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Broadgate: Weekly Briefing 3/8

3 August 2012

Europe – Investors are looking for the European Central Bank (ECB) President to deliver on his promise to do whatever is needed to protect the euro, interpreted by most as a signal that the ECB will intervene in bond markets. Should Mario Draghi fail to overcome the objections of Germany’s Bundesbank to such action, the disappointment could spark a sell-off in stocks.

“If Draghi just comes out with a do-nothing, markets are going to react extremely badly and the ECB will have a full- blown crisis on their hands,” said James Nixon, chief European economist at Societe Generale SA in London. “I can’t see what form of words Draghi can come up with that would replace concrete intervention.”

Germany – Germany retained a stable outlook for its top credit rating at Standard & Poor’s (S&P) just over a week after Moody’s Investors Service warned that the nation’s AAA grade was at risk.

The long-term debt sovereign rating for Europe’s largest economy was maintained at AAA, S&P said in a statement on Wednesday.

“In our view, Germany has a highly diversified and competitive economy with a demonstrated ability to absorb large economic and financial shocks,” S&P said. “The outlook on the long-term rating remains stable, reflecting our view that Germany’s public finances and strong external balance sheet will continue to withstand potential financial and economic shocks.”

Spain – Standard & Poor’s has kept Spain’s credit rating at BBB+ in light of ongoing reforms but maintained the country’s negative outlook.

Last month, the Spanish government reaffirmed its commitment to its fiscal consolidation and structural reform programme after securing a loan of up to EUR100bn from the eurozone to support its stricken banking sector.

In its appraisal of the country, S&P says: “In our view, Spain’s commitment to the ongoing implementation of a comprehensive fiscal and structural reform agenda remains strong.”

The ratings agency adds: “Our BBB+ long-term foreign currency rating on Spain is supported by our view of its diversified prosperous economy, stable political system, and the ongoing implementation of a comprehensive fiscal and structural reform agenda.”

Global – Manufacturing in most of the world is in a slowdown, a raft of reports for July has suggested.

U.S. manufacturing growth shrank for the second month in a row, a survey by the Institute for Supply Management suggests.

In the U.K., the manufacturing sector shrank at its fastest rate for more than three years, while in the eurozone, factory output contracted at its fastest pace in three years.

And manufacturing activity in China had its slowest increase in eight months.

The ISM, a trade group of U.S. purchasing managers, said on Wednesday that its index of manufacturing activity rose to 49.8, from 49.7 in June (a reading below 50 indicates contraction).

U.S. – The Federal Reserve moved a step closer to pumping more stimulus into its struggling economy, suffering with weakening growth and a jobless rate that has stayed at 8% or higher for more than three years.

Central bankers led by Ben Bernanke concluded their two-day meeting on Wednesday saying they “will provide additional accommodation as needed” to bolster the expansion. The Federal Open Market Committee also said it will “closely monitor” economic data and financial developments, suggesting it is focused on the economy’s near-term performance.

“The Fed is ready to act if things don’t improve,” said Roberto Perli, managing director of policy research at International Strategy & Investment Group in Washington and a former Fed economist. Policy makers probably want to build a “stronger case” for action, he said. “You need more data to do that.”

Spotlight on: Managing Lat Am

A slowing economy, poor corporate earnings and macroeconomic fears have put Brazil under intense scrutiny from investors, according to BlackRock’s Will Landers.

The manager of the GBP224m Latin American investment trust, who oversees about $7bn in Latin American equities, said the proportion of analysts cutting forecasts for Brazilian corporations last month stood at its worst level since April 2009, presaging a disappointing Q2 earnings season.

Brazil’s stock index, Bovespa, has fallen 5% this year to add to the 18% decline seen in 2011. “Brazil has not delivered on growth for the second year in a row, and there are now an unprecedented number of companies missing results,” Landers said.

“Everything is being questioned now by global investors, from company management to the quality of balance sheets.”

Brazil has cut rates eight times since last autumn, bringing the benchmark rate down from 12.5% to 8%, in an effort to kick start its economy. But GDP rose by just 0.2% on the quarter in the first three months of 2012 as the country failed to shake off its 2011 slowdown.

Landers said there will be two further 50bps rate cuts in the current cycle, but has concerns over exchange rate policy, calling on the government to drop its focus on weakening the Brazilian real.

He labelled such tactics “unmanageable” in the long run. Instead, he said, Brazil should focus on fiscal and labour reforms to limit the impact of tax complexity and labour laws on the country’s corporate sector.

Landers is wary of rising global grain prices bringing about a resurgence in inflation, which he said would lead to the government shifting its priorities from growth to price stability.

“The government has spent too long earning its credibility on inflation to give it up that easily. But it is also important to note that the benchmark Selic rate often does not represent the real cost of financing for corporations and consumers.”

For now, Landers is looking to corporations with U.S. dollar earnings streams, such as miner Vale, to capitalise on currency weakness.

Elsewhere, he has cut his position in Itau Unibanco, the country’s second largest bank by assets, once the largest position in the portfolio but now an underweight relative to his benchmark, as part of a wider paring of financials.

The manager has added to Brazilian retailers, viewing consumer strength as being relatively resilient, and has also moved overweight Mexico, whose stock market has benefitted from its close links to the U.S.

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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