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Broadgate: Weekly Briefing 19/8

19 August 2013

Productivity in U.S. Rises Above Forecast as Output Grows – The productivity of U.S. workers rose more than projected in the second quarter as the world’s largest economy expanded.The measure of employee output per hour increased at a 0.9% annualised rate, after a 1.7% decline in the prior three months, a Labor Department report showed today in Washington. Expenses per worker rose at a 1.4% rate, greater than estimated.

Even with the second-quarter pickup, productivity was unchanged in the 12 months ended in June, below the average 2.4% annual gain in the 2000-2011 period, the report showed. Businesses are reaching the limit of how much efficiency they can squeeze from their existing staff, a sign they may take on more workers once they see faster sales.

“Productivity is growing at an extremely slow pace,” said Guy Berger, an economist at RBS Securities Inc. in Stamford, Connecticut, who projected a 0.8% increase. “We’re in an environment where businesses are finding it very difficult to eke out more from the labour they employ. We could see more hiring, but the bad news is, if you’re a worker, you’re seeing your pay cheque barely go up.”

Hong Kong Raises 2013 Growth Outlook on Second Quarter Spurt – Hong Kong’s economy expanded more than estimated in the second quarter on consumer spending and investment, prompting the government to raise its forecast for the full-year expansion. Gross domestic product rose 0.8% in the April-June period from the previous three months after a 0.2% gain in the first quarter, the government said on Friday.

A strengthening economy may aid Hong Kong Chief Executive Leung Chun-ying, whose popularity dropped in July to the lowest since he took office amid allegations of wrongdoing by members of his administration and calls for electoral reform. The government said that growth this year will be between 2.5% and 3.5%, after in May estimating a gain of between 1.5% in 3.5%.

“The risk is still pretty much the external environment and that includes the Chinese economy, because Hong Kong depends on them in terms of exports of goods and services,” Frances Cheung, a senior strategist at Credit Agricole CIB in Hong Kong, said before the release. “Hong Kong will do better because we’re looking for a continued recovery in the U.S. economy and the bottoming out in the Chinese economy.”

The economy expanded 3.3% from a year earlier in the second quarter, the government said, from a revised 2.9% pace in the first three months.

Indian Rupee falls to Record Low Against US Dollar – The Indian rupee has hit a record low against the dollar despite recent efforts to prop-up the currency. On Wednesday India’s central bank put further restrictions on the amount of money that companies and individuals can send out of the country. That had little impact and the rupee fell to 62.03 to the dollar, below its previous low of 61.80 hit on 6 August.

Overseas investors have been pulling money out of Indian shares and debt on concerns over the economy. According to official data, international investors have withdrawn USD 11.58bn in shares and debt from India’s markets since the beginning of June. India’s economy had been growing at a fast clip, reaching annual growth of 9%. In recent months, it has seen a sharp decline largely because of a slowdown in its manufacturing and services sectors. “There is a complete lack of faith in the markets. There are fears that the RBI (Reserve Bank of India) measures may not help improve the rupee,” said Param Sarma, chief executive with NSP Forex.

Indian authorities are concerned that the weak rupee is stoking inflation. The nation relies on imports of crude oil, chemicals and some foodstuffs, which are priced in dollars. The weak rupee makes those more expensive, a cost that is eventually handed on to the consumer. In July, India’s main gauge of inflation, the Wholesale Price Index, was 5.79% higher than a year earlier, up from 4.86% in June.

Spotlight On: What’s Next in 2013 – Question and Answer Session with BlackRock

Question. When will central banks begin changing policy and what impact will that have?

Answer from BlackRock. Policy dominates markets – that’s likely to be a key theme for the rest of this year and beyond. Central bankers have expended too much capital – of the monetary, intellectual and reputational kind – to reverse their stimulus policies prematurely and risk a stillborn economic recovery. But monetary policy is starting to diverge.

With tapering of asset purchases in the US expected to start as soon as this year, many market participants anticipate that the world’s largest economy will become the first in the developed world to put up interest rates.

By contrast, Europe remains in a more difficult position that will likely warrant further accommodative monetary policy. Unemployment is at a record 12.2% in the eurozone as governments implement austerity measures, consumer spending remains constrained and credit contracts given banks continue to delever. The Bank of England is also likely to remain accommodative via its own open market purchase programme, having characterised the UK’s recovery as being weak by historical standards. In Asia, the Bank of Japan is seeking to create growth, and has embarked upon an aggressive monetary policy campaign of quantitative easing that is three times the size of open market purchases in the US.

