Fed Switch From QE to Forward Guidance, as China Starts Belated
Deleveraging in 2014

Sean Maher
Strategist
sean.maher@ent...
Given Scale of Fed Balance Sheet, Delaying Exit Much Longer Dangerous
$3.9trn into GEM Debt and Equities Since Crisis, $2....
Markets Face Pivotal Moment by Mid 2014 – Does QE Work in Real Economy?
US Credit Spreads at Post Crisis Lows, USD Biggest...
Investor/Corporate Liquidity Preference Has Peaked –1990s Style Asset Bubbles?
Technology Absorbing CPI Pressures by Suppr...
How Much of Falling US Participation Rate is Structural?
Full-time employment/population ratio bottomed at 46% in January ...
Fiscal Deficit Sub 2% of GDP in FY2015 – State/Local Hiring Budgets Growing
Inequality Key Structural Theme Globally - Sha...
Korea Vs. ASEAN Bet in Q3 Paid Off, as Did China Banks and AXJ Tech
Global Cyclical/Defensive Mean Reversion as ‘Low Volat...
Favour GEM to DM Exporters Over Domestic Consumer , Strong USD Beneficiaries
Japan and Europe Equities Over US, GEM Inflow...
Weak US Corporate Investment a Drag on Recovery, But Acceleration Looms
High Correlation With Employment Growth – Surveys/...
US/Europe Fiscal Drag Eases in 2014, Boosting Global Trade
GEM Underperformance on loss of GDP and Earnings/Margin Momentu...
BOJ Injecting 16% of Annual GDP into Asset Markets, 3x More than Fed
Wage Inflation Critical or ‘Abenomics’ Will Backfire ...
Modest 1-1.5% Recovery in 2014 – Credible Stress Tests Crucial, New LTRO?
Loan to Deposit Ratios Unsustainable – Credit Co...
Plenum Marked Decisive Shift in Pro-Market Direction, RMB Overvalued?
Pressure to Accelerate Convertibility – But Needs De...
Productivity Growth Falls to 7-8% as Investment/Output Ratio Soars
Boosting Productivity From 17% of US Levels Key - SOE C...
External Balances and ‘Stickiness’ of Capital Flows Matter Again for GEM
$3.9trn in GEM Inflows Since 2009, Largely in Deb...
US Biggest Non-OPEC Oil/NGL Producer by mid-2014 at 11m bpd
Over Past Decade, 50% of US Trade Deficit Was Energy Imports –...
Stagflation Trend Until Post Election - INR Fair Value 60 on Productivity Adjusted Basis
Key is Private Investment Rebound...
Structural Investment Themes
Intelligent Machines, Mobile Web, Safe Food, and Chinese Wealth Dispersal

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‘In...
Lower US/Europe Fiscal Drag in 2014, Low US Energy Costs Underpin Growth

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A global resynchronization in...
Macro Summary
Recommendations as Tilt Versus Strategic Benchmark/Single Class Limits or Long/Short
For Absolute Return Inv...
