Rudi's View | Nov 01 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, editor FNArena
Equity markets at or near all time highs should not worry investors as the best is yet to come. That was the view expressed by most of the experts who last week gathered together in New York for an investment conference organised by BCA Research (formerly known as the Bank Credit Analyst).
Although some of the experts at the meeting painted a pretty horrific outlook, such as Merrill Lynch Chief North American Economist, David Rosenberg, who advocated a US recession had simply become unavoidable, the majority of the attendants proved surprisingly upbeat about the outlook for the world economy and global share markets.
A survey conducted by BCA at the conference revealed bears such as Rosenberg were outnumbered by six to eight optimists, which proved remarkably similar to a recent study amongst global fund managers by Merrill Lynch. The study found about 14% believed a US recession was likely, while 86% thought it was rather unlikely.
The irony was, of course, that one of the most bearish bears at the conference turned out to be Merrill Lynch’s Rosenberg who’d already concluded several weeks ago that the odds of a US recession had grown to 70%.
Rosenberg was far from the only one with a pessimistic view. Others offered serious doubts over whether the rest of the world could de-couple from the US, or whether central banks across the globe were not printing too much money (buy gold!). However, the majority of the speeches delivered a positive core message and some of these turned out the most interesting dissertations at the two day event.
A Portfolio Manager at Lansdowne Partners, Richard Davidson, argued that as long as the Federal Reserve was in cutting mode, and as long as an economic recession could be avoided, the US share market should be in for a strong performance in the next six months. We’re talking double digit returns.
If Davidson’s view is correct, investors should not even consider the option of selling equities until the reflation period (Fed pumping money into the economy to keep growth positive) has been fully discounted and US rate hikes appear on the horizon.
Davidson’s scenario is in line with BCA’s house view. Ever since the subprime mortgages crisis broke and froze international credit and debt markets, strategists at BCA have argued investors should play the reflation card and this was best done via sectors that had clear leverage to global growth, such as technology and resources.
Davidson thinks investors should pile up on gold (a view shared with many other experts, including BCA), while also opting for US consumer staples, beverages, and household
and personal care stocks. He explained these stocks offer a high dividend yield as well as protection in a recession scenario (you never know).
Moreover, Davidson argued many of these industry groups in the US enjoy rising margins and most also do well when the US dollar is weakening as they receive high percentage of their income from outside the US.
However, his most surprising call was to start buying US home builders. As investors had abandoned the sector relative dividend yields are now at an all-time high, while in absolute terms they are at a 27 year high, Davidson pointed out. On the assumption that the first quarter of 2008 will prove to be the lowest point for US housing starts, so should share prices of US home builders be at their lowest for this cycle, he argued.
Francis Scotland, Director Global Macro Research at Brandywine Global Investment Management, even went one step further: we yet have to see investors indulging in a China mania similar to how they embraced Japanese equities or the tech bubble in previous decades.
There’s still a fair degree of doubt about China’s economic growth and the impact on the rest of the world, Scotland believes. Once this doubt has evaporated share prices of Chinese companies, and of resources companies (prime leverage to the China story) will move beyond current valuation restrictions, he predicted.
Bottom line is, according to Scotland, if you think Chinese shares and resources stocks have appreciated a lot so far, wait till you see where the next wave of genuine investor mania will take them.
Andy Xie, once upon a time one of the super-bears at Morgan Stanley but nowadays an independent economist based in Shanghai, also argued in favour of a sustainable China success story.
Xie sees three strong pillars under the Chinese growth outlook: (1) state banks have amassed huge cash reserves which ensures there will be no credit seizures in China; (2) China’s increased trade links with other emerging economies practically ensures GDP growth will not fall below 10% per annum; (3) China’s productivity story is similar to Japan and Taiwan in the 1980s, but it will last much longer due to the country’s huge labour pool.
Xie agrees with a growing number of market watchers that a Chinese stock market correction has become likely in the next twelve months, but he also believes this will not necessarily be a bad thing for the Chinese economy.
Mark Schwartz, President of PIRA Energy Group, extended the economic emergence story of China, and other emerging economies, into the oil market, arguing investors should prepare for sustainable higher oil prices.
It is his view that a structural increase in emerging market demand is being met by only a muted supply response from the producers. Another important factor is that demand in emerging markets is not price sensitive. In other words: oil demand from emerging economies will not suffer from higher prices.
Low global inventories, significantly higher costs for finding and developing new sources of supply and an increasing involvement in the energy business by governments such as Venezuela and Russia are all supportive factors of a sustainable higher oil price, according to Schwartz.
Merrill Lynch’s David Rosenberg tried to pour a bucket of cold water over so much unbridled optimism by concluding that all major recessions since 1975 have been preceded by a clear majority of economists sticking to a positive outlook prior to the event. A table provided by him at the conference shows consensus expectations are on average some 300 basis points off the mark. Current consensus is for US GDP growth of 2.0% in 2008.
According to Rosenberg’s table, this figure may well be revised to minus 0.6% sometime next year.
However, if the majority at the conference is correct, share markets still have a lot of upside left; oil, gold and resources stocks in particular.
(The above summaries have been written from a BCA report on the conference. I was not present at the event.)