Global Economic Outlook

The resurgence in US economic growth, following the first-quarter slowdown, and continued strong global growth abroad (with the exception of Japan) has driven handsome returns in the global equity markets, as seen below.

The US bond market experienced a more difficult quarter, as seen by the representative indices below.

Several themes that were important in the first half of 2007 will become even more important in the second half. First, broad expectations for resilience in the US economy have led the market to push back expectations for a Federal Reserve (Fed) rate cut in 2007. Despite its gloomy outlook, the US housing correction will not cripple the broader economy. It will, however, limit acceleration for growth in the second half of the year. Second, investors will be on the watch for signs of further fallout from subprime lending. News that two Bear Stearns hedge funds that had invested heavily in these mortgages were nearing collapse reminded markets about the fundamental meaning of risk. In the second half of 2007, there could be more equity risk aversion, which could prop up demand for high quality large cap stocks, a significant asset class in all of Oakwood’s managed portfolios; and also prop up demand for bonds, keeping the yield curve positively sloped.

The outlook for economic growth in Europe, long the laggard of major economic powers, is running at the highest level in years. Despite the prospect of higher interest rates, high oil prices and the euro’s current strength, we note that confidence in the European economy was the strongest in six years, according to a May 2007 European Commission survey.

The Chinese economy continues to surge ahead, and there has been little slowing in the pace of credit growth, thanks in large part to the still-undervalued currency. The valuation of the Chinese yuan remains a key issue in global financial markets. The US Treasury’s semi-annual report on currencies failed to identify China as a currency manipulator. Instead, the Treasury noted that the yuan remains “undervalued and market sentiment clearly favors appreciation.” China may turn out to be one of the larger markets in our diversified emerging markets strategies. As of March 2007, it was the third-largest country in the MSCI Emerging Markets Index, after South Korea and Taiwan.

Through the first five months of 2007, the US dollar’s correction has accelerated in pace. While on a trade-weighted basis the greenback has only dropped 1%, its adjustment against the major currencies has been much more obvious. The combination of shifting interest-rate differentials, imbalances in global current accounts, volatility in commodity prices, and potential corrections in global markets such as China will influence currency trends.

Gasoline stockpiles remain well below their average levels for this time of year and refinery utilization is weaker than it should be. Moreover, gasoline demand is holding steady despite elevated gasoline prices. With these factors in mind, the oil bull story is still intact and we feel oil will continue to trade above $70 in the near term.