Broadgate: Weekly Briefing 26/7
26 July 2013
UK Economy Shows Weak Recovery – Second quarter UK GDP growth of 0.6% may be weak but as it follows 0.3% over the first quarter, many commentators are concentrating on the fact it proves the UK economy is on a forward path.
Mouhammed Choukeir, chief investment officer at Kleinwort Benson, called the momentum from Q1 to Q2 “remarkable” considering fears of a “triple dip” recession have dominated newswires this year. Ian Kernohan, Economist at RLAM, also noted such commentary and said he hoped the debate will now move on from speculation over the potential for triple dips, to whether the weakest recovery on record is finally gathering pace.
Schroders European economist Azad Zangana said the details of the Office for National Statistics report shows almost 70% the Q2 GDP growth came from the services sector. “The estimates released today are preliminary and may be revised up or down. However, it appears that the economic recovery is broadening out with every major sub-sector making a positive contribution.”
Marcus Bullus, trading director at stock brokers MB Capital, believes deep down the markets will be disappointed by the weak rate of growth shown in the Q2 figures. “0.6% is double what we had in the previous quarter but it still shows that the recovery is meek, not mind-blowing.”
He pointed out the UK still faces numerous challenges, not the least of which is static or negative wage growth, which will inhibit spending. “To achieve escape velocity, as Governor Carney refers to it, you need a strong consumer but the UK’s consumers are still feeling bruised by weak confidence and rising prices.
“There’s something artificial about the current resurgence of the economy. It doesn’t really correlate to economic reality. It may be more of a lurch forward after years of austerity rather than the beginning of anything sustainable.”
Choukeir believes there are many aspects of this growth to indicate the recovery, while slow by historical standards, is sustainable. The UK Purchasing Managers Index (PMI) monthly survey, a leading indicator of growth, has been demonstrating expansion for each of the last three months; a first since early 2012, he noted. He went on to add that other surveys show exports are at their highest level since 2007 and that confidence in turnover and profitability is high; many businesses are expecting to hire more staff over the third quarter.
Manufacturing Recovery in Europe – Western Europe, and investors who have exposure to the region, finally received some good news. The latest monthly figure for the purchasing managers’ index (also known as PMI) beat expectations, showing that manufacturing appears to be expanding for the first time in two years. While the PMI reading of 50.1 was barely above the threshold that indicates growth, even a flat reading would have been a positive.
Europe continues to try to work its way out of its second recession since the global financial crisis, and it appears to be making progress. A Bloomberg survey of economists predicts a return to economic growth in the third quarter of the year. Germany, the cornerstone of the euro zone, also recorded a return to manufacturing growth in July after months of contraction. German manufacturing, in fact, is one of the most important data points to watch as Europe’s recovery tries to gain traction. If Germany can recover and continue to pull the regional economy along with it, Europe may yet get some lift. Its stock market is already up nearly 10 percent this month, and this latest data might keep the trend going.
Worst over for Vietnam? – As one of the world’s few remaining communist states, Vietnam’s relationship with foreign capitalists is complex. That hasn’t stopped private equity group Warburg Pincus closing the first tranche of a USD 200 million investment in the country’s largest mall owner. It’s early days, but for global investors Vietnam may be back in the game.
Warburg and its associates are buying about one-fifth of Vincom Retail, their first foray in the country. The investment will help parent Vingroup pare its debt load, and follows rival KKR’s decision earlier this year to double its stake in a Vietnamese fish-sauce maker.
It isn’t obvious Vietnam’s retail industry will deliver much juice in the short run. Retail sales grew 12 percent in the first six months, their slowest since 2003. Strip out 6.7 percent inflation, and real growth of retail spending barely beat last year’s 5 percent GDP growth.
Besides, the safety of assets remains a worry. Foreign creditors to shipmaker Vinashin found out that a “letter of comfort” from the government didn’t live up to its billing when the state-owned shipbuilder failed to honour a USD 600 million loan in 2010. After much bickering and a lawsuit – later dropped – from pugnacious U.S. hedge fund Elliott Advisers, the government offered lenders a settlement this year.
Poor contract enforcement and endemic corruption won’t go away soon, but Warburg and KKR may be right in betting that the economy is on the mend. Inflation – which peaked at 23 percent in August 2011 – is under control. And that’s giving the authorities wiggle room to revive growth: large companies will see their tax rates fall to 22 percent next year, from 25 percent at present. Developers like Vingroup can now improve their cash flows by paying land costs to the government in instalments.
