Rudi's View | Sep 04 2013
By Rudi Filapek-Vandyck, Editor FNArena
While most investors and market commentators have had their focus firmly on the Federal Reserve's intentions and on the local reporting season these past few weeks, economists and market strategists across the globe have been releasing interesting updates and predictions for equity markets and financial assets in general. This week's Weekly Insights provides a little colour and detail on a selection of such reports.
The world is changing every day and nowhere does this become more apparent than in global bond and equity markets. Economists at UBS have asked the question whether investors are genuinely catching up with what is happening behind the daily headlines that move asset prices either way. The suggested answer is, of course, no, they are not.
At least not yet.
The 21st century may well become the century when China proves to the world it is ready to challenge the US in its global economic, military and political leadership, but such a prospect is, at best, a long term outlook. In the shorter term, suggest said economists, it appears the US is setting itself up for a formidable come-back on the back of numerous technological breakthroughs.
At the same time, it is increasingly becoming clear that the growth story from yesteryear, emerging markets, is starting to show more and more cracks and internal barriers.
The combination of these two developments, suggests UBS, is setting the stage for a decade of renewed US focus, strength and leadership. In simple terms this translates into: China, Brazil, India and Russia are sooooooo yesterday. Investors better set themselves up to benefit from a stronger US economy, a stronger US dollar and stronger US profits and US share prices.
So the yanks are once again set to prove the sceptics wrong?
Yup, predicts UBS, and it is not all about hydraulic fracturing or "fracking", though this technological breakthrough is at present re-shaping the US economy and, in a broader context, the world of tomorrow.
The advances are significant. Report UBS economists: "Since 2007, rising domestic production has halved the price of natural gas for American consumers, in contrast to a doubling of the domestic price of gas in Western Europe. US production of crude oil has risen 43% in the past five years, pushing the US to the world's second largest producer of petroleum and helping to narrow its energy import bill by over a quarter since 2008".
Supported by the new developments of "fracking" and the development of tar sands in Canada, UBS is brave enough to predict higher economic growth for the US in 2014 -on average 3% compared with mostly numbers below 2% thus far- starting in the second half of 2013, which is pretty much now. And inflation is projected to remain lower than it has in the past.
Outside the US, today's changes taking place have the potential to keep inflation 100 basis points below the historical norm while adding an economy of the size of Switzerland (0.5-0.7% of global GDP) each year in additional growth for the decade ahead. If these projections come to fruition, corporate profits on average could be 5% higher.
This is not just a story about cheaper energy through "fracking". UBS points out there are numerous other technological advancements that may not be on investors' radar just yet today, but these new technologies have already started to re-shape the global economy. Additive manufacturing, otherwise known as "3D printing", advanced robotics, mobile technologies, and cloud computing; these new technologies all improve productivity while assisting in achieving cost savings. The end results could be quite spectacular.
Reports UBS: advanced robots could work 24/365, for as little as US$4 per hour. 3D printers could remove 90% of the waste from some manufacturing processes and save more than 50% from production-related energy bills.
As things stand, the US should be one of the main beneficiaries. Says UBS: "That's because of the US' favourable cyclical position, superior access to debt and equity capital, as well as a comparative advantage in the production of new technology. Accordingly, the US dollar will benefit from capital inflows seeking high returns from innovation. Equally, the dollar ought to be supported by the structural improvement in the US current account balance as energy imports fall owing to increased domestic production."
Economists at Macquarie do not disagree with the prospect of yet another US ascendency, but they prefer to take a slightly different tack than their peers at UBS. Macquarie sees a schism opening up between developed countries and emerging economies, in favour of the come-back kids in the US, Europe and Japan. Again, the underlying message could well be translated as: China and Asia are sooooooo yesterday's news.
Note also: AMP funds management recently decided to reduce its global exposure to emerging markets to zero.
In what may come as a surprise to many among you, Macquarie has been upgrading its growth forecasts for troubled Europe to 1.2% for this year with the caveat that GDP growth prospects for 2014 and 2015 look a lot better. This is supposed to be the continent that was never ever again going to fix itself, remember?
Macquarie is not on the same level as UBS when it comes to prospects for US economic growth in the years ahead, but there's a similar theme that underpins the outlook ahead: things are improving and they will get better still. In the meantime, foresees Macquarie, emerging markets are susceptible to more negative shocks and will be facing some serious policy challenges. "We expect the divergence in developed world/emerging world economic performance to be a dominant theme over the remainder of this year, resulting in further unsettling capital flows for many emerging market economies".
Market strategists at BA-ML have studied assets, yields, returns and various financial assets since 1800, and have drawn some conclusions too. The first one might come as a surprise, given the above and the ongoing positive sentiment towards US equities, but BA-ML states firmly "History does not suggest significant upside to US stock indices from current levels, especially given the absence of a meaningful correction in the equity market in past 18 months."
