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Investment Markets in 2011The holidays are over. In between the chocolates, fairy cakes and biscuits, Ihave had the chance to do an unusual amount of reading (which only comesreally at this time of year). As a result, (in addition to the turkey), I haveabsorbed and digested economic reports and news to the point that I haveformed a world and investment market view.The key investment market trends of the year will be symptomatic of theunderlying macro position and changes in the global economy.Macro1. Two-speed global economyThe rapid growth in the BRIC economies and the emerging world will continuewith China acting as an engine and largest source of demand forcommodities. Growth pains will be felt in China in particular with inflationarypressure a key metric, note the recent sneaky hike in base rates beforeChristmas whilst the rest of the world was distracted.These pains will continue to be addressed through government policy which isaware of the need to develop stronger internal markets, consumer spendingand local development as a gradual shift away from the export led economicmodel. RMB devaluation will continue – at a snails pace.Developed world economies in Europe and the US will find some stabilitypost-crisis but with high levels of unemployment, public sector budget cutsand low levels of inflation from spare capacity continuing to supply dis-inflationary pressures. The US will have a good ear with stronger growth than2011, the UK will likely under-perform as a result of ʻfront loadedʼ spendingcuts in 2011 so that the coalition government has 4 years in office if it goeswrong.The global imbalance of spenders and savers persists. Trade imbalancesbetween developing and developed world also still persists and will do so forthe next 5-10 years. This will present additional challenges to developed worldeconomies (US, Europe) in reducing trade and budget deficits and todeveloping countries in stimulating domestic consumption.2. Demand-led commodity price rally (...with isolated supply shocks)The rapid growth of EM and large BRIC economies in particular will feed thecommodity price rally in 2011. This, coupled with continued supply shocks incertain markets (cereals, oil, iron ore) will see continued price rises for keycommodities.
This is coupled with dollar weakness and concerns over the expansion of theglobal monetary base will see metals such as gold, silver and bronze continueto appreciate. Gold may strike $1500 in 2011 with Silver laying catch-up.Whilst the global demand for commodities is unbalanced, the global price isthe same. To this end, the developed world economies will have to pay higheroil and cereal prices as a result of the rising demand in the developing world.This will provide some inflationary pressure and has the potential to create astagflationary environment. However, given that there is some 25% sparecapacity in European economies in particular from 2007 levels, this may becontained.3. Developed world de-leveraging (...and developing world leveraging)De-leveraging at the household, corporate and sovereign level coupled withhigh unemployment will continue to sap aggregate demand in the developedworld which will in turn hold back economic growth below trend.The bond market will continue to attack those economies which have weakfiscal positions with Portugal and Spain to be tested in Q1 2011. The effect ofausterity measures in European economies will start to be seen in 2011 withkey tests for GDP in Q1 and Q2. We will know the results of these tests inApril and July respectively with higher market volatility across asset classesaround these dates.If growth starts to weaken markedly, 0.25% change or higher, markets willenter a period of volatility similar to 2008. Key measure of market volatility willbe the CBOE Vix Index.The potential for further financial shocks within the banking system shouldalso be monitored carefully as a result of continued deleveraging. Variousgovernment support mechanisms will be withdrawn in the UK and Europe in2011 that will see banks forced to seek new sources of liquidity.Lending to both households and corporates in developed world will remainsubdued compared to 2006-7 levels. A lot of the so-called new lending isactually refinancing of outstanding loans to existing borrowers through newloans. This enables banks to project their ʻwillingnessʼ to lend whilst keepingtroubled loans on life support, claiming higher interest rate margins in theprocess and not extending credit to new, higher risk borrowers (which is goodfor their bottom line).2011 will see the continued use of leverage and credit expansion in thedeveloping world and in the BRIC economies in particular.