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2014 Global Macro Outlook - Nov 2013

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Transcript of "2014 Global Macro Outlook - Nov 2013"

  1. 1. Fed Switch From QE to Forward Guidance, as China Starts Belated Deleveraging in 2014 Sean Maher Strategist sean.maher@entext.com + 44 207 687 2213 Nov 2013
  2. 2. Given Scale of Fed Balance Sheet, Delaying Exit Much Longer Dangerous $3.9trn into GEM Debt and Equities Since Crisis, $2.2trn to Asia • • • • • • • Global broad money M2 up $3trn YTD to end September (annualised 6% growth) of which $2trn in GEM; global CPI inflation index up by only 2% - excess liquidity driving asset prices Late stage bull market? – watch for frenzied US momentum tech trades on 100-200x PERs reversing (Tesla, Amazon, Netflix) PCE inflation well under 2%, real risk of delay is growing market dysfunction, disruptive credit spread volatility - $4trn balance sheet makes Fed solvency questionable on normalization - IMF estimates Fed losses in most likely rate normalization scenario would amount to about 3% of GDP, or $500bn. 2% interest by 2015 on current excess reserves is $44bn annually i.e. slowing down money velocity will be expensive once inflation expectations rise above 3% - interest payments plus capital losses on LT bond holdings would require Fed recapitalisation, a huge political problem One strategy would be to reduce duration of bond portfolio with a ‘reverse Operation Twist’, using the short-term bonds obtained to mop up excess reserves, much like the BOJ did in 2006 - average maturity on Fed balance sheet about 10 years – versus 6 years for overall market. Blurring of lines between central banks and governments, led by Japan – shift globally to Nominal GDP targeting? ECB and BOJ likely to ease further in 2014, to counter inflation target undershoot - short JPY/Long Topix trade to resume in Q1 Fed likely to shift to rules based forward guidance from QE as policy focus in early 2014, to cap LT rate expectations while diminishing near-term asset bubble risks Sean Maher Q1 Economic & Strategy Outlook Market Overview Almost $2.4trn in Excess Bank Reserves at Fed – Over 60% of Balance Sheet by Year End 2
  3. 3. Markets Face Pivotal Moment by Mid 2014 – Does QE Work in Real Economy? US Credit Spreads at Post Crisis Lows, USD Biggest Loser from Debt Ceiling Scare Gold Weakness Driven by ETF Liquidation, EM Demand Pressured from India to Turkey Junk/IG Spread At Lows, Gold Struggles 500 450 400 350 300 250 2 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 22 18 14 10 200 Barclays US Agg Credit Option Adjusted Spread % (lhs) Gold Spot Price ($) (lhs) Junk/IG Yield Spread (bps) (rhs) VIX Index (rhs) S&P 500 Companies Boosting ROE Via Buybacks Rather than Capex Will USD Strength Resume in 2014? 122 118 15 114 (4Q through Q2 13) 20 Macro Overview 1950 1850 1750 1650 1550 1450 1350 1250 1150 1050 VIX Spike Reversed by QE For Longer 10 5 110 0 106 ROE % Earnings FCF Sales Growth Reinvestment Reinvestment % (annualised) Rate % Rate % JPM Asian Dollar Index Sean Maher Q1 Economic & Strategy Outlook 3
