Outlook 2011

Describing the current (December 2010) U.S. market as a “world of slack demand and excess productive capacity,” Chris Beck continues to position his portfolios to attempt to take advantage of current conditions as well as four macroeconomic themes he believes could benefit small- and mid-cap stocks in 2011. These themes include:

• accommodative Fed policy
• a subpar economic recovery characterized by unusually lackluster consumer spending, with a focus on a continuation of a below-average recovery in housing
• healthy corporate balance sheets
• a revival in mergers-and-acquisitions activity

Joe Baxter notes that “the municipal market seemingly limps into 2011 after several difficult months.” Yet he believes that many of the problems the muni market experienced in late 2010 were due to changes in supply/demand forecasts, and not because of a fundamental weakness among issuers.

He cautions that 2011, however, could remain volatile for municipal investors. Within such an environment, he identifies several themes to mitigate potential volatility within the market. These themes include:

• emphasizing premium bonds with relatively short call dates
• continuing to rely heavily on rigorous credit analysis to choose higher yielding bonds that could offer good value
• maintaining a disciplined, long-term perspective amid volatile conditions

Though many high-profile macroeconomic risks exist, the Delaware Investments Fixed Income team retains a generally optimistic outlook on the fixed income markets for 2011. The team believes that opportunities within the following markets may arise in 2011:

• high yield
• bank loan
• investment grade bond markets

It is important to note, however, that while members of the team see room for possible growth within each of these areas, they do not expect to see performance within the investment grade or high yield bond markets that matches that of 2010.

Liu-Er Chen and his team describe several beneficial trends in the global economy that they believe could continue to aid emerging market equities in 2011. These trends include:

• greater economic stability
• lower risk
• access to, and comfort, with leverage

Because emerging market equities have been the beneficiaries of considerable global liquidity, Chen expects this trend may continue in 2011 as growth in emerging markets remains stronger than that of many developed markets.

Ned Gray notes that, while developed markets may not return to their growth trajectories of past decades, many stocks across international markets may appear more vulnerable than he believes they truly are.

Gray also shares the team's key criteria for seeking stocks, including:

• the existence of sustainable barriers to entry
• geographic diversification
• resilience provided by strong internal cash generation and balance sheet positions

Bob Zenouzi shares his belief that economic growth in 2011 may be lower than is typical for the recovery phase of an economic cycle. Nonetheless, his 2011 outlook is generally positive due to his belief that:

• corporate earnings could continue trending positively
• China's economic engine should remain resilient
• deal volume could likely trend upward in 2011

At the same time, the extent of central bank actions around the world gives reason to pause. Overall, investors should have to interpret a variety of policy moves, keeping in mind the political pressure that sometimes drives these decisions.

The team that manages infrastructure securities at Delaware Investments looks to 2011 with confidence. The team bases its optimism on three themes:

• the relatively healthy fiscal positions of many emerging market countries
• the potential continuation of stimulative policies by many central banks
• a potential for ongoing merger-and-acquisition activity within the infrastructure asset class

The team, however, notes several risks that could derail the performance of infrastructure equities in the new year, such as a rise in real rates or soft demand in certain markets.

Despite the likelihood of sustained macroeconomic uncertainty, Francis X. Morris continues to believe the U.S. economy is on the road to recovery. He cites three factors to support his optimistic view on the markets, including:

• an upward trend in corporate profits
• credit markets that remain in relatively good shape
• accommodative monetary policy

Morris' optimism is tempered by factors that include commodity prices and high unemployment figures.

Jeff Van Harte of the Delaware Investments Focus Growth Equity team identifies several growth trends in sectors of the global economy that he believes could drive stock prices in 2011. He shares his belief that the team's "research advantage" and long-term investment horizon are positive attributes.

The team looks ahead to 2011 as they consider a few interesting factors:

• fiscal and monetary policy potentially having limited effects
• finding secular growth stories in the global economy, regardless of the economic cycle
• attempting to gain a "research advantage" by identifying opportunities that are not recognized by competitors

Anticipating a "more subdued earnings environment with the potential for ongoing volatility of returns" in 2011, Ty Nutt discusses his team's focus on several key portfolio themes, including: quality, cheap valuations, and a focus on downside risk. He also discusses attributes of stocks he believes may have a good chance of outperforming the broader market, including:

• market leadership
• balance sheet strength
• earnings stability
• above-average size

Nigel May of Mondrian Investment Partners Limited, the nondiscretionary subadvisor to Delaware Investments International Equity ADR managed account portfolios, breaks down 2010 international-equity market performance by market cap and dividend yield, drawing some compelling inferences:

• some investors may be extrapolating current high economic growth rates
• quantitative easing and low interest rates may have depressed investor discount rates and favored growth stocks in 2010
• many stable, high-yielding companies with strong balance sheets appear to have been overlooked

May expresses confidence that Mondrian's managed account international equity portfolios appear to be well positioned for the year ahead, as the management team continues to employ a time-tested style in which dividend yield and future real growth play a central role, and which has historically produced less volatile performance than the MSCI EAFE Index over time. Of course, past performance is no guarantee of future results.