Waddell & Reed

Portfolio Perspectives

Maintain long-term view despite recent dramatic market moves

Fred Sturm
Portfolio Manager
Ivy Global Natural Resources


Ivy Global Natural Resources Fund - August 2011

Despite the dramatic market moves of the past two weeks, we still expect global economic growth to return — tepid, for sure, but growth nonetheless. We expect margins and corporate earnings to prove more robust than the stock market apparently now believes, based on the recent market action. If we are correct, then markets have the potential to recover smartly after the shake-out.
Macroeconomic concerns remain
We believe the euro structure is poorly equipped to deal with the contrast of a solid core in Northern Europe – principally Germany, Europe’s largest economy – and a challenged group of periphery countries including Greece, Ireland, Portugal, Italy and Spain. We expect the European Central Bank (ECB) will step up its direct market intervention efforts of buying the sovereign debt of these countries, as it has recently. This intervention was a positive move, but the market is likely to test the ECB’s resolve. Its resolve must hold or some banks in Europe could be at risk, and we already have begun to see some pressure on selected European bank stocks.
The U.S. appears to be stuck in political wrangling rather than engaged in implementing solutions to its debt and budget issues. The lack of a long-term policy decision on these matters prompted Standard & Poor’s to downgrade U.S. Treasury debt on August 5 to AA+ from AAA with a further negative watch. The other major ratings agencies, Moody’s Investors Service and Fitch, have maintained their ratings at this time. Under normal circumstances, downgrades of a country’s debt lead to a higher cost of capital – for example, higher bond yields and a weaker currency. But we think a flight to safety, given current market and economic headlines, may well provide an offsetting prop to the U.S. dollar and help keep yields low. The U.S. Federal Reserve made it clear in its policy statement on August 9, that interest rates will stay low for an extended period of time.
Emerging-market countries have been tightening policy to combat inflation. Emerging markets stocks have been stuck between superior growth, relative to developed markets, and more hostile monetary policy. We expect these emerging markets to re-establish leadership once inflation has clearly peaked and investors begin to anticipate easier monetary policy. We expect inflation will peak in the third quarter and we may have easing measures by the fourth quarter. An announcement that we think really would generate excitement would be easier monetary policy intentions in China. However, we think China may hold off a little longer because it wants to wrestle commodity prices lower first.
A long-term view
We have made few changes to the portfolio of the Ivy Global Natural Resources Fund, but given the rapid price decrease of equities, we are looking to increase exposure at some point in the next several weeks. In the years prior to natural resources gaining widespread interest, higher quality companies with more visible prospects tended to fare better during stock market declines. However, now “swing traders” that also hold the stocks of these companies can apply additional pressure. This means we anticipate an opportunity to further concentrate in preferred sectors and companies, but we may need to wait for this selling to move through the system.
We maintain our bullish view on gold. While the stocks of companies in this sector have performed better than other sectors, they have not kept pace with the price rise of the metal itself. Coal stocks have been poor performers because they have had some delivery and cost pressure misses. However, we think electricity growth in emerging markets will be an enduring theme during the next three to three to five years. We still like this group despite the recent market pummelling. We also continue to favor energy service companies. Oil prices may be pushed lower by liquidation, but we do not expect low prices to last long enough to materially impact energy exploration and development expenditures.
Broader investment implications
Going forward, earnings estimates probably will need to be trimmed. Investor uncertainty can overshoot on the downside, compressing valuations further, but many stocks have fallen significantly to levels that we think offer stronger valuation support. Global forward price/ earnings ratios range from 9 to 14 times, with the average roughly 11 times. Even after allowing for a reduction in earnings expectations, we think this still leaves equities moderately undervalued relative to historic comparisons and very attractive relative to fixed income alternatives when using a multi-year view.
When we look at stocks, we favor financially strong market leaders – weaker companies are more exposed during challenging periods. We also prefer companies with what we consider attractive dividend yields. More than 150 U.S. companies have yields beyond government bonds, with at least a chance for dividend growth.
We think the macro issues around the globe should lead to sustained easing in monetary policy, and that easing should be supportive for limited-supply assets such as gold. Given additional social and budget stresses for oil-producing nations, we believe a higher oil price will be needed going forward, relative to past years. We would put that price at roughly $80 (U.S.) per barrel, and consider a price less than that to be unsustainable. Investors in oil may put pressure on prices as they liquidate, but Saudi Arabia is the only effective source of spare oil. The Saudi government may allow prices to drift temporarily, but it has the means to defend prices if it wishes.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 10, 2011, and are subject to change due to market conditions or other factors.
Risk Factors: Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in natural resources can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments; and the cost assumed by natural resource companies in complying with environmental and safety regulations. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the prospectus. Not all funds or fund classes may be offered at all broker/dealers.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. for a prospectus, or if available a summary prospectus, containing this and other information for the Ivy Funds, call your financial advisor or visit us online at www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.

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