This will be closely monitored by central banks but is a necessary part of thedevelopment of consumer spending and the consumer class. Inevitably, creditmarkets will either expand too quickly or too slowly which will provide shocksbut these will most likely be seen in 2012 and beyond rather than in 2011.Investment MarketsThe global macro position will feed the performance of various investmentclasses in 2011. The strongest trends will be;1. Rising commodity prices (cereals, oil, metals)2. Emerging market outperformance (debt, equities)3. Weakening of developed sovereign fixed income markets4. Use of covered bond market by banks as source of liquidity5. US equity market rally as the little guy returnsInvestment Capital will be attracted to;1. Emerging markets (all classes)2. Commodities and commodity producers3. Technology (hard, soft, web)4. Real assetsThese classes and markets can all be defined as representing real change.Real development of markets, real output of products and real development oftangible technologies.This is in contrast to the largely superficial credit driven prism of developmentand change from 2002 to 2007. This therefore represents a desire from themarket to acquire real assets or have exposure to real development.2011 WinnersEquities Winners:EM, Mining, Metals, Energy, Tech, Security, TelecomsEM economies should continue to post 5%+ growth rates in 2011 and will bethe major source of global growth. As a result, the stock markets of EM will dowell as investors continue to buy into the growth as part of a re-weighting ofwestern portfolios.Mining, metals and energy stocks will do well broadly as a category on thebasis of continued and rising demand from the BRIC countries as well asgrowing EM for the underlying commodities these produce. Of course, sectorwill see individual winners and losers – note continued recovery in BP shares.
Technology and telecoms will do well as categories because there is realinnovation that is rewriting many of the old rules of IT. We used to talk of oldeconomy and new economy companies. Now, I believe we can talk of oldand new tech companies. Old tech companies would be Dell, Microsoft,Cisco, AT&T whilst new tech companies would be twitter, RIM, Facebook,Apple.Needless to say, I believe new tech companies can be defined as those whospecialise in wireless, device based technologies that offer users the ability toconnect to social networking sites as well as communicate on the move.The old tech companies are those who offer users mainly fixed location (pcbased) IT services from software to hardware.New tech company equities will do well at the expense of old tech in 2011. Forinstance, in 2010, shares in HMV fell by 70% as they failed to adapt theirbusiness model quickly enough to online based services.Commodity Winners:Cereals (wheat, soy) oil (crude) and metals (gold, silver) Iron ore, copper,bronzeCereals will further rise in price in 2011 driven by supply shocks as well asrising demand from developing Asia. Similarly, China, India and Brazil arevery thirsty with their annual demand for crude oil incasing faster than thepossible rate of production. This will see further pressure on oil prices toabove $100 per barrel and probably between $100-120.Gold and silver will continue to do well as investors continue to price the riskof inflation after the large monetary expansion of the last few years. QE2 hashelped drive gold higher and it will be the safe haven off choice during anymarket shocks during the year. Whilst the market may worry that gold has hada good rally over the past 18 months, investors will be tempted to also investin silver.Iron ore is necessary for steel production which will also have a good year in2011 as the US economy has a stronger year than in 2010. Also, continueddemand from developing EM markets will feed demand for this, copper andbronze.Fixed Income Winners:EM, Covered Bonds, E-bondsWhilst EM credit has performed exceptionally over the past 18 months as anasset class (EMBIG index) investor appetite for exposure to the developingworld will continue to grow in 2011.
Portfolio managers will continue to increase their investment allocationtowards this asset class. The average US pension fund (the US has about80% of the worlds investable capital) has about .5% invested in EM. Thepotential for increase is huge.Covered bonds will have a fantastic year and beyond as it will be theinstrument of choice to commercial and investment banks which will continueto rebuild their balance sheets and de-lever. The debt security is popular withinvestors because it offers a rated position against real bank balance sheetassets, including in bankruptcy. This is opposed to securitisation, which istypically off balance sheet and does not offer investors recourse to issuingbank assets.The launch of e-bonds by the EU via the European stability fund and othernewly created institutions will be popular with global investors, especiallysovereign wealth fund from the ME and Asia. The bonds offer a 100-200 basispoint (1%-2%) spread to German bunds (German government issued bonds)and are guaranteed by the EU.Currency Winners:RMB, RUB, Euro, JPYAlternative Winners:Commercial real estate, data services, telecom hardware2011 LosersEquities: Consumer goods, Banks, Durable goodsFixed Income: Gilts (US, UK, Eurozone)Currencies: USD, GBPLets see in December how I did!Have a great year!Malcolm