FYI | Jan 19 2010
By Chris Shaw
Each year Saxo Bank, an online trading and investment specialist, offers up ten “outrageous claims” to provide investors with a chance to mentally stress test their portfolios. Last year Saxo was quite bearish, but this year it is basing its claims on expectations 2010 will prove to be a year of reflation and consolidation, meaning its claims are more balanced than was the case in 2009.
This in part reflects Saxo’s view that financial markets in 2010 will continue to benefit from the stimulus measures introduced in 2009, as evidenced by leading indicators continue to move strongly higher. This means weak growth in the first half of 2010 is regarded unlikely, though the second half of the year may be more challenging as risk willingness in the first half of the year will increase the danger signs for investors as the year draws to a close.
One emerging trend likely to be sustained for some time is deleveraging, especially in the private sector in response to higher unemployment, excess spare capacity and greater difficulty in accessing credit. As well, there are signs of a change in international capital flows, as it is unlikely rapid consumption growth will continue in the developed world in the next few years. These trends have influenced Saxo’s claims for what may occur in the year ahead.
Over now to Saxo Bank’s claims. The first claim is the yield on German bunds will reach 2.25%, with the investment specialist suggesting a combination of deflationary forces and excessive monetary policy will see yields edge lower as traders refuse to buy into the growth story being implied by the equity market. Saxo suggests one or more negative macroeconomic triggers could force bund prices to 133.3, which compares to a current price of 122.6.
Claim number two is that the VIX, which is the Chicago Board Options Exchange Volatility Index, will trend down to 14 during 2010, which compares to a current level of just below 18. Saxo suggests this could happen as it appears the market’s assessment of risk is more and more resembling that of markets in 2005/06 when trading ranges narrowed and implied options volatility declined. In other words, claim number two reflects on the chance of increased complacency towards risk on the part of investors.
Claim number three sees potential for the yuan to be devalued by 5% against the US dollar during the year, as there is a risk the efforts of policymakers to stem credit growth to avoid bad loans and the creation of asset bubbles could show Chinese investment-driven growth to be short of expectations. This becomes a bigger risk given China’s massive spare capacity and its economic backdrop and so could force the hand of policymakers with respect to the currency.
With respect to gold Saxon Bank suggests there is some speculative element in the price at present, so a general strengthening of the US dollar could see the gold price drop as low as US$870 per ounce (claim number four) from gold’s current level of around US$1,130 per ounce. Long-term the group remains bullish on the metal and takes the view gold could hit US$1,500 per ounce within 2014, so even a drop below US$900 wouldn’t push the metal out of its long-term uptrend.
A stronger US dollar is certainly in the group’s sights as it suggests the greenback could recover against the yen in particular sometime in 2010, both because the carry trade has simply been too easy and the Japanese currency is not reflecting the true state of economic conditions in Japan. Saxo’s fifth claim is the USD/yen rate could move to 110 from around 89.30 now.
Claim number six sees the formation of a third political party in the US that could become a deciding factor in Congress following the mid-term elections this year. Saxo suggests this because it senses there is general disapproval of both major parties among the US electorate at present, increasing the calls for real change going forward.
While it may sound outrageous, Saxo Bank’s seventh claim sees the US Social Security Trust Fund go broke. This, explains the bank, is an actuarial and mathematical certainty as 2010 may well be the first year where outlays from the non-existing trust fund will need to be financed at least in part by the government’s General Fund. This will mean part of social security outlays will need to be funded by higher taxes, more borrowing or the printing of more money.
While a drought in India and greater than normal rainfall in Brazil has supported sugar prices Saxon Bank doesn’t see the strength as sustainable, pointing out the forward curve is already indicating considerable downside beyond 2011. As well, high ethanol prices have caused both Brazil and the US to lower the ethanol share of gasoline, which means lower demand. This forms the background for claim number eight: sugar prices could drop by as much as one-third from their current levels of around US$23.33 per pound.
Small cap companies have underperformed the Nikkei lately, but on Saxon Bank’s calculations this has come despite their fundamentals suggesting a better investment case than for their big cap peers. Given a price to book ratio of only around 0.77 at present and with only 12% of the TSE Small Index made up of financial stocks, Saxo sees scope for this index to surprise on the upside. Claim number nine is the TSE Small Index could potentially rise by as much as 50% from its current level of around 888 points.
Finally, Saxo Bank’s tenth outrageous claim sees the US trade balance again turn positive this year, which would be the first time since the oil crisis in 1975. This could occur in the bank’s view because the US dollar has become cheap enough to stimulate US exports and punish exports, which has already seen the trade balance improve somewhat in recent months and may see the currency improve further to record a positive reading for one or more months during the year.
Having offered the above claims Saxon Bank has also offered its top ten trade picks for the year, the first being to be short the euro and South African rand against the Turkish currency given inflationary pressures appear to be building in the Turkish economy and both other currencies appear overvalued at present.
Secondly, Saxo suggests going long German bunds as current pricing appears overly optimistic given the economic problems both German and the European Union (EU) in general are facing, given expectations of low growth and a number of deflationary pressures and high unemployment levels as a whole in the EU in particular.
While neither Japan nor the Eurozone will offer much help, Saxon also sees 2010 being a good year for the CRB Index as global growth in demand for commodities should remain strong. This is top ten trade number three, with the best price performance likely to be seen in the first half of the year.
Saxo also likes a trade of long US 10-year bonds and short Japanese Government Bonds (tip number four) as the US offers greater upside from deflationary pressures thanks to credit contraction in that economy while there is little incentive to lend money in Japan given low yields and an already debt burdened economy. The other positive is there is some forex exposure inherent in the trade, meaning another way for investors to generate a positive return.
Given expectations small cap stocks in Japan are likely to outperform their large cap counterparts, Saxon favours going long the TSE Small cap index and short the Nikkei (tip number five), especially given the fact the yen is weakening at present and the Japanese government has indicated it favours a weaker currency for trade reasons.
With US stock indices priced for a steep recovery heading into 2010, Saxon Bank takes the view likely weak levels of capital investment mean this is not fully justified, so it suggests going long the GWX ETF of companies in developed economies and going short the NASDAQ100 index (tip number six).
Its view sugar prices will come under pressure this year sees Saxon recommend selling the March 2011 sugar contract (tip number seven), supported by its view supply is bound to expand as growing conditions improve in both India and Brazil.
For the first half of the year Saxo also recommends going long the IShares S&P Global Energy Sector Index Fund (tip number eight) as it sees the energy sector generally as a beneficiary of a global economic recovery plus a rebound in resource demand. The sector has recently started to catch up to the move in the oil price and this is expected to continue, which should help drive outperformance as more funds are rotated into energy investments and in particular the large integrated players in the sector.
Back in currency markets, Saxo Bank sees potential in a short euro/Canadian dollar strangle (tip number nine), as 1.55 appears to be something of a pivot point and 1.39 to 1.76 has captured nearly all extremes over the past five years. Breaking down the trade, the bank suggests selling 1-year December euro puts with a strike if 1.45 and selling euro calls with a strike of 1.68 to receive 590 Canadian dollar pips.
Its final trade recommendation for the year (number ten) is to go long the December 3-month short Sterling future contract as the bank takes the view the British economy remains in the doldrums, adding to the potential for the Bank of England to keep rates unchanged for an extended period of time, similar to what the Federal Reserve is doing in the US economy.
