Economic Commentary
February 2014
US and Developed Markets
The excitement in equity markets was palpable during the fourth...
The ASX Accumulation Index which was down -3.0% for the month of January. This correction was
unsurprising after...
Emerging Markets
Emerging markets have had a tough few months. First the fear that the tapering in the US would slow
The world was too optimistic towards the end of last year. The equity markets overlooked the pressure
on emerging ...
The information and any recommendations contained in this document are for the benefit of the
addressee only an...
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Simon Ibbetson Economic Commentary February 2014 - Funds Management


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This is an economic commentary by Simon Ibbetson of 359 Australia. In this commentary Simon states that it has not been a good start to the year, so much for the January effect, with losses in the month at least 3%, depending on which market. Subsequently, we have seen equity markets rebound and recover around two thirds of the losses experienced this year. (The NASDAQ is positive for the year). The forecast volatility will likely remain with this year as some of the unresolved issues which were put on the back burner come to the fore.

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Simon Ibbetson Economic Commentary February 2014 - Funds Management

  1. 1. Economic Commentary February 2014 US and Developed Markets The excitement in equity markets was palpable during the fourth quarter as the rally continued unabated. For global financial markets, the single most significant feature continued to be the Fed’s quantitative easing (QE) program. The market’s fixation on the timing of the central bank’s exit from QE was finally put to rest by the $10 billion taper announcement mid-December, at which point it appeared to have been completely priced in. The year was also characterized by the sense that a “great rotation” into equities was just beginning due to a paucity of alternatives when short rates (and for a while, even 10-year Treasury yields) seemed destined to provide investors with negative real rates of return indefinitely. Not surprisingly, bonds performed poorly, with investment grade bonds suffering their worst year since 1994. The concomitant rise in share prices resulted in significant multiple expansion as earnings growth was relatively modest. The broadening of the economic recovery in developed economies lifted earnings, but only by a relatively modest amount. Cash on companies’ balance sheets rose to levels last seen consistently in the 1960s, fuelling shareholder-friendly corporate activity. The steady stream of share buybacks and dividend increases was welcomed by stockholders. While share buybacks boosted EPS growth, the impact was a relatively modest 0.9% versus net income growth of 4.7%. Global economic growth continues to show signs of improvement, with US fourth quarter GDP growth now running at 3.2% p.a. and US consumer spending tracking ahead of estimates. In Europe, manufacturing indicators are recording their highest levels since 2011, while British unemployment is falling. In China, manufacturing indicators have slowed marginally. The European markets benefited as the euro crisis faded into the background while leaders worked on plans (unsuccessfully so far) to fix some of the structural issues that face the common currency. During the summer, European economies showed signs of having emerged from recession and positive sentiment propelled European markets and the euro higher. Indeed, investors seemed to extrapolate that the European markets would experience a rebound similar to that of the US and the ECB reinforced this belief with statements indicating they were standing at the ready, if needed. Japan also awoke from its slumber with the launch of “Abenomics,” the three-pronged plan of Prime Minister Shinzo Abe to help jump-start the Japanese economy. Although still in early days, the plan to lower the value of the yen has been successful thus far with the currency depreciating more than 15% since the start of the year and the Nikkei advancing 57%. 14th February 2014 Page 1
  2. 2. Australia The ASX Accumulation Index which was down -3.0% for the month of January. This correction was unsurprising after a very strong couple of years in the stock market, where valuation multiples have rerated sharply. So it is not surprising that the start to 2014 has been a bit rocky for markets. We think that there will be a limit to the amount of re-rating and going forward companies will need to justify their re-rating with solid earnings growth. Put another way, the beta of the market has driven the industrials in the Australian market over the last couple of years; we believe that going forward there will have to be a focus on alpha generation. Over the next month the interim results from companies and the outlooks they provide will likely show that the underlying economy is still pretty soft with some signs of life in specific sectors. The strongest performing sectors over the last month included Utilities, REITs, Health Care, Telecommunications and Materials, and the weakest performing sectors included Banks, Consumer Discretionary, Energy, Consumer Staples and Resources. The outlook for Australia moving forward is mixed. On the positive side, domestic earnings growth is emerging from a prolonged period of flat to negative growth, and the lower AUD has positive implications for some industries. On the negative side, rising inflation will challenge monetary policy and corporate cost control. This from NAB’s business survey for the last quarter. “Business confidence in the December quarter was at its highest in more than 2½ years. Business conditions lifted to their highest level in more than 12 months suggesting activity is starting to catch up – albeit still below trend. Forward indicators remain soft, including forward orders, keeping labour demand weak. The survey measures of price pressures remain muted. Special question on the impact of currency now showing increased pressures on transport but less on wholesale.” However with the currency back around the A$0.90 cents to the US dollar, and the softening of our manufacturing industry, (there is unlikely to be any investment or employment growth in the automobile sector!) the prospects of higher tax revenues are fading to a distant memory. This starts to put pressure on the spending prospects of the government and puts the government in the same dilemma as the Southern European countries. Does the government cut spending and threaten to flat line the growth prospects of our economy, or do they continue to spend, or even increase the spending to maintain the growth rate but risk the wrath of our creditors? To add to the complexity the pickup in inflation is correlated to the falling value of the A$. Now that the A$ has returned back to $0.90 the impact of inflation from this source should be muted. This does nothing to help our domestic exporters. 14th February 2014 Page 2