  4. 4. Investor/Corporate Liquidity Preference Has Peaked –1990s Style Asset Bubbles? Technology Absorbing CPI Pressures by Suppressing Labour ULC as well as Investment Costs YTD Equity Inflows Outpacing Bond for first time since 2007 ($350bn versus $170bn) • • • • Bubble risks advanced in corporate credit (esp. Europe), US social networking stocks, prime Asian real estate – US HY net leverage at 3.8x, over 10% above LY average Fed obsession with employment/output gap framework misguided – structural shifts in income distribution, demographics and employment intensity of growth being ignored Further equity re-rating above LT CAPE trend likely if liquidity preference declines further – US liquid assets rose from 9% to almost 13% of total household assets, now declining and flowing into markets, combined with excess global liquidity S&P 500 revenue growth running at just 3.5% annualised – yet consensus 15.4% operating EPS growth in 2014 Market Cap./GDP at 1.12x, price/sales ratio at 1.6x, EV/sales 2.3x – latter only exceeded in 1999; margin debt over $400bn, testing July 2007 highs Sean Maher Buyout Median EBITDA Multiples Above 2008 Highs 10.7 10.0 9.0 9.1 9.5 8.1 7.7 8.0 6.2 3.4 3.3 8.1 8.5 8.5 4.5 3.8 3.0 3.5 6.0 3.8 3.2 3.9 2.2 4.0 5.1 2.0 5.6 5.8 5.7 4.0 3.9 4.6 4.7 5.3 6.2 Bubble Trouble? • 0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 YTD Debt/EBITDA (x) Equity/EBITDA (x) Valuation/EBITDA (x) Q1 Economic & Strategy Outlook 4
  5. 5. How Much of Falling US Participation Rate is Structural? Full-time employment/population ratio bottomed at 46% in January 2010, 47.7% now Lower Immigration, Retiree Surge and Later Workforce Entry Supply Side Factors Weak US Workforce Participation Rate Complicates Fed Exit Strategy US Workforce Growth Declining on Demographics/Slower Immigration 69% 79% 67% 78% 4% 3% 65% 76% US Labour Market 77% 2% 63% 75% 1% 61% 74% 59% 73% 57% 72% 0% -1% Employment-Population Ratio 12mma (lhs) -2% Civilian Participation Rate 12mma (lhs) Civilian Participation Rate of Men Over 20 Years Old 12mma (rhs) Total Civilian Labour Force (3yr % growth saar) Total Civilian Employment (3yr % growth saar) Sean Maher Q1 Economic & Strategy Outlook 5
  6. 6. Fiscal Deficit Sub 2% of GDP in FY2015 – State/Local Hiring Budgets Growing Inequality Key Structural Theme Globally - Share of US employees earning sub $15k in real terms at 13% up 2ppts since 2000 - share making less than $35k grew 4ppts to 35.4% 50% 48% 9% 46% 55% 50% 45% 40% 35% 30% 11% 7% Top 10% Income Share (Excluding capital gains) Top 10% Income Share (Including capital gains) Healthcare Inflation Slowing to 1-2% 44% 5% 450 350 250 42% US Structural Themes Top 10% Income Share at Record High Wage Share of GDP at Record Lows 3% 150 50 Wage and Salary Disbursements (% GDP 12mma) (lhs) Corporate Profits After Tax (% GDP 12mma) (rhs) Overall Urban CPI Index (1982-84 = 100) Healthcare CPI Index (1982-84 = 100) Sean Maher Q1 Economic & Strategy Outlook 6
  7. 7. Korea Vs. ASEAN Bet in Q3 Paid Off, as Did China Banks and AXJ Tech Global Cyclical/Defensive Mean Reversion as ‘Low Volatility Anomaly’ Sectors Overshot GEM Investors Rediscover Relative Macro Risks in Portfolio Differentiation – Bet on Capex Rebound? Defensive Yield to Cyclical Switch Has Legs, GEM Volatility to Resume S&P 500 Stretched Vs. Japan, Europe 2.8 115 6% 110 4% US 0% 100 -2% 95 -4% 90 Price to Book x 2% 105 Australia World 2 UK 1.6 Eurozone -6% GEM Sing Japan HK 85 -8% 80 Sector/Style Rotation 2.4 -10% 1.2 0.8 3 Global Cyclical - Def Spread (RHS) Emerging Markets (Jan 1 2013 = 100) (LHS) Sean Maher Q1 Economic & Strategy Outlook 7 11 Trailing ROE % 15 7
