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Broadgate: Weekly Briefing 28/10

28 October 2013

U.S. – The U.S. economy added 148,000 jobs in September, official figures show, lower than analysts had predicted. The unemployment rate fell to 7.2%, down from 7.3% in August, the US Department of Labour said.

The release of the figures was delayed by the partial shutdown of the U.S. government earlier this month. Economists had predicted 180,000 job gains for September, and the lower-than-expected figure could raise fears the U.S. economy is losing momentum.

China – A pick-up in Chinese economic activity lifted world shares back toward five-year highs on Thursday, though weaker-than-expected European growth pulled the euro off a two-year peak against the dollar.

Activity across China’s vast factory sector reached a seven-month high this month, according to an HSBC survey, easing concerns about a slowdown in Chinese exports which would point to weakening global demand.

Mining stocks and oil gained on the data though shares on the Shanghai Stock Exchange ended lower as domestic investors worried that a spike in short-term money rates engineered by the central bank could hurt growth going forward.

“What we’re seeing is not much more than a stabilization of growth expectations in China. If that does gather momentum the key winners will be those countries that export to China,” said Adam Cole, head of FX Research at RBC Capital Markets.

Japan – Japan’s government downgraded its assessment of export performance for the second consecutive month in October on slowing shipments to Asia, suggesting external demand may now contribute less to Japan’s growth than initially anticipated.

The government left its overall assessment unchanged, saying the economy is set to recover at a moderate rate as high corporate profits fuel capital expenditure, which then spurs labour demand.

Domestic demand, boosted by increasing public and consumer spending, has largely driven Japan’s recovery from recession last year, but signs of weakening exports may mean Japan having to rely even more on domestic demand to continue growing.

“Exports are almost flat,” the government said in its report for October. “Exports are expected to pick up in the future, because overseas economies are stable and because the yen has weakened, but we must be mindful of downside risks to overseas economies.”

Spain – Spain’s economy has emerged from recession after growing for the first time in more than two years, according to estimates from the Bank of Spain. Spain’s gross domestic product (GDP) grew by 0.1% between July and September, the bank said.

However, GDP was still 1.2% lower in the quarter compared with the same period last year.

Spain’s economy has been struggling ever since the credit crisis struck in 2008. The bank’s figures are an estimate, and the country’s National Statistics agency INE is due to release preliminary third quarter GDP data on 31 October.

Trends – An “extraordinary” amount of cash was withdrawn from money market funds and channelled into equity portfolios last week, after the U.S. averted a default, according to EPFR Global.

Data from the fund flow analyst shows that $69.7bn was pulled from money market products in the week ending 16 October while equity funds captured net inflows of $17.2bn.

Last week saw sentiment bolstered by the U.S. government reaching a last-minute deal to end its partial shutdown and extend its debt ceiling past $16.7trn. Investors had been nervous that the government would effectively run out of money, leading to fears of a catastrophic default.

U.S. equity funds were the main beneficiaries of this move, witnessing net inflows of more $10bn over the week. European, Chinese and Japanese equity funds also took fresh investor money.

Spotlight on: The outlook for Indian equities

Rajendra Nair, co-manager of the J.P.Morgan Indian fund (the underlying asset to MC52 & MC52S2, available via Hansard International), investigates at how India is dealing with its challenges.

Emerging markets have fallen out of favour in 2013, and investors in India have felt the pain more than many other countries.

In the short term, there are two challenges the Indian economy and stockmarkets are facing. One is the global macro environment, which is putting pressure on all emerging markets. The other is troubles at a domestic level.

Over the summer, the global macro environment was dominated by concerns about the U.S. Federal Reserve tapering its QE programme.

While the expected tapering failed to materialise at the committee meeting in September (and has perhaps been delayed further by the U.S. government shutdown this month and fears over the debt ceiling), the effects were still profound.

Treasury yields rose in expectation of higher interest rates to come, and the U.S. dollar also appreciated. This, in turn, caused all emerging market currencies to weaken. The Indian rupee was more affected than some of its peers, because of the country’s relatively large budget deficit.

Economic activity

But the outlook for the Indian economy over the short-to-medium-term, needs to be evaluated in the context of what has occurred over the past few years, not in the past few months.

The GDP growth rate has decelerated from 7%-8% per annum, to around 4.5% now. This has been due to a combination of rising inflation and interest rates, and a lack of government policy momentum, which has affected investment and capital spending in the economy.

Economic activity is likely to remain sluggish over the coming months, and growth is unlikely to recover dramatically. There are two reasons for this. Firstly, in July, the Indian central bank put in measures to defend the currency and tighten domestic liquidity. Interest rates at the short end, rose quite sharply.

Monetary policy had begun to ease at the start of the year, but come July, that easing was reversed. We have to assume those measures will stay in place for a while. If interest rates are going up, it tends to put a dampener on the economy in the short-to-medium-term.

Elections

Secondly,there are national elections due before May 2014. While the government has made some progress in the last 12 months, it does not have much scope to try to kick-start the economy, as the ability of any government to take measures that might be unpopular in the run-up to an election is limited. Consequently, economic activity and earnings forecasts are likely to remain tepid for now.

From a medium-to-longer-term perspective, a lot of the negatives are very well flagged and are increasingly being priced into valuations. As a result, valuations are looking interesting.

The Sensex index valuations are at below five and 10-year averages on a forward price-to-earnings basis. In itself, that is not necessarily compelling, but what you do not see from the headline number is, while earnings are facing cyclical pressures across the board, there is a high degree of polarisation in the P/E multiples, with a few big stocks on high multiples and a lot of smaller companies on lower multiples. This suggests there may be more attractively valued opportunities, away from the most well-known companies.

Price-to-book value is a good measure to use if you are making an argument for long-term investing, as it allows us to look through earnings volatility. Price-to-book values on the MSCI India Small Cap index, which is a very broad universe, are not very far from the troughs in early 2009 and mid-2002.

Trailing price-to-book on the MSCI India index is in the bottom decile, relative to the past 20 years. So the probability investors will make money from these levels over the next one-to-three years is fairly high.

Although, the caveat is it is not impossible to imagine multiples heading lower before they rebound, as the macroeconomic challenges are not going away in a hurry.

Emerging from the cycle

At the moment there is intensity about the macroeconomic headwinds, but this is a cycle, and we will emerge from it. Regardless of the short-term issues, India has a wealth of companies that have a demonstrable record of doing well through cycles, and we believe they will continue to compound and grow over time.

Although it can be easy to forget in times of market stress, equity investors – and particularly those in more volatile emerging markets – need to rise above the market noise, searching out businesses that will grow over a long-term horizon.

In the J.P.Morgan Indian investment trust, for example, we have held some of our holdings for a decade or more.

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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