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Broadgate: Weekly Briefing 9/12

9 December 2013

India – India’s current account deficit, a key area of concern, narrowed sharply in the second quarter after a series of measures helped curb gold imports.

The deficit fell to $5.2bn during the July-to-September quarter, down from $21bn during the same period last year.

A current account deficit is the difference between inflow and outflow of foreign currency and occurs when imports are greater than exports.

India’s deficit had been widening raising fears over its economic health.

India’s Finance Minister, P Chidambaram, said the latest numbers indicated that the country was “on target to contain the current account deficit”.

According to India’s central bank, the Reserve Bank of India (RBI), the current account deficit stood at 1.2% of the gross domestic product (GDP) during the quarter, down from 5% of GDP during the same period last year.

Surveys – A key global survey of international perceptions of official corruption has put Spain down six points to 40th place, following a series of recent scandals.

Only Syria, in the middle of a civil war, lost more points in the survey, carried out by the Berlin-based Transparency International. The list of 177 countries put Denmark and New Zealand top with 91 out of 100.

The U.K. is ranked in 14th place, up from 17 last year, with a score of 76 points out of 100.

The U.S. ranked 19th and China 80th, both unchanged from last year. Russia improved slightly to 127th place, from 133rd previously, and Japan was down one point at 18th.

Transparency International says the world’s marginalised and poor remain the most vulnerable to corrupt officials.

Chris Sanders from the group said: “In practice, these numbers mean that corruption is a constant burden in daily life. This June, our global survey showed that you are twice as likely to pay a bribe if you live in a poor country.”

Currencies – The Chinese yuan is now the second most used currency in trade finance, surpassing the euro in October.

According to the Society for Worldwide Interbank Financial Telecommunication, the yuan had a 8.66% share of letters of credit and collections in October compared with 6.64% for the euro.

China has been working to build the yuan’s role in global trade and investment by reducing controls on the currency and promoting it beyond local markets and to international players.

However, the U.S. dollar remains the leading currency with a share of 81.08%.

Commodities – Last month was the worst November for gold prices in more than 30 years, but investors pounced on the precious metal’s weakness to add to their positions.

According to gold exchange BullionVault, its clients have now bought back 60% of the 1.2 tonnes sold between April and June, taking their gold holdings above 32.6 tonnes in aggregate.

Although gold ETPs continued to see outflows, BullionVault said that sentiment towards the physical metal is on the up, even if it is still depressed versus last year’s levels and lower than in September 2011, when gold’s price streaked past $1,900 as investors fled for safety.

Predictions – One of the economists who shared this year’s Nobel Prize for economics has argued that the significant rise in stock and property prices risks creating a financial bubble.

Robert Shiller, who scooped the prize with Eugene Fama and Lars Peter Hansen for his research into market prices and asset bubbles, told German magazine, Der Spiegal, that the U.S. stockmarket and the Brazilian property market are the main areas of his concern.

The American economist’s work on financial bubbles, crises, market volatility and risk sharing has received widespread attention.

He told the magazine: “I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets. That could end badly.

“I am most worried about the boom in the U.S. stockmarket. Also because our economy is still weak and vulnerable.”

Markets – November saw developed market equities come close to the highs last seen in 2007, according to S&P Dow Jones Indices, while emerging markets continued to lose ground.

The S&P Global Broad Market Index shows that developed markets gained 1.61% over the month to 30 November, taking the year-to-date gain up to 22.12%. Emerging markets, on the other hand, fell 1.92% and saw their year-to-date loss reach 3.09%.

S&P Dow Jones Indices senior index analyst Howard Silverblatt says: “Overall, developed markets are nearing their peak while emerging markets remain over 22% off than their October 2007 high – struggling with reduced growth expectations as their developed counterparts make progress in economic stability and recovery.”

Only three emerging markets posted a positive result last month, with China advancing 4.44%, Mexico 2.92% and Poland 1.27%. Indonesia was hit by the strongest fall after losing 12.19% in the four-week period, while Peru lost 9.15% and Columbia 8.03%.

Spotlight on: Has QE resulted in ‘bubble trouble’ for global equities?

Bill O’Neill is head of CIO research UK, UBS Wealth Management

On 25 November 2008, the U.S. Federal Reserve kicked off its QE programme.

Over the past five years, QE has become increasingly common in the global economic landscape.

Other developed countries have emulated it by launching similar programs, all of which helped cut borrowing costs and supported asset prices.

In fact, in the five years since QE took off, global equities have returned more than 15% on an annualised basis, treasuries close to 5%, and US high yield credit more than 20%.

This has been a great period for investment returns, but not so great for the growth of the global economy. This disconnect poses the question – does QE’s reflation of asset prices represent the creation of a bubble waiting to burst?

QE has distorted financial markets and, as a result, seems to have caused investor complacency.

The one month average level of bearish sentiment, measured by the American Association of Individual Investors is at levels last seen in early 2011 and 2012. On both occasions this level represented complacency.

Stock markets seem almost indifferent to whether fundamental economic data is good or bad, as support in the form of monetary policy acts as a safety net for investors.

This government intervention is occurring worldwide. Japan’s economics minister attempted equity strategy earlier in the year, setting a two-month target return of 17% on the Nikkei 225.

On the other side of the globe, ECB President Mario Draghi’s “do what it takes policy” in the eurozone implicitly guarantees positive returns on short-dated peripheral government bonds.

It is plain to see how investor complacency may arise from this powerful backing. Yet with investment returns having seen such a significant rise in the past five years, should investors prepare for an imminent bubble burst and end to confidence in equities?

Despite concerns, this indifferent sentiment among investors has not pushed asset valuations beyond reasonable levels. This is good news for long-term investors.

Looking at simple ratios of prices to earnings in equity markets, and at cyclically adjusted earning yields, it does not appear we are in a bubble, not least one fit to burst.

The net result is a cyclically adjusted earnings yield of 5.4%. This represents about a 10% discount to the 20-year median yield of 4.9%, showing that after a significant rally over the last five years, share valuations are fair to slightly high.

Clearly, the important point is there is scope for earnings to drive price appreciation.

Yet, investors should not expect a repeat of the 15% annualised returns they have enjoyed over the past five years.

Annual returns are likely to halve to around 7%-8%. Equally, it is highly unlikely high yield corporate bonds will continue to produce double-digit percentage returns.

Though a bubble does not appear to be emerging, investors should be aware that returns from equities may not be as impressive in the years to come, and inflation is also a risk.

Even moderate inflation could diminish returns for medium-term investors.

Although there will always be risks and warning signs to consider when investing in equities, we are not in the midst of a dangerous bubble in risk assets. Investors’ own bubbles will not be burst just yet.

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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