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Broadgate: Weekly Briefing 2/11

2 November 2012

U.S. – The U.S. economy grew by 2% during the third quarter, the U.S. Bureau of Economic Analysis has revealed in its first estimate.

The growth in the economy was an improvement on the 1.3% GDP growth reported during the second quarter of the year.

According to the Bureau of Economic Analysis, the economy benefited from positive contribution from personal consumption expenditure (PCE), federal government spending and residential fixed investment.

Capital Economics chief U.S. economist Paul Ashworth says: “With less than two weeks to go before the election, the conspiracy theorists will be up in arms about the reported 9.6% surge in Federal spending, which contributed as much as 0.7% to overall GDP growth.

U.S. – In addition to the unfortunate growing number of human lives claimed, the economic toll on the U.S. of Hurricane Sandy is still uncertain. Figures supplied to Citywire Global by Wells Fargo estimate that damage following the storm is likely to exceed $30bn, with only around $10-20bn of this figure likely to be insured.

The actual economic activity through closer of businesses and Wall Street could amount to a further $50bn in loss.

Brazil – Brazil is to grant a tax exemption to foreigners who buy mortgage-backed securities or invest in funds that purchase them, after sales of new debt supported by real estate loans fell almost 50% this year.

The tax break only applies if proceeds of the debt are used on “investment projects” and the bonds have an average maturity of at least four years, Pablo Fonseca Pereira dos Santos, deputy secretary of economic policy at the Ministry of Finance, said in an interview from Brazil.

The tax incentives are designed to develop local debt markets and help raise about 1tn reais ($493bn) for roads, factories and airports. Local long-term funding is provided mainly by the nation’s development bank, known as BNDES. The government is seeking to develop the real estate and construction industries to boost employment as economic growth slows.

India – India’s central bank has kept interest rates unchanged, despite signs that the country’s economy is being hit by a global slowdown. However, in an effort to boost lending, it cut the amount of money that banks need to keep in reserve.

It said cutting the cash reserve ratio to 4.25% from 4.5% would inject 175bn rupees ($3.2bn) into the market.

Critics have called for more stimulus measures, and the Indian rupee and stocks fell on the news on Tuesday.

“There was definitely lot of expectations in the markets for a rate cut, but people will have to wait for some more time,” said Srividhya Rajesh, fund manager at Sundaram Mutual Fund.

South Korea – South Korean exports have risen for the first time in four months, raising hope that the economy could be starting to recover. Overseas shipments rose 1.2% in October from a year earlier, the Ministry of Knowledge Economy said on Thursday.

South Korea, an export-led economy, has seen global demand for its cars, electronics and ships slump in recent months. Analysts, however, were cautious that the numbers heralded a recovery while the global economy was still struggling.

“Until the U.S. overcomes the risk of a possible fiscal cliff [higher taxes coupled with spending cuts] and China decides to partake in more easing policy, trade will tread water,” said Park Hyung-jung from Meritz Securities.

Commentary – Bill Gross, who runs the world’s largest mutual fund (a link to which is available via CO3 in both Hansard International & Hansard Europe) at Pacific Investment Management Co., said there is no evidence that investment is being spurred by the Federal Reserve’s quantitative easing program.

“All of the money being created and freed up is elevating asset prices, but those prices are not causing corporations to invest in future production,” Gross wrote in a monthly investment outlook. Furthermore, lower interest rates are being used “to consume as opposed to invest,” he said.

Commodities – Slumping energy and metal prices sent commodities to their biggest monthly loss since May, lagging behind stocks, bonds and the dollar, as the global economy grew at the slowest pace since the 2009 recession.

The Standard & Poor’s GSCI Total Return Index (MXAP) of 24 raw materials fell 4.1%, erasing gains for the year. The MSCI All-Country World Index of stocks slid 0.6%, including dividends, while the U.S. Dollar Index slid 0.02%. Bonds of all types gave positive returns, according to Bank of America Merrill Lynch’s Global Broad Market Index.

Investor optimism dimmed as the International Monetary Fund cut its global growth forecast and the Federal Reserve said strains on the world economy present “significant downside risks.” China reported the seventh straight quarter of slowing growth, while services and manufacturing in the 17-nation euro area last month contracted more than economists forecast.

Spotlight on: Why investors cannot ignore political risk

Investors who base asset choices simply on economic data could be making faulty decisions over the balance of risk and reward, according to one fund group, which views the global political outlook as increasingly unstable. Potential sources of risk include regime changes and even, some fear, a major war.

Economic data is too shallow of an analysis of market trends and geographic risk/rewards, according to Hermes Fund Managers (a U.K. fund manager with GBP24.8bn of assets under management). Today’s world is heavily influenced by the political stage – in both developed and emerging nations – and understanding the implications of political actions, is key to assessing value in asset classes and markets, the group asserts.

In a paper published this autumn, Hermes chief executive officer and head of investment, Saker Nusseibeh, notes it has been at least two generations since investors actively looked at the problem of political risk in the context of developed markets.”They need to start.”

“Today, growing unrest brought on by anger over austerity, worries about resource scarcity and threats of increased taxation has refocused attention on national problems as opposed to international concerns. In such an environment politics can have as much impact on the attractiveness of different markets as GDP figures,”he says.

Keith Wade, chief economist at Schroders, says the long period of political stability in the West has perhaps made investors complacent as to the risks it can pose and that the situation today is merely a return to normality.

Nusseibeh says it is, noting that in the history of developed markets political risk was once quite prevalent but faded as an investment consideration post World War II. He and Wade agree the presence of the Cold War played a part in creating such stability as it polarized developed nations and allowed them to focus their attention on common threats. Since its end and the subsequent onset of the global financial crisis, more nationalistic interests have arisen.

Andrew Parry, Hermes Sourcecap, observes:”Economic strife can and does bring, historically, a whole legion of tensions. Recovery requires a long period and political intervention is necessary. Unfortunately, the steps needed do not necessarily sit comfortably with election cycles. Welcome to the political economy.”

The European crisis may be a prime example of a step up in national interests and tension, but it is not the only political field managers have to watch, nor is sovereign debt the only asset class that is affected. Political events in China, the US as well as those in the Africa and the Middle East are all front-page news these days, impacting a range of asset classes to varying degrees.

Commodity prices are the obvious fall-out from Middle Eastern conflicts but there is also the rise of gold owing to the uncertain climate; downtrodden financials are being affected by stiffer regulations; real estate investments are focused on safe haven regions; and Capital expenditure spending of companies in some countries is hampered by uncertainty over the prevailing and potentially changing tax climate. Consumers, worried over the state of unemployment and disgruntled over respective home politics, remain unconvinced of market opportunities and reluctant to invest.

James Bateman, the head of manager selection at Fidelity Investments, says investors remain inherently nervous, with the scars from the events of 2008 a long way from healing. This has led to a greater emphasis on the analysis of risks, including geopolitical ones.

Nusseibeh adds:”Some may argue the much heralded era of globalisation minimises political influence on a stock or securities selection basis. Not necessarily. As national interests and protectionism increase, this will have significant impact on companies and corporate interests.

“Also, consider the debt levels of many countries compared to the strength of corporate balance sheets. How long will indebted nations allow companies to reap such profits without taking more of the pie for themselves? Will they tax the companies or the shareholders? What if political change affects the way companies pay dividends?”

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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