Credit is also reviving as the government starts to tackle bad debt, at almost a fifth of total bank loans. Vingroup’s cost of local borrowing has fallen from above 20 percent early last year to around 13 percent, while the stock market is up 42 percent from January 2012. The worst may be over for Vietnam; investors should pay attention.
Spotlight On: Where Have All The Safe Havens Gone?
Midway through 2013, strategists, economists and analysts have taken pause to weigh up the events that have dominated investor sentiment over the first six months of the year and predict what will cast shadows over the second half. With markets still reliant on central bank liquidity and the erosion of safe havens in recent months, conditions are expected to remain challenging – although some commentators see opportunities emerging.
Charles Stanley investment analyst Rob Morgan says the stand-out trend of 2013 so far has been a high correlation between asset classes. While it could be argued this undermines diversification within portfolios, Standard Life global thematic strategist Francis Hudson sees it as a positive development.
“It signifies a healthier market and provides scope to do fundamental bottom-up analysis. It also shows a move away from risk-on, risk-off trading, due to liquidity flooding in from central banks,” she says.
So-called safe assets have also been affected. Gold and cash have seen a turnaround, with the former experiencing poor fortunes in the market – signified by the worst drop in value in 34 months – and cash being seen as the only safe asset left. Hudson says: “It is interesting that cash is seen as a safe asset because it used to be quite risky. That is a change that tells us about the outlook for inflation.” Morgan adds: “Apart from cash we have not got a safe asset class anymore. That is a problem for investors because the benefits of diversification worked well in the past.”
However, Legal & General global equities strategist Lars Kreckel sees gold’s fall from favour as a positive sign. He says: “It is one of the most promising signs that we are not looking at the start of a bear market. If people have been worried about inflation getting out of control, we would not have expected the gold price to fall so much.”
The main event so far is arguably Federal Reserve chairman Ben Bernanke’s suggestion that the pace of quantitative easing in the US could slow later this year, which brought the stockmarket rally to a halt and ushered in a global sell-off. F&C director of global strategy Ted Scott says: “There was a big rise in bond yields everywhere, especially emerging markets. We also saw an enormous withdrawal of capital from riskier products and a move into safe havens.” This showed just how vulnerable markets still are to sentiment. Newton global strategist Peter Hensman says: “We are expecting markets to remain skittish. There was confidence at the beginning of the year around central banks and this has diminished as we have gone on. “As some of the certainty starts to reduce then we will continue to have a more difficult period. The excessive optimism starts to reverse a bit.”
Investors also continued to be driven by a hunger for yield. With QE impacting yields and the outlook improving, many expected a great rotation out of bonds and into equities. However, now the end of QE may be on the cards, there is the possibility there will be another mass movement of money. Morgan says: “That fear manifested itself with Bernanke’s comments and there was a potential policy change all of a sudden. All that risk got taken off the table again. We are back to November and December levels in a way. I think people will still look to add risk because there is an underlying demand for it. Potentially, we will have a more stable period. It will it be a stockpicking environment going forward.”
Kreckel believes that if markets become more confident and signs of global economic expansion return, asset classes will see a shift in favour as investors move from more defensive, income-focused parts of the market towards growth. “The acceleration in global growth will begin in the second half. If this picks up it will be more about growth than the dividend,” he says. “With bonds yields rising, such income characteristics are not as attractive and investors will want economic beta and exposure to economic cyclicals.”
Scott is more sceptical of equities being given a boost in the second half of the year and believes bonds may start to receive more attention, especially if the demand for yield still dominates investors’ vision. “A lot of high-income assets were changed up to find yields. There was actually the reverse this time. As bond yields went up, the worst performers in equity markets were high-yielders,” he says. “There was also a bubble in dividend-paying stocks. Looking ahead, the question is the strength of company earnings and the strength of the market.”
If nothing else, so far this year has reiterated how big a part sentiment plays in global markets. With asset classes behaving in a highly correlated way, and investors prioritising yield yearnings, the biggest stand-out theme that has a lot of people on their guard is what the Fed will do next. Hensman says: “We are expecting some of the more challenging conditions that recently appeared to continue through the second half of the year.”
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