated end date of mid-2013—came after the two-day meeting of the Federal Open Market Committee, which also brought forth new and lower projections for economic growth.

Adding up the impact from the data above, we have updated our Asset Mix Indicator as shown below.  The reading for each indicator is from -2 to +2 so the total score will be between -10 and +10.  A positive number moves us to have an overweight position in stocks (the larger the number, the larger the overweight) while a negative number would have us position portfolios more defensively with an underweight position in stocks.  The current reading is 5, a slight drop from the 7 level it had risen to at the market lows last October, but still a very positive indicator that has us keeping our Balanced Fund stock weights at about 120% of their ‘benchmark’ or ‘neutral’ position.

Asset Mix

The downgrades in our model were to Corporate Profits (from +1 to 0) and Sentiment (from +2 to +1).  Profits were downgraded due to the points mentioned above; profit growth is slowing down and companies are having a harder time beating expectations.  However, profit growth is still positive.  The downgrade to Sentiment, our most volatile and short-term oriented indicator, is simply a reflection of the fact that bullishness among individual investors has increased and bearishness has receded from the record levels seen last year.  The strength of stocks since the October lows and the better economic data has clearly removed some fear from investors.  Since sentiment is always a ‘contrary indicator’ (i.e. more bearishness is good) then the rise in optimism lead us to downgrade the Sentiment indicator.  Stock Valuations and Monetary Conditions both remain at +2, a continued reflection of the valuation levels versus historical levels as well as the indications from most central banks that they will keep interest rates lower for a longer time.

One of the ‘wild cards’ for global economic growth in 2012 will be the ability of China to achieve a ‘soft landing’ (i.e. to decelerate their economic growth from the inflationary levels of over 10% to their longer-term plan of 7-8% growth).  While many investors worry that this is difficult to achieve, the chart below shows how the Purchasing Manager’s Index (PMI) has turned down over the past year but has recently stabilized and started to turn slightly higher.

Chinese Mftg - Slower but Still Expanding

When monetary conditions were tightened at the beginning of 2011 (interest rates were increased and bank reserve requirements raised), it was done to cool off the highly speculative property market as well as reduce the inflation rate, which had surged to almost 7%.  As the year ended, inflation has cooled down to a 4.3% annual rate and looks to fall further as food prices moderate.  The property market in the key urban areas (Bejing and Shanghai) has also pulled back.  China now seems more focused on growth again as they prepare for new leadership and a new ‘Five Year Plan.’

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