Global events over the past few weeks remind us how quickly the unexpected can lead to rising uncertainty and turbulence in financial markets.

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The devastating earthquake, tsunami and nuclear crisis in Japan and a chain reaction of unrest in the Middle East and North Africa ... plus rising inflation in emerging markets ... and unresolved sovereign debt issues in Europe ... all proved too much for markets to handle last week.

The result, not surprisingly, was a sharp uptick in volatility and a sell-off in stocks, partially offset by an end-of-week rebound. So where do we go from here?

First, our investment outlook at Banyan Partners remains unchanged. In fact, we see new opportunities coming from this latest bout of market volatility.

Of course we continue to closely monitor ongoing events, but based on what we have seen so far, we don’t expect a downshift in global economic expansion at this point. And most importantly, our research continues to indicate that the recent pullback in markets is nothing more than an ordinary correction.

Undervalued Equities Get Even Cheaper

Most of last week’s headlines were devoted to Japan, and with good reason. Living and working in Hurricane Alley here in South Florida, we have firsthand experience coping with the aftermath of natural disasters. But in this case, the scale of devastation is orders of magnitude beyond anything we can imagine and our thoughts and prayers go out to the people of Japan.

The Japanese economy will certainly experience an abrupt slowdown in the short term, but longer term we should see accelerating growth due to rebuilding efforts. Economic damage could be $300 billion or more according to estimates, or roughly 5 percent of Japan’s economy as measured by GDP. But the impact should prove temporary.¹

Japanese stocks, however, slumped out of proportion to the actual economic hit. The Nikkei 225 Index declined more than 20 percent at last week’s lows before rebounding somewhat.²

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Stocks in Japan were among the world’s most undervalued to begin with, but now Japan looks even more attractive, in our view. Once the reconstruction boom gets into full swing, the economy should get back on track. Japan has struggled with persistent deflation for the last two decades, so the boost from rebuilding may actually create some welcomed inflation in this slow-growth economy.

In our view, the bigger issue for global markets is likely to be ongoing political unrest in the Middle East and North Africa. The escalating conflict in Libya is most visible, but turmoil has also cropped up in Bahrain and Syria.

More flare-ups could result in continued market volatility. However, the global economy has enjoyed strong upside momentum in recent months, and at this point, we expect fundamental improvement to continue.

Meanwhile, ongoing unrest in the Middle East continues to drive crude oil prices higher... keeping the issue of rising global inflation in sharp focus for investors.

Crude Oil Contagion?

Oil inventories fell 5.1 million barrels last week as strong global demand continued to outpace supplies by a ratio of 4-to-1. Overall, crude oil stocks have declined 38 million barrels over the past five weeks alone.³

Nymex crude oil futures jumped nearly 2 percent higher yesterday to close near $105 per barrel. The spot price for Brent crude, the European benchmark, is already above $115 a barrel and rising.⁴

According to BCA Research, a spike in oil prices toward the $120 to $130 range could be cause for investor concern.⁵

The month-to-month change in the US Consumer Price Index has accelerated at a rapid rate in recent months due to rising food and fuel costs. Conveniently, most economists exclude food and energy from their inflation calculations, preferring to focus instead on the “core” rate.

That’s ok when we’re talking about temporary price spikes. But this hasn’t been the case recently.

We’re seeing a more sustained rise in these prices (See graph) and consumers are beginning to feel the pinch.

Producer prices paid by businesses are on the rise too, as wholesale food costs rose 4 percent last month — the largest increase since 1974. Investors will recall that crude oil prices also surged higher back then due to unrest in the Middle East, leading to an ongoing struggle with inflation.⁶

Investing for Inflation: Consider Bond Surrogates

Last week’s market turbulence triggered a rise in US Treasury bond prices while yields fell as money flowed into “safe haven” investments. That’s a classic knee-jerk response to unexpected global events, but how long will bond buying persist?

It’s our opinion that if you can be certain of anything in today’s turbulent markets, it’s that interest rates are eventually going to move higher from today’s low levels. It is only a question of timing.

One of the biggest catalysts for higher interest rates would be an unexpected acceleration of inflation — and surging global food and energy costs are certainly driving this trend today. Since money has been pouring into fixed income mutual funds over the past few years, many investors may be ill prepared for an unexpected rise of interest rates driven by inflation.

If you’re an income-oriented investor with a moderate risk tolerance, this may be the right time to take a closer look at your fixed income portfolio and consider alternatives to traditional long-term bonds, including bond surrogate securities.

Many of the income-producing alternatives we favor at Banyan Partners offer our clients the potential for ... higher current income ... long-term capital gains ... and rising yields over time, unlike the fixed coupons of traditional bonds.

To learn more about how to help protect your wealth from the threat of higher interest rates and inflation, we’ve just published: The Banyan Guide to Bond Surrogates. In this special report, we provide you with more details about some of the income-producing strategies we’re using in today’s uncertain markets. And you can get a free copy of this report now by going here.

Good investing,

Mike Burnick
Director of Client Communications
Banyan Partners, LLC

P.S. Investing for income can be challenging today with bond yields near record lows. There are alternatives to consider and there’s never been a better time to learn more about bond surrogates. Go here now for all the details.

¹ Bloomberg: Japan Sees Quake Damage Bill of Up to $309 Billion, 3/23/11
² Bloomberg market data, 3/22/11
³ US Global Investors: Weekly Investor Alert, 3/18/11
⁴ Bloomberg market data, 3/22/11
⁵ BCA Research: Global Investment Strategy, 3/18/11
⁶ US Global Investors: Weekly Investor Alert, 3/18/11