Broadgate: Weekly Briefing 3/2
3 February 2014
U.S. – The US Federal Reserve announced a $10bn reduction in its monthly bond purchases from $75bn to $65bn in the second straight month of winding down stimulus efforts.
The central bank had been buying bonds in an effort to keep interest rates low and stimulate growth. In a statement, the Fed said that “growth in economic activity picked up” since it last met in December.
Although the move was expected, US shares still fell on the news.
The Fed left its overnight interest rate unchanged at 0% – the level it has been at since December 2008.
Global – With expectations that volatility will increase this year, BlackRock chief investment strategist Russ Koesterich stresses the need to diversify into international stocks.
After “unusually low” levels of volatility in 2013, the onset of QE tapering from the US Federal Reserve this year will likely see market volatility “climb to levels that are closer to long-term averages, according to Koesterich.
“While we still think stocks will post gains this year, those gains will be accompanied by more ups and downs,” he adds.
Against this backdrop Koesterich reinforces the need for diversification into international names, particularly within the US market.
Japan – Japan has reported a record annual trade deficit after the weak yen pushed up the cost of energy imports.
Its deficit rose to 11.5 trillion yen ($112bn) in 2013 – a 65% jump from a year ago.
Japan has seen its energy imports rise in recent years following the closure of its nuclear reactors in the aftermath of the tsunami and earthquake in 2011.
But it is having to pay more for those imports after a series of aggressive policy moves weakened the yen sharply.
The Japanese currency fell more than 20% against the US dollar between January and December last year.
Taiwan – Taiwan’s economy expanded at a faster-than-estimated pace in the fourth quarter last year, as a recovery in Europe and the U.S. boosted the island’s exports.
Gross domestic product rose 2.92% from a year earlier after increasing 1.66% in the third quarter, the statistics bureau said in a preliminary report in Taipei.
The World Bank this month raised its global growth forecasts as the easing of austerity policies in advanced economies supports their recovery. Taiwan’s finance ministry last week revised its exports figures for the fourth quarter and full year to reflect missing data, showing sales climbed 1.4% in 2013 after shrinking 2.3% the previous year.
India – India’s central bank has unexpectedly raised interest rates in an attempt to rein in stubbornly high consumer prices in a crucial election year.
The Reserve Bank of India (RBI) raised the benchmark repo rate – the amount at which it charges to lend to commercial banks – to 8% from 7.75%.
The RBI said that another near-term hike was unlikely if inflation eased to a more comfortable level.
India’s main gauge of inflation, the wholesale price index (WPI), rose 6.16% in December, from a year earlier. While that was a slight fall on from the previous month, the rate continues to remain an issue with the central bank.
Trends – Investors poured money into European equity funds in the third week of 2014 while continuing to shun the world’s emerging markets.
European equity fund across the globe took more than $4bn in new money during the week ending 22 January, according to fund flow data provider EPFR Global, as the move towards developed market stocks continued in force.
“Investors continue to favor regional funds over country specific ones, with Europe and Europe ex-UK regional funds accounting for three-quarters of the week’s total inflows,” EPFR Global says.
“But both UK and Spain equity funds posted weekly inflow records and investor appetite for the PIIGS markets [of Portugal, Italy, Ireland, Greece and Spain], measured in flows as a percentage of assets under management, remains strong.”
Spotlight on: Emerging markets: Not the time to be underweight this unloved asset class?
Emerging markets had a tough 2013 and events of the last week have seen them sell off even more. But should investors be cautious about being underweight emerging markets right now?
The MSCI Emerging Markets Index dropped 4.08% during 2013 after investors become worried by the impact of the Federal Reserve’s tapering on these countries and signs of slowing economic growth across the region. Over 2014 so far, the index has shed another 6.42% as currency weakness sharpened.
Fund managers plan to shun emerging markets over the coming months too. The most recent Bank of America Merrill Lynch Fund Manager Survey found that a net 28% of asset allocators say they want to be underweight emerging markets on a 12-month view.
However, others argue that investors who have gone underweight emerging markets should consider increasing their weightings to take advantage of the long-term valuation opportunities that have appeared in the space.
Iveagh chief investment officer Chris Wyllie says: “We’re not going gangbusters on emerging markets but we are saying we don’t think you should be underweight now. If you have been clever or lucky enough to be out or underweight then you should be moving back at least to neutral.”
Wyllie says the economic catalyst for a recovery in emerging markets is not yet present, although “the value is strong” and creating opportunities.
He adds: “With markets at 1.5x price-to-book, pretty much whenever you’ve bought them at that level you’ve made good returns from there.”
The CIO also points out that worries such as the devaluation of some countries’ currencies, fears of a hard landing in China and political events such as elections are “inherent risk factors” in emerging markets but seem to be spooking markets nonetheless.
“From a lot of the narrative, it sounds like this is just starting. I hear a lot of comments like ‘it has a lot worse to get yet’ or ‘it’s only just started’. Actually, this has been going on for three years, nearly four, already,” Wyllie says.
“If you look at the risk factors people are name-checking to justify still selling, even after a very pronounced period of underperformance, we don’t feel there is any fresh information to justify selling out.”
JP Morgan Asset Management global emerging markets strategist George Iwanicki says emerging markets look “tactically oversold” as investors have reacted to the Fed’s tapering as though it were full-scale monetary tightening.
He also argues that the falls in emerging market currencies which has sparked the latest sell-off could actually be a good development over the longer-term.
“As painful as it may be in the short term, it is actually very positive that the brunt of the pain from tapering is being felt through currency adjustments; this is making emerging markets more competitive as a whole,” Iwanicki says.
“Encouragingly, we are seeing central banks responding with orthodox moves like rate hikes; India, Brazil, and even Turkey raised rates. This is a key difference versus the 1990s and should reassure investors’ confidence in emerging markets.”
The strategist notes that the market seem to be concentrating on the problems in Argentina, Venezuela and Ukraine. But while the challenges facing these countries are “significant”, they are not directly relevant for equity investors.
He says: “From a stock investor perspective, we believe the emerging market earnings slowdown is largely cyclical, driven by the emerging market business cycle.
“After a prolonged growth slowdown and currency adjustment, emerging market valuations have fallen to a buy territory: price-to-book below 1.5x, emerging markets are cheap on 10-year price/earnings versus the US and the gap with Europe is rapidly diminishing.”
F&C multi-managers Gary Potter and Rob Burdett have recently started to take another look at emerging markets, and Asia in particular, after being heavily underweight the asset class in 2013.
“We think 2014 will be a transition year for emerging markets,” Potter says.
“Of course it’s hard to look at it as a bloc as you have vastly different circumstances in China to India to Brazil. The QE withdrawal in the US will continue to affect emerging markets to a point but we do think emerging markets have changed significantly for the better since the 1997 Asian crisis and the 1998 Russian crisis.”
Potter and Burdett have started to put small amounts of money back into Asia after seeing the compelling valuations present in the region, but remain underweight. This has been funded by taking profits in the US, following a strong 2013 that saw the S&P 500 rise by 29.93%. “On a price-to-book basis, some of the cheapest markets are in emerging markets,” Potter says.
“Asia has traded this low only three times in the past 30 or 40 years, I think, and if you buy Asia at this price you are definitely going to make money over the next five to 10 years.”
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