  8. 8. Favour GEM to DM Exporters Over Domestic Consumer , Strong USD Beneficiaries Japan and Europe Equities Over US, GEM Inflow/FX Volatility to Resume Low Volatility Has Hit Macro Hedge Funds, Particularly in Commodities/Bonds – Volatility Looks Cheap • • • • • Citi US surprise index rolling over, but truck tonnage in September hit all-time high, up 8.4% y/y - US corporate credit option adjusted spread at post-crisis lows Large portion of EM portfolio flows this cycle from dedicated global EM funds and large ‘Total Return’ style global bond strategies, rather than banks – total inflows 5% of EM GDP Risks highly correlated ‘risk off’ episode when Fed finally tightens - EMD has recouped about half summer losses – EM feedback to Fed policy via S&P earnings/exports complicates monetary policy further Underweight commodity terms of trade losers – deteriorating external balances combined with consumption/real estate booms a risk from Brazil to Indonesia and Australia, potential banking sector funding cost if inflows reverse Trend strengthening in USD will draw capital out of Asia, Japanese AXJ reallocation sufficient to offset? Scale and timing of RMB convertibility key factor – early opening of capital account could add further excess liquidity to regional markets Sean Maher Excess Returns by Asset Class 20% 15% 10% Asset Allocation • 5% 0% -5% -10% -15% 1 year Q1 Economic & Strategy Outlook 3 years 5 years 8
  9. 9. Weak US Corporate Investment a Drag on Recovery, But Acceleration Looms High Correlation With Employment Growth – Surveys/Replacement Cycle Positive Capex 53% of NIPA Profits in 2012, 68% Average Since 2002 – Mean Reversion on Replacement Cycle? US Corporate Net Cash Flow as % GDP Has Surged, Led by Tech Sector US Corporate Investment Intentions and Job Openings Turn Higher 14 30 25 12 20 20 10 15 8 10 But Corporate Investment Still Weak… 16% 8% 0 5 -10 0 -5 -20 % GDP 7% -10 14% 6% -30 -15 12% 5% 4% 10% 3% US Capex Corporate Net Cash Flow as % GDP 12mma Index % y/y 10 -40 -20 8% 2% Non-Residential Fixed Investment (% y/y SAAR) Total Nonfarm Job Openings % y/y 3mma Private Residential Fixed Investment Government Fixed Investment Private Nonresidential Fixed Investment - rhs Sean Maher Philly Fed Future Corporate Capex Diffusion Index (6mma) Q1 Economic & Strategy Outlook 9
  10. 10. US/Europe Fiscal Drag Eases in 2014, Boosting Global Trade GEM Underperformance on loss of GDP and Earnings/Margin Momentum, Reform Paralysis FX Reserve Growth Just 5% in 2012 - BOP Focus as Terms of Trade for Commodity Exporters Slump • • • • GEM EBITDA margin at 16% now sub DM - 3 and 6mth GEM earnings revisions still negative as is revision breadth, but improving at margin – P/B at 1.4x and CAPE at 16.5 x (versus US at 23x) offers support – Europe cheaper but limited LT growth Historically high return on EM labour vs. capital undermined productivity growth, which has been falling everywhere, while earnings driven by top-line growth rather than by expanding margins has created poor capital discipline. Resources account for 40% of GEM equity earnings – secular bull market now over, driving soft earnings momentum Sustained QE destabilising EM economies with pegs to the USD, BOJ action hasn’t added to portfolio inflows yet – bank credit quality deteriorating Net $28bn in EM debt outflows since May, resumed in recent weeks – 5% correction in GEM real exchange YTD only beginning of trend Sean Maher DM Structural Budget Balance Adjustment Easing in 2014 ex Japan (% GDP) 2.3% 1.8% GEM Debt & Equities • 1.3% 0.8% 0.3% -0.2% -0.7% Q1 Economic & Strategy Outlook 2013 2014 2015 10