Here's another one (that will no longer surprise given the above): "The secular outlook for EM [Emerging Markets] looks less compelling than that of Developed Markets, as the twin-drivers of the 15 year bull market, lower interest rates and higher China/commodity demand, are reversing".
On a relative comparison, BA-ML believes US equities have likely commenced a period of relative outperformance vis-a-vis equities in Australia (same vis-a-vis Canadian equities).
Similarly fitting in well with the forecasts published by UBS and Macquarie, BA-ML reports "The US dollar looks very attractive to a longrun contrarian investor. We expect the US dollar index to trade back up to its long-term average of 100." (This means the years ahead should see tremendous downward pressure on the AUD).
BA-ML has been on the lookout for the so-called Great Rotation -out of government bonds and in equities- for a while and has no hesitance today in stating this Great Rotation has started in 2013. In the 1940s, 50s, 60s and 70s, US government bonds had negative returns when adjusted for inflation, note the strategists.
The study tries to pin down long term secular trends and concludes that secular contrarians today should be buying Equities, Europe, Japan, Banks, Utility and Telecom stocks while selling (or avoiding) Gold, Bonds, Emerging Markets, Consumer Staples and Discretionary stocks.
Inside this framework, global asset allocators at Citi look a bit like contrarians on a mission, arguing the best places to park investment funds for the year ahead are equities and cash. Citi also argues it seems as yet too early to wave goodbye to government bonds (while not disputing the fact the 30 year bull market has ended), while commodities are projected to generate a negative return until mid-2014 with Citi remaining of the view that underlying market fundamentals remain bearish, except, maybe, for nickel and palladium.
Citi is in particular negative on copper and on iron ore. Note the likes of Macquarie have also recently reiterated their negative outlook on copper.
If Citi's projections prove correct, returns from global equities over the next twelve months shall rise to circa 17% and while risks are rising for Emerging Markets, Citi remains a fan on the basis of relatively cheap valuations, projecting a return of 25% for the year ahead.
Asset allocators at Macquarie, not the same guys as those behind the economists' desk, hold a view which is closely correlated to the opening gap between developed and emerging economies. At the basis of their view lies a belief that the recent outperformance of developed over emerging markets has "much further to run". The macro theme is expected to play out in global fixed investment trends which implies investors will be better off seeking exposure to capital goods companies in developed economies (such as GE and Siemens) as well as companies such as Germany's SAP that are highly leveraged to corporate spending, while avoiding companies that will suffer from overspending in the resources sector, like mining services providers.
As everyone can see from the paragraphs below, Asset allocators at Macquarie are not in favour of directing more funds towards Emerging Markets:
"Emerging markets are feeling the hangover from a decade-long boom. The structural drivers were a rising middle class, urbanisation and technology catch-up. These will continue."
However,
"The boom was also fuelled by cheap US dollars and rising commodity prices. Expectations of QE3 tapering have seen the tide of money flows shift away from emerging markets, and back to the US. The commodity boom has also been fading since 2011. We think these cyclical headwinds will continue to offset the structural attraction of emerging markets."
As shown by Asset Allocators at Citi, not everyone is equally convinced just yet, but if this year's rotation towards equities in developed markets is indeed going to dominate the decade ahead, then maybe most investors (and market commentators) are today focusing on the wrong Big Rotation?
(This story was written on Monday, 2 September 2013. It was published on the day in the form of an email to paying subscribers).
P.S. According to my Twitter feed (thanks to Chris Weston at IG Markets) strategists at UBS at present are Overweight equities, Underweight fixed income (as curve normalises), cautious/neutral EM and Underweight commodities (the super cycle is over).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)
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THE AUD AND THE AUSTRALIAN SHARE MARKET
I have been researching and writing an eBooklet titled "The AUD and the Australian Share Market". From late July onwards this eBooklet has become part of the bonus package that comes with a 6 or 12 months paid subscription to FNArena. If you are not as yet a paying subscriber, maybe now's the time to consider joining?
My previous eBooklet (see below) is also still included.
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DO YOU HAVE YOUR COPY YET?
At the very least, my latest e-Booklet "Making Risk Your Friend. Finding All-Weather Performers", which was published in January this year, managed to accurately capture the Zeitgeist.
All three categories of stocks mentioned in the booklet are responsible for the index gains post 2009 and this remains the case throughout 2013.
This e-Booklet (58 pages) is offered as a free bonus to paid subscribers (excl one month subs). If you haven't received your copy as yet, send an email to info@fnarena.com
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Rudi On Tour
– I am scheduled to present to members of AIA NSW North Shore at the Chatswood Club on Wednesday 11 September, 7.30-9pm
– I have also accepted an invitation to present to ATAA members in Canberra in late November
– I might give my final presentation for the year at the ASA's Sydney Investor Hour in December