  3. 3. Emerging Markets Emerging markets have had a tough few months. First the fear that the tapering in the US would slow growth in the developed markets and thus impact on the developed markets demand for goods produced in the emerging markets affected both their bond and equity markets. This was followed by sustained pressure on emerging market currencies. The “fragile five,” Which are some of the largest emerging market economies had a tough time. These five are Turkey, India, Indonesia, South Africa and Brazil. The pressure on their currencies is such that Turkey has had to increase its key interest rate from 4.5% to 10%. India also raised rates by another 0.25%, the third time in five months. South Africa raised its rates by a further 0.5%. Argentina continues to be week and rather than increase interest rates it tried to support its currency by spending its foreign reserves to support its currency. This has failed and it has now squandered a large chunk of its foreign exchange reserves in the process. As the quantitative easing program in the US picks up pace yield on their bonds will become more attractive. (10 year bond rates are already up to 2.8% from a low of 1.4%) This will have the effect of making these look more attractive than the “risky” emerging market bonds. This will have the effect of drawing money to the US away from emerging markets increasing the pressure on these markets. While the growth rate in China for 2013 came in a fraction over the target rate of 7.5% other indexes, including the most important manufacturing index fell more than expected in January. In China, we expect the policy stance to remain balanced with a slight tightening bias and continual fine tuning to keep property prices and shadow-banking growth in check. India, Indonesia, and Brazil seem close to the end of their monetary tightening cycles, which could create a favourable environment for growth going into the second half of the year. China has stated that they will achieve 7.5% growth for 2014. We would not challenge that as they are able to predict very accurately what the growth rate will be! As their economy grows and becomes more complex they may find it hard to be so precise. Early numbers indicate that growth continues on the capital side suggesting that the move to a more consumer based society will take longer and be harder than they anticipate. This may be helpful for our resources sector as continued demand from China acts as a backstop for demand. 14th February 2014 Page 3
  4. 4. Summary The world was too optimistic towards the end of last year. The equity markets overlooked the pressure on emerging market that the US tapering would bring and continued to overlook the warning signs such as the downgrades to world growth by the World Bank and others and the continued poor news out of Europe and China. Since January over $3 trillion dollars has been wiped off the value of world stock markets. However we feel that this is a slight over reaction, by the equity markets, to the continued US QE tapering, and the slight downgrades in the growth outlook for the US and China. There is still positive growth in both these major economies and we see this level of growth being maintained this year. That is we don’t see any major changes to these growth rates, on the upside or the down side. The subsequent over reaction in the emerging markets has resulted in their markets, (and for some their currencies and bond markets,) coming off in a major way. For investors looking for exposure in emerging markets, and who have a medium to long term investment horizon now may be a time to venture selectively back into these markets. There is still a shadow hanging over the recovery prospects of the world’s economies. While the US has addressed their issue of mortgage lending, (The primary cause of the GFC.), most of the rest of the developed counties’ banks have not resolved this problem. The hope that a strong recovery coupled with strong tax receipts would help corrects the imbalances at the sovereign level has failed to materialise. The huge piles of government debt need to be significantly reduced or the lenders might start to behave badly, by asking for their money back! If this happens then global contagion will be back and the efforts of the past two years with the quantitative easing and asset buyback programs will come to nought. We are not out of the woods yet. 14th February 2014 Page 4
  5. 5. Disclaimer The information and any recommendations contained in this document are for the benefit of the addressee only and are made as at the date of this document. Nothing in this document constitutes “personal advice.” Any investments made as a result of any of these recommendations are subject to investment risks including loss of income and capital. The performances of all investments are subject to a range of external factors, including economic and political factors that at any time may change the outlook. 358 Pty Ltd does not guarantee any rate of return, the performance of an investment nor the repayment of capital. Nothing in this document constitutes an offer to invest. This document may include information that was prepared or compiled by third parties. 358 Pty Ltd believe the information to be reliable at the date of this document. However, 358 Pty Ltd make no warranties or representations as to the accuracy or completeness of the document or its contents. To the extent permitted by law, 358 Pty Ltd excludes all liability to any party for any loss, costs or damage incurred as a result of reliance on this document or its contents. 14th February 2014 Page 5