  11. 11. BOJ Injecting 16% of Annual GDP into Asset Markets, 3x More than Fed Wage Inflation Critical or ‘Abenomics’ Will Backfire – Cash Wages Down 0.6% y/y LT MSCI World Relative PER Premium on Topix Normalised at 16-17k – 110 JPY Target end Q1 • Cash Wage Growth of +0.5% y/y Probably Requires Unemployment Sub 3.5% • Female Participation Rate Rising, Still Sub 49% – Key To Reducing Demographic Drag • Bank lending at 4-year high but limited credit demand; key measure of success is whether private investment accelerates into 2014 Households Invested for Deflation 7.0% 900 Euro Area (€19.3trn) 35.8% 600 9.5% 14.4% 3.2% 32.8% Japan (JPY 1,547trn) -300 -600 55.2% 0% 20% 28.1% 4.0% 2.1% 0 31.7% 11.8% United States 14.6% ($54.4trn 300 3.9% 7.2% 6.8% 40% 60% 4.2% 27.7% 80% Currency and Deposits Stocks Net Flow 12 Week MA - JPY Bn Bonds Net Flow 12 Week MA - JPY Bn Sean Maher Japan Will Japanese Investors Return to Foreign Markets? Bonds Investment Trusts Shares and Equities Insurance and Pension Reserves 100% Others Q1 Economic & Strategy Outlook 11
  12. 12. Modest 1-1.5% Recovery in 2014 – Credible Stress Tests Crucial, New LTRO? Loan to Deposit Ratios Unsustainable – Credit Contracting at 4% y/y Bank Assets 375% of GDP Vs. 160% in Japan, 75% in US, Bad Debts 8% of Loans in Italy, 12% in Spain • • • Bank Loan to Deposit Ratios 120% in Italy/Spain, vs. 70% in Asia/US – Eurozone GDP Almost 3% Below Pre-Crisis Peak, but 1-1.25% Growth in 2014 German ‘Grand Coalition’ Unlikely to See Austerity Relaxation, But Fiscal Drag Peaking; Bundesbank wants removal of zero risk weighting on sovereign debt Political Risks Receding – Backlash versus Golden Dawn in Greece/Berlusconi in Italy French Spreads Over Bunds to Widen by 50-100bps in 2014? German Trade Surplus Near Record 11 750 650 550 450 350 250 150 50 -50 -150 -250 -350 -450 9 Current Account % GDP Spanish Eurosystem Liabilities Down Over €160bn Since mid-2012 7 5 3 1 -1 -3 -5 Europe • -7 China Sean Maher US Germany Finland Greece Netherlands Q1 Economic & Strategy Outlook France Ireland Portugal Germany Italy Spain 12
  13. 13. Plenum Marked Decisive Shift in Pro-Market Direction, RMB Overvalued? Pressure to Accelerate Convertibility – But Needs Deeper Bond Markets (only 45% of GDP) Investment 56% of GDP Growth in Q3 as House Prices Accelerated in Tier 1 Cities • Average Price/income ratios from 12x (Shenzhen) to 15x (Shanghai) and 22x (Beijing) versus 5x in Singapore, 7x in London/NY and 9x in Sydney - real estate 25% of fixed investment • Leverage heading toward 250% of GDP by 2016/17 on current trend, pace of domestic investment growth must slow 57ppts to mid-teens; external demand pick-up key to deliver even 6-7% growth during the transition 20% RMB Real Appreciation Since 2010 a Drag on Growth 120 Property Price Boom Destabilizing 24 21 18 112 15 108 104 China REER (Jan-2010 = 100) 116 12 100 9 96 92 6 88 3 84 80 0 -3 China Indonesia India Korea Malaysia Singapore Thailand Brazil Russia Tianjin Guangzhou Shenzhen Sean Maher Big 5 Average Beijing Shanghai Q1 Economic & Strategy Outlook 13
  14. 14. Productivity Growth Falls to 7-8% as Investment/Output Ratio Soars Boosting Productivity From 17% of US Levels Key - SOE Capex/Sales Ratio at 10% Peaking 45% of Debt ST Vs. 33% in non China AXJ – 50% of Listed Stocks Have Sub IG Credit Profile 6 5.2 5 3.9 4 3.2 3 2.7 3.2 2 1 0 2009-2012 1961-1970 1981-1990 1981-1990 1991-2012 China Japan S. Korea Taiwan Investment Ratio (%GDP) GDP Growth % Investment/Output Ratio x China 5 Industrials 4 Materials 3 Real Estate Median NonFinancial 2 1 Energy Consumer Discretionary 0 0 5 10 15 EBITDA Interest Cover (x) 20 China FCF/Debt Cover A Third of AXJ China GDP Drivers (% Growth) 25 30% 3.0 1997-2002 Capital Labour (Quality Adjusted) 2003-7 2008-11 3.5 4.3 3.9 2.5 - 3 25% 2.5 20% 2012-17 1.6 1.3 1 0 - 0.5 2.0 2.5 6.6 4.8 2.5 - 3 GDP 7.6 12.1 11.5 6 - 7.5 TFP as % of GDP Growth 33 54 51 35 - 40 Sean Maher 15% 10% 1.5 TFP China - Productivity 60 50 40 30 20 10 0 Cyclicals Remain Vulnerable to Reform Led Slowdown in 2014/15 Gross Debt/EBITDA (x) Collapsing Investment Returns Force Growth Model Shift 5% 1.0 0% China AxJ ex China Europe US Median Gross Leverage (x, lhs) Median FCF/Total Debt (%, rhs) Q1 Economic & Strategy Outlook 14
