FYI | Jun 18 2008
Market strategists at Standard Chartered saw their in-house measurement of global investor risk appetite starting to decline over the past weeks, with the index indicating this week the investment community has again become risk adverse. The switch is regarded as important with several regional experts at the bank taking the effort to trying to ascertain what it means for their particular part of the world.
As it was Standard Chartered’s in-house view that investor optimism had returned too strongly and too soon, which explains the rapid recovery for global equity markets in April and May, it comes as no surprise to the strategists that this optimism has now begun deflating. They don’t seem to think this process is about to reverse anytime soon either.
Here are a couple of things I picked up recently from various other sources and reports:
– international fund managers have started to withdraw funds from Asian equity markets
– even Asian investors themselves are questioning current growth assumptions for the region
– there seems to be a growing uneasiness with rather strong earnings growth projections for 2009, especially with economists starting to think their global growth projections are under threat more than that they are likely to surprise to the upside
– market price projections for base metals and bulk commodities suggest rather serious declines in prices, with the notable exceptions of copper, aluminium and iron ore
– the bulk of speculators seems to have departed from most base and precious metals markets in favour of oil (and certain agricultural markets)
– global banking shares, including those in Australia, are once again trading at or near multi-year lows
– there’s an increasing focus on inflation, slowing growth, rising costs and the term “stagflation” is mentioned even more than was “recession” earlier in the year
Viewed from the above perspective it is no coincidence several retail stocks, and media shares, have been hitting year-low share price levels this month. The investment community is adjusting portfolios and views. The general theme is, of course, higher inflation and slower growth and how to best position vis-a-vis such prospect.
Market strategists at Citi in the US changed their recommended sector allocations this past week and I think the changes made are in many ways illustrative for what is currently happening across the globe.
– Technology hardware and equipment was downgraded to Underweight (companies are likely to spend less from here on);
– Healthcare Equipment and Services was upgraded to Overweight (non-discretionary spending largely insulated from most of the problems plaguing the rest of the economy);
– Media was downgraded to Marketweight (total ad spend is expected to slow down too);
– Consumer Services was upgraded to Marketweight (must be a valuation thing);
– Food and Staples Retailing downgraded to Underweight (earnings forecasts to fall);
– Food, Beverage & Tobacco and Household & Personal Products upgraded to Marketweight (Citi makes no secret of the fact that this is purely a defensive tactical decision: these sectors tend to outperform during a general market downturn)
- Citi likes Financials (must be a valuation thing) and cautions towards so-called late cycle industries which includes capital goods, materials (that’s resources to you and me) and energy – all three are rated Underweight
It is probably worth noting that part of the reason why Citi doesn’t like these last three categories is because of high expectations priced in share prices. It is clear the broker believes the risks have now turned in favour of likely earnings disappointments.
Strategists at GaveKal even took the theme a few steps further. They argued earlier today that part of this global re-positioning includes investors allocating more funds towards countries where inflation and interest rates pressure have not yet become an obvious problem. It is therefore no coincidence, says GaveKal, that equity markets in Switzerland, Japan, Taiwan and the US have recently outperformed markets elsewhere.
The main culprit behind all this is, of course, the high oil price. With crude oil futures persistently trading above US$130 per barrel, and pressure on global economic growth mounting, central bankers across the globe find themselves increasingly trapped between a rock and a hard place. Believe me, they would very much like to teach those investors in the oil market a lesson they would not easily forget. Problem is, however, that most roads to a forced lower oil price only reach their destination via severe blows to the health of their respective economies; and nobody wants to be held responsible for tomorrow’s recession.
The new environment of higher inflation (which essentially means higher costs for both consumers and businesses) will lead to a step-up in global interest rates. No wonder investors are turning increasingly risk adverse: businesses worldwide are being hit by higher input costs, higher costs for borrowing and with less chances of passing on these extra costs (as demand for their products is slowing).
Investors in energy and resources stocks better not think their companies will remain immune to all this. Already the first reports have entered my inbox suggesting margins are to come under pressure as costs to service debt, and to operate projects and operations, are eating into yesterday’s profit margins. This effect will be more severe for companies leveraged to falling product prices and with no prospect for sizeable production increases. There’s another factor that will become increasingly important from here on: is your company a low cost or a high cost producer?
As suggested by commodity analysts at Citi and at PriceWaterHouseCoopers this week, many of the high cost producers are facing some serious tests ahead. Many may even be forced to close shop. In addition, say the consultants, many a medium sized resources company may not realise its goals because of mounting obstacles.
Some analysts have already suggested bringing greenfield operations (from scratch) on line may already have become too expensive. This, obviously, favours the big commodity players with established large, low cost operations. And this, in a roundabout way, fits in perfectly with the overall decline in risk appetite.
Your editor will be appearing again on Sky Business’s program Business View this Saturday from 9-10am.
Till next week!
Your editor,
Rudi Filapek-Vandyck
(As always firmly supported by Greg, Todd, Grahame, George, Chris, Paula, Sarah, Joyce and Pat)