So what does all of this mean for investors? We would continue to advocate underweight positions in core government bonds. Volatility is up, and we believe it will remain elevated. Even with the recent increase in real interest rates, we still believe Treasuries are overvalued and expect that yields are likely to rise over the long term.

Question. What is the state of the global economy? Are risks from Europe receding?

Answer from BlackRock. Global economic growth is still stuck in a low gear, with little sign of an acceleration ahead. Indeed, in the second quarter, many areas of the world appeared to be decelerating further – particularly many emerging markets. There is less risk of a widespread global recession than there was a year ago, but overall global growth is still hovering around a relatively slow 3.3% to 3.5%. One surprising bright spot has been Japan. Following decades of economic stagnation, the country’s economy grew at an astounding rate of 4.1% in the first quarter. Japan’s new economic policies and increasing confidence is feeding through to the underlying economy.

The near-term threat of an outright Eurozone breakup has definitely receded. Although the economic data is mixed there are some signs of improvement in the underlying economic fundamentals. Certainly the economic data is stabilizing albeit at low level. Overall the region’s banking system is fragile and undercapitalised and remains a source of potential market gyrations. Tail risks such as austerity measure in Greece, or the banking systems in Cyprus remain, but these risks are generally short lived in the global capital markets given the perceived support provided by the European central Bank (EcB) to economies/financial systems at risk. Real European wide reform will require more resolute political will than we’ve seen so far, but we don’t expect much progress ahead of German elections in September.

Question. Where are the best opportunities in stocks for the next six months and beyond?

Answer from BlackRock. Generally speaking, we prefer equities over bonds but investors must brace for more volatility. Most equity valuations look reasonable – with notable exceptions in Southeast Asia and Mexico. In the US, stocks are not as cheap as last year, but we would suggest a focus on cyclical sectors of the market (but not those that are overly exposed to the US consumer), like the energy and technology sectors which both look inexpensive.

Outside of the US, we are seeing some good values in international stocks. While we would back away from yield plays in the US, dividend stocks look cheaper elsewhere. They still trade at discount to broader equities, and still offer higher yields. The UK and Europe dividend equity markets remain attractive given the recent uptick in economic data and outcome statements from the EcB and BoE indicating that interest rates may remain at low level for the foreseeable future. In addition, the uncertainty about growth and the level and direction of interest rates and inflation make minimum volatility equity wrappers another potential option for investors.

Elsewhere, emerging markets have underperformed so far this year and are trading at a significant discount compared to developed markets. We believe valuations have reached depressed levels and this may present some attractive entry points. In particular, we are seeing good long-term value in parts of Asia and Latin America.

At the sector level, many defensive stocks are at their peaks of profitability and valuation – and have outperformed their more economically sensitive counterparts. But valuations of consumer brands and other defensives now look stretched. For example, our research shows that US defensives (minus healthcare) are in the top valuation decile of the past 35 years on a price/earnings basis. As a result, these stocks may not provide the downside protection investors have come to expect.

Question. Will emerging markets’ underperformance continue?

Answer from BlackRock. In the short term, we would not be surprised to see additional performance challenges for emerging markets (EM). Slowing growth, concerns over the Chinese banking system and a general preference among investors for US stocks have been hurting performance and these trends are not going away any time soon. In addition, a less accommodative monetary regime and a stronger dollar will represent headwinds for many EM countries. Finally, anaemic growth in most of the developed world will hinder their exporters. All of this leads us to believe that anomalies and relative value opportunities are likely to emerge. Differences between emerging markets are growing – and investors need to become more discerning.

Over the longer term – say, three to five years – however, we believe EM stocks represent good value, given that they are trading at more than a 30% discount to their developed counterparts, the largest gap since the crisis of 2008. Although the stellar economic growth we saw in China/India in 2010 is not likely to be repeated, EM growth as a whole should continue to outpace that of developed markets. In addition, while EMs face numerous headwinds, by many measures these countries are more stable than many of their developed peers, with lower sovereign debt, significant currency reserves and (with some notable exceptions) relatively stable current account balances. Together, stronger macroeconomic conditions and attractive valuations make for a compelling long-term argument for EM equities.

Question. What of the gold price?

Answer from BlackRock. We believe that investors should still hold gold as a long-term, strategic part of their portfolios. However, we expect gold prices to remain volatile, and anticipate a general downward bias in the price. Sentiment has clearly changed in the gold market and investors my consider reducing holdings in this asset class. Gold prices are facing the headwind of rising real interest rates (adjusted for inflation) for the first time in years. Many investors focus on inflation and the US dollar when thinking about gold prices, but real interest rates actually tend to have a more significant effect. All else being equal, higher real interest rates should create a less supportive environment for gold.

BWB

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.

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