  15. 15. External Balances and ‘Stickiness’ of Capital Flows Matter Again for GEM $3.9trn in GEM Inflows Since 2009, Largely in Debt – EM FX Volatility to Resume in Q1 Indian and Indonesian Current Account Rebalancing in 2014? • • • • Since 2008 bank inventories of EM assets have shrunk more than 70% to about one day’s trading volume - combined with ‘one click’ ETF flows, makes risk-off episodes inherently more violent and correlated Markets with trend credit/GDP ratio rising, inflation above trend are going to face sustained volatility i.e. Turkey, India, South Africa, Indonesia, and Brazil Thailand, Malaysia adjustment to be absorbed mostly by currency depreciation rather than by broader economic and asset market disruption. Negative feedback loop focuses on currency weakness driving inflation dynamics and challenging the credibility of central banks – stagflation environment persists from India to Indonesia and Brazil Moderate improvement in EM PMIs in recent months, but level remains relatively low and China has disappointed - watch for improving Indian/Indonesian trade data to offer INR/IDR support in Q1 Sean Maher FX Investors Fled Funding Vulnerability 6 30 20 4 10 2 0 0 -10 -2 -20 -30 -4 -40 -6 GEM FX • -50 -8 -60 Current Account Q213 (%GDP, 4Q sum) Net International Position % GDP Q1 Economic & Strategy Outlook 15
  16. 16. US Biggest Non-OPEC Oil/NGL Producer by mid-2014 at 11m bpd Over Past Decade, 50% of US Trade Deficit Was Energy Imports – Long Term Trend USD Positive China Now Biggest Importer - Needs Urgent Energy Pricing Reforms To Curb Pollution • US Oil Production at 8.2m bpd next year – Rising Auto Fuel Efficiency Reducing Consumption • China consumes about 35-40% more energy than Korea, 2x Brazil at comparable income levels • Iranian crude exports halved after the EU/US sanctions in mid-2012, cutting revenues by over $35bn a year – return to market by mid-2014? China's Energy Intensity Unsustainable Net Oil Imports Halve Since 2007 3100 13000 2800 12000 2500 11000 2200 10000 1900 9000 1600 8000 7000 250 200 150 100 50 1300 6000 300 Energy 14000 350 3400 Exports (ths bl/d, 4wk avg) Imports, Balance (ths bl/d, 4wk avg) 15000 1000 Energy Intensity (mt oil equivalent/$m GDP) Balance (lhs) Sean Maher Imports (lhs) Exports (rhs) Q1 Economic & Strategy Outlook 16
  17. 17. Stagflation Trend Until Post Election - INR Fair Value 60 on Productivity Adjusted Basis Key is Private Investment Rebound and Current Account – Gold Imports Have Collapsed Since May Corporate Capex 11% of GDP from 17% in 2008 – Modest Growth Rebound to 5% in FY2014 • • • • Chronic Supply Side Inflation Bottlenecks Remain – Vulnerable to renewed USD Rally State banks Risk 15% Peak NPLs – Restructured Debt Over 6% of Loans Rajan Strategy Cheered by Markets But Will Backfire if Capital Goods Output Trend Remains Dire After 15% rally, Sensex at 10-yr avg. 15x forward PER – ROE under pressure; Corporate Debt Better Bet Low Indian FX Reserves Underline Funding Risks Industrial Output Growth Weak, and Inflation Persistent 0 130% -50 120% 62.0 11% 60.0 9% 58.0 7% 56.0 5% 54.0 3% -300 52.0 1% -350 50.0 -1% 48.0 -3% -100 IIP 3mma (% y/y) (RHS) Sean Maher WPI (% y/y) (RHS) 100% -250 Manufacturing PMI (LHS) -200 90% India 110% -150 80% -400 70% -450 60% Total External Debt (USDbn) Current Account (USDbn) Reserves as % of Debt + CA (RHS) Q1 Economic & Strategy Outlook 17
  18. 18. Structural Investment Themes Intelligent Machines, Mobile Web, Safe Food, and Chinese Wealth Dispersal • • • • • ‘Internet of Things’ boom – Smartphone market maturing (c2bn globally by end 2013), but smartphone technology embedded in consumer durables and industrial machines, MEMS (micro engineered machines) – Samsung and TSMC– chip prices rising on supply discipline (DRAM, NAND) ASEAN Investment over Consumption exposure – flipside of China rebalancing is higher fixed investment share of GDP in Philippines/Indonesia/Thailand Global Internet Traffic Shift to Mobile – Currently only 15% - e.g. Baidu’s mobile search app downloads up 50% q/q, Facebook ad revenue Chinese Food Safety - Baby Formula panic likely to widen as middle class favour imported/local organic food over domestic, after spate of scandals – a third of arable land contaminated with heavy metals/pesticides China Pollution Crisis – PV solar cycle is turning after overcapacity price crash as alternative share of China/Japan energy mix surges – wind and solar 3-4% of China energy mix by 2020, global PV glut easing and prices stabilising. Global PV industry to install 42 GW this year, up 40% y/y Sean Maher • • • • • Long China Asset Gatherers/Wealth Management – capital market deepening (bonds), opening of capital account as liquidity is redirected from real estate China R&D spend – target to add 1% of GDP by 2015 or $60-70bn - recent weak manufacturing investment trend should reverse, suppliers of instrumentation, testing, laboratory equipment etc. China Industrial Automation/Robotics – driven by rapid decline in school leavers entering factory workforce, 15% compound wage growth and weakening productivity ex FDI sectors US Consumer Revival – record low debt service costs and rising net worth will offset still weak real income growth, pockets of skill shortages from industry to IT already driving a wage pick-up Short Asian Petrochem Industry - impact from US energy boom – gas 5-8x more expensive in Asia, feedstock margins far higher for US processing – excess capacity in Asia? Q1 Economic & Strategy Outlook Investment Themes Cost of capital to Rise Globally as GEM Reserve Accumulation Peaks at $9trn on Demographics 18
  19. 19. Lower US/Europe Fiscal Drag in 2014, Low US Energy Costs Underpin Growth • • • • • • • • A global resynchronization in growth plausible in 2014: the easing in fiscal drag next year alone will add 0.6 ppts to growth for G7, including more than 1.5% in the US (IMF). Business surveys suggest that ‘animal spirits’ are gradually returning from depressed levels. From the Tankan survey, to the IFO, to the Philly Fed survey, capital spending plans are being revised up. Repeated central-bank intervention has repressed market volatility, lowered correlations and given the illusion of systemic stability – but can’t tackle structural trends including technology shifts driving inequality/weak aggregate demand - ‘Financial Repression’ via QE driving asset bubbles from Asian real estate to US high yield corporate debt – but inflation still well contained globally China’s growth transition implies huge wealth transfer from state/SOEs and opening capital account - liberalising interest rates and deepening domestic bond markets key reforms – 7% GDP trend growth with downside if reforms delayed US GDP and productivity growth look set to accelerate versus Europe/Japan as share of global economy generated online soars - energy competiveness/low unit labour costs boost ‘on shoring’ trend – positive for USD on current account Japan taking huge risk with belated monetary stimulus – will ultimately backfire unless wage growth/productivity and lending also accelerate Global online economy growing 5-8x faster than offline – but China productivity can benefit in telecom, finance, retail, and education from domestic internet giants Cost of capital globally likely to rise structurally from mid-decade, as demographic dividend from China reverses, shortage of domestic deposits USD looks very cheap on LT fundamentals – test of 100 on DXY in 2014? Both ECB and particularly BOJ likely to be expanding stimulus to pre-empt disinflationary risks Sean Maher Q1 Economic & Strategy Outlook Summary Global Growth to Accelerate Toward 3.5%, 3% in US if Capex Recovers EM Export Pick-Up, But Domestic Demand Constrained by Slowing Credit Growth 19
  20. 20. Macro Summary Recommendations as Tilt Versus Strategic Benchmark/Single Class Limits or Long/Short For Absolute Return Investors Investment View Asset class Equities Trading View (3-6 months) (1-3 months) Rationale Bullish US Neutral Neutral Tes ting 1800 ERP bas ed fair value target des pite earnings downgrades - cyclical top in Q1? Europe Bullis h Bullis h Reces s ion eas ing, Target 2 balances im proving expens ive UK Neutral Neutral Dom es tic earnings expos ure preferred, res ource weighting a drag on valuation and m om entum Japan Bullis h Neutral 110 JPY/$ by end Q1 on portfolio rebalancing, s tructural reform s key for equity break out on ROE boos t Asia Pacific Bearis h Neutral O/W late-cycle s ectors (e.g. Indus trials ), Chines e banks , Korea, Taiwan - clos e Thailand/Ppns s hort GEM Equities Neutral Bullis h Valuations dis count negative earnings m om entum , particularly GEM m aterials - O/W China, Korea, CEE Fixed Income Bearish Governm ent Bearis h Bearis h 10yr Treas ury in 2.5-3% range until Fed tim etable clear Investm ent Grade Bearis h Bearis h Prefer HY to IG. US Financial bonds within IG. High Yield Bullis h Neutral Default rate at record lows offers s upport EM deb t Neutral Neutral EMBI tapering led correction was overdue, value in Indones ia, India as CA deficits peak in com ing m onths Commodities Neutral Energy Neutral Bearis h Brent fair value $90-95/bbl on overs upply, geopolitical prem ium s hould revers e in Q4 Industrial Metals Neutral Neutral Copper near m arginal cos t s upport, China data and low inventories s upporting iron ore at $100/m t Precious Metals Neutral Neutral Gold in $1100 - $1400 range - ETF adjus tm ent over but India likely to turn net s eller s o re-tes t of lows feas ible Agriculture Bearis h Neutral Overs upply near term (es p. rice on Thailand) - LT bull cas e intact on China food quality cris is USD Bullis h Bullis h Bearis h s entim ent prevails on tapering delay but breakout to 100 on DXY in 2014 feas ible - cheap on LT fundam entals GBP Bearis h Neutral New hous ing boom underway and GDP likely to grow 1.5% this year, but UK fis cal outlook challenging JPY Bearis h Neutral Cons olidating as expected s ub 100, target productivity adjus ted fair value 110 vs USD Europe Bearis h Neutral Reces s ion eas ing, but ECB will eas e in 2014 as Fed exits - target 1.25 Neutral Neutral Long pes o, INR fair value at 60, IDR s till high ris k but cheap - KRW, SGD LT bets Summary Asset View - prefer European large caps over US but getting FX Asia Pacific Sean Maher Q1 Economic & Strategy Outlook 20
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