In contrast to the Fed, European Central Bank President Mario Draghi has pledged to keep official rates low until the end of 2016. Furthermore, the deposit rates were reduced to -0.1 percent from zero in an attempt to boost economic growth and avoid deflation, which would increase the real debt burden of regional debt-ridden economies.Furthermore, the latest ECB stimulus allows lenders to access cheap funding for as long as four years to encourage lending to small- to medium-enterprises. We believe these measures should help the economic recovery in the periphery of Euro Zone and also have positive spillover effects on US companies doing business in Europe. There was also some good news from emerging markets: China's manufacturing showed signs that government's efforts to prevent a slowdown are being effective. The Purchasing Managers' Index came in at 51.0 up from 50.8 in May, according to the National Bureau of Statistics. A positive reading of the index is encouraging, since a China slowdown is a major tail risk to global economic recovery. On the negative side, geopolitical risks have increased. In addition to the crisis in the Ukraine, instability in Iraq and Syria have sent oil prices higher in the last few weeks. Crude Brent price reached levels not seen since September 2013, touching $115 a barrel. The Islamic State in Iraq and Syria, an extremist group, has seized control of Iraq's borders with neighboring Syria and Jordan and may even threaten control of Baghdad. However, in my opinion, if the crisis does not spread to the south where the main oil reserves are located, the spike in oil price may be contained in the $110 to $115 per barrel range. In contrast, if the violence threatens Baghdad or the southern oil reserves, the oil price could spike further by 50% as the largest OPEC producer Saudi Arabia may not be able to compensate for the lost capacity.
So far the global financial markets have not overreacted to the tensions in Iraq as oil analysts regard $120 a barrel as a crucial benchmark for concern. Energy normally does not exceed 10 percent of the consumer price index in most countries. That suggests a 10 percent increase in energy prices will increase inflation by an additional 1 percent.Core U.S. consumer prices have risen 2% over the last year. If inflation rises much higher because of higher oil prices, it may put pressure on the Fed to consider moving to raise rates quicker. A further surge of oil prices could also make the global economic recovery more difficult in the second half of the year. Emerging markets such as China, the world's biggest oil importer, and India's manufacturing sector are both highly sensitive to rising oil prices. In June, I did not make any changes to the Long Only Sector Rotation portfolio. As I had hoped, the momentum and growth stocks in our portfolio (3-D printing and Internet stocks) recovered to a large extent. As the geopolitical tensions in Iraq and Ukraine continue, the commodity stocks in our portfolio (oil, gold and silver) recorded gains. DISCLAIMER: The investments discussed are held in client accounts as of June 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
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