FYI | Dec 16 2010
GaveKal offered the following observations this week:
The Fed reiterated its plans to continue with QE2 and keep policy rates just above zero. Interestingly, the Dollar rose, UST yields moved higher, commodities were tepid and gold traded down. As we see it, this is another sign that the typical "reflation" phase of the recovery is behind us, even as risk is on. What then are investors looking for? Our view is that we may be moving into a new phase of the economic environment. Since March 2009 the investment environment has been characterized by risk-on vs. risk-off trades, and in this environment yesterday's announcement would have been met with a lower Dollar, lower UST yields and rising commodities. However, now that the US growth outlook is improving, economic participants may become more discriminating. This has several implications:
1) Emerging market growth versus developed market value: As we noted in our most recently Quarterly, EM equity markets are in many cases trading on similar, or even higher, valuations than their DM counterparts. This is partly because EM is where the growth visibility has been the clearest. Now that the growth outlook is improving for the developed markets, while the cost outlook is deteriorating for EMs, we expect flows to move back to the developed markets.
2) A post dash-for-trash environment: We have noticed that many hard-driving investors-those that typically take on more company-specific risk-have started to look at some of the biggest and traditionally most boring blue chip US companies. Their view appears to be that the rally in lower quality, high-beta stocks that started in March 2009 has more than run its course. The large, high quality, "boring" companies more typically favored by large institutional investors were left behind, and these companies now represent very good value compared to their higher-risk counterparts.
3) Strong companies are getting stronger: The business environment favors stronger companies, and many will use this to reinforce and extend their advantages over their competitors. This environment includes easier financing conditions for larger, more established competitors. However more importantly, the regulatory uncertainty in the post-crisis world has weighed heavier on smaller businesses, as surveys have showed that concerns about healthcare costs and future tax burden is one of the key reasons limiting small-business expansion (although optimism, while still low, is improving according to the latest NFIB survey-see p. 2). This ultimately benefits large and strong players-when smaller businesses are not expanding, the landscape is generally less competitive.
4) Consumers becoming more demanding: Yesterday's 3Q earnings report from Best Buy is a reminder that not all boats will be lifted by the recovery. US retail sales may be coming back to life (see p. 2), but not every company is benefitting from this. Clearly some companies are meeting consumers needs, but Best Buy learned the hard way that shoppers are not ready to splash out on big-ticket items, but are searching for deals on cheaper items, and, at least for now, favoring Wal-Mart, Target and Amazon.com for their purchases.
It makes sense that, at this stage in the recovery, the macro-trade is giving way to a more bottom-up dominated environment. Just like consumers, we believe investors will also be spending their money more discriminately, with value trades likely to characterize the next stage of the bull market. And today, it seems some of the best value trades are to be found in developed markets, specifically in the large blue chip sector.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
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