The Investment World in 2011


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An outlook for world investment markets in 2011 and the key macro themes.

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The Investment World in 2011

  1. 1. Investment Markets in 2011The key investment market trends of the year will be symptomatic of theunderlying macro position and changes in the global economy as well as ashift in the positioning of investors as a response to stronger US growth.Macro1. Two-speed global economyThe rapid growth in the BRIC economies and the emerging world will continuewith China acting as an engine of growth and the largest source of newdemand for commodities. Growth pains will be felt, in particular in China, withinflationary pressures a key metric. The recent interest rate lending hike of.25% to 5.81% before Christmas whilst the rest of the world was distracteddemonstrates that inflation is being carefully monitored.These growth pains will continue to be addressed through government policywhich is aware of the need to develop stronger internal markets, consumerspending and local development as a gradual shift away from the export ledeconomic model that has been so successful since 1978. RMB devaluationwill continue – at a snails pace - and will be a continued talking point as partof the ʻcurrency warsʼ paradigm.In contrast, developed world economies in Europe and the US will find somestability post-crisis but with high levels of unemployment, public sector budgetcuts and low levels of inflation from spare capacity. The US will have a goodyear with stronger growth than 2011 and will cause a re-positioning ofinvestors. The UK will likely under-perform as a result of ʻfront loadedʼspending cuts in 2011 so that the coalition government has 4 years in office ifit goes wrong.The global imbalance of spenders and savers through the trade balance willpersist and will do so for the next 5-10 years. This will present additionalchallenges to developed world economies (US, Europe) in reducing trade andbudget deficits and to developing countries in stimulating domesticconsumption.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. However, this will be during a year of greater price volatility thanin 2011 with Gold prices at risk in particular as investors shift away fromhedges given stronger US growth.
  2. 2. However, dollar weakness and concerns over the expansion of the globalmonetary base should see metals (gold, silver and bronze) continue toappreciate, but by less than in 2010.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 is one of the biggest global risks of the year.Rising commodity prices will generate inflationary pressure and has thepotential to create a stag-flationary environment. However, given that there issome 25% spare capacity in European economies in particular from 2007levels, this may be contained. The policy response of changing interest rateswould be contained by fears of raising interest rates at a time of fragileeconomic stability – leaving policy makers with a dilemma as to how tomanage the risk.3. Developed world de-leveraging (...and developing world leveraging)Developed World DeleveragingDe-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. However,growth will be stronger in the US than in 2010 which will cause investors toreposition their portfolios across the year. Last yearʼs rally in fixed incometreasuries (high point in August) and commodities were partly driven byhedges against weaker US growth and volatile equity markets.This will partly unwind in 2011.The bond market will continue to attack those economies that have weakfiscal positions relative to peers with Portugal and Spain to be tested in Q12011. The effect of austerity measures in European economies will start to beseen in 2011 with key tests for GDP in Q1 and Q2. We will know the results ofthese tests in April and July respectively with higher market volatility acrossasset classes around these dates. If growth starts to weaken markedly, 0.25%change or higher, markets will enter a period of higher volatility.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. The maturitycliff in 2011 and 2012 will see banks have to manage their exposures tocommercial real estate (CRE).
  3. 3. The UK market has some £38bn maturing against CRE assets in 2011 alonewith a global funding gap of around $245bn between 2011 and 2013according to DTZ. In addition, corporate loans and LBO loans to PEborrowers are maturing from 2006 and 2007 vintage.As a result of these legacy exposures and the withdrawal of liquidity facilitiesand other support mechanisms from 2008/9, lending to both households andcorporates in the developed world will remain subdued.To a large degree, a lot of the so-called new lending is actually refinancing ofoutstanding loans to existing borrowers through new loans. This enablesbanks to project their ʻwillingnessʼ to lend whