Broadgate: Weekly Briefing 17/12
17 December 2012
China – China’s economic growth rate may be gathering pace again, as the government released strong industrial output and retail sales figures.
Industrial production rose by 10.1% in November, compared with a year earlier, according to the official data from the National Bureau of Statistics. This was better than expected, and the strongest performance since March.
At the same time, China’s retail sales increased by 14.9%. This was also the best showing for eight months.
“The Chinese economy is in the sweet spot now with rebounding GDP growth, rebounding earning growth and low inflation,” said Lu Ting, China economist at Bank of America Merrill Lynch.
U.S. – Christine Lagarde has urged U.S. leaders to reach a deal to avoid the “fiscal cliff”, warning that the uncertainty is damaging the global economy.
The head of the International Monetary Fund said that the U.S. had a duty “to try to remove uncertainty and doubt as quickly as possible”.
The fiscal cliff refers to U.S. tax rises and spending cuts set to automatically come into force in January.
She added: “The U.S. is about 20% of the global economy. If the U.S. suffers as a result of the fiscal cliff, a complete wiping out of its growth, it is going to have repercussions around the world. If the U.S. economy has 2% less growth there will be 1% less growth in Mexico and China… there will be ripple effects outside of the U.S.”
U.S. – Meanwhile, the U.S. Federal Reserve has said it plans to keep interest rates at close to zero at least until the U.S. unemployment rate falls below 6.5%.
The Fed previously had a date-driven target, rather than a data-driven one.
The Fed also said it will continue to buy $85bn a month of government bonds and mortgage-backed securities to try to boost the economy.
But changes in the way it does this will mean more money is pumped into the economy.
“The committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions,” the Fed said in a statement.
Emerging Markets – Emerging-market stocks rose for a seventh day on Thursday, led by technology companies, and currencies strengthened after the U.S. Federal Reserve expanded its bond- buying program and the outlook for display makers improved.
“There is optimism that a global economic recovery will boost consumer demand and that is driving technology stocks higher,” Gopal Agrawal, chief investment officer at Mirae Asset Global Investments (India) Pvt. in Mumbai, said. “Emerging-market equities have run up quite a bit now and investors will keenly watch the U.S. fiscal-cliff negotiations and corporate performance in the upcoming earnings season for more cues.”
The MSCI Emerging Markets Index has advanced 14% this year, compared with a 13% increase in the MSCI World Index.
Europe – The European Union reached a landmark deal on Thursday to make the European Central Bank the bloc’s top banking supervisor, giving E.U. leaders greater confidence that they are gaining the upper hand over the euro zone’s debt crisis.
E.U. finance ministers forged a deal on the single supervisor in the early hours of Thursday after lengthy talks. Leaders will give their stamp of approval at a summit starting later in the day, their last of 2012, and also discuss closer fiscal ties for their troubled currency area.
After a year of crisis management, during which Greece had a close brush with the euro zone exit, getting an agreement on the first stage of a banking union is a victory for the E.U. and represents a bold step towards pooling sovereignty.
Japan – Revised growth figures for Japan have suggested that the world’s third-largest economy is in recession.
The economy shrank by 0.9% in the July-September quarter, while the April-June quarter was revised from 0.1% growth to show a contraction of 0.03%.
That means that Japan is technically in recession, having contracted for two quarters in a row.
Spotlight on: Equity outlook in to 2013
Dominic Rossi, chief investment officer of equities at Fidelity, presents the case for and against a strong run for the asset class next year, and highlights the sectors and regions he expects to shine.
Next year will be another challenging and event-driven one for equity investors to negotiate. Markets face a number of risks with binary outcomes, not least the imminent fiscal cliff facing the U.S. economy.
While the prospects for earnings growth in most developed equity markets are now more modest, a positive case can be made for a re-rating of equities, yet this is dependent on progress being made against some powerful headwinds.
The positive case for equities rests on three supportive factors:
· Equity valuations are reasonable relative to history, with price/earnings (PE) ratios of around 13 to 14 times trailing 12-month earnings. While this is not extremely low, the relative attractions of equities are enhanced when valuations are compared with sovereign and investment grade bonds.
· We have seen sustained outflows from equities in the last few years, so much so that institutional levels of equity ownership are now at 30-year lows. Equities are an unloved asset class and there is growing scope for a reversal of this trend.
· Volatility has subsided. I have always believed a reduction in volatility is a prerequisite to any re-rating in equities. Encouragingly, the VIX (a broad index measure of market volatility) has fallen back to around 15%, having remained below 20% since July.
While these factors make a re-rating possible, there are some considerable hurdles to be overcome that could prevent it. In my view, there are three key risks facing equity markets in 2013:
· Lack of a resolution to the U.S. fiscal cliff would throw the U.S. and global economies into recession. The likelihood of going over the cliff, and detracting around 4% from GDP, is being underestimated given the ideological divide in Congress.
· The economic, sovereign and banking crisis in Europe remains unresolved despite central bank promises having had a favourable impact. With politics in peripheral countries becoming radicalised, there is the potential for more flare-ups. Unfavourable debt dynamics and poor economic fundamentals suggest further deterioration is likely.
· Geopolitics, particularly in the Middle East, could pose a significant and unpredictable risk in 2013, this being the year that the confrontation between Israel and Iran over nuclear facilities is likely to come to a head.
So what can investors do? With government bonds failing to provide a store of value after inflation, investors will continue to search for yield, particularly in short-duration assets.
In this respect, equity income remains an attractive story given the dividend yields available on equities compared with government bonds.
In Europe, investors can expect yields of around 3% to 4%, except in financials where many dividends have been scrapped.
Balance sheets are healthy, cash-flow is solid and payout ratios are low with scope to grow. I think we will see earnings and dividend growth of 4% to 5% in 2013, particularly at large high-quality companies.
So, if you combine 3% to 4% dividends and estimated growth of 4% to 5%, we can generate attractive total returns of 7% to 8%, which should support further flows into equity income funds.
In terms of sectors, I expect the leadership we have seen over the last year to continue. Quality will remain a powerful theme and stocks with high returns on invested capital will continue to attract a premium.
I think selected healthcare, technology and consumer stocks remain attractive. There are high-quality stocks available with strong franchises benefiting from structural tailwinds; many of these are also returning cash to shareholders, such as Nestlé, Unilever, and Sanofi.
With these strong multinational companies, investors can be fairly confident that they will get their money back and in the meantime, they receive a higher income than they would from investing in sovereign bonds. Some pharmaceutical companies are on single-digit PE ratios despite having among the highest returns on capital.
Among technology companies too, there is good scope for dividend growth: some of the large technology stocks have matured into stable, lower-growth businesses that offer attractive total returns.
While the estimated 3.5% yield on Microsoft may seem a little low, this is covered about four times by cash. This means that it has the potential to grow dividends in the future significantly ahead of earnings.
The Chinese economy is well placed to have a rebound in 2013; inflation has been brought under control and the leadership transition is now out of the way, suggesting policy can be accommodative. Investors appear to have discounted economic growth rates in the 6% to 8% range and the market should perform relatively better now that these headwinds have passed.
In developed markets, the U.S. looks attractive if the fiscal cliff can be successfully navigated. The housing market is recovering, which is a key bellwether for the broader economy, and consumer confidence is also picking up.
In energy, the U.S. could become the largest producer of both gas and oil thanks to the exploitation of its shale reserves. But it is the broader effect of cheap energy costs on the economy that is particularly supportive; this will give the U.S. a competitive advantage among advanced economies and play a central role in the renaissance of U.S. manufacturing.
The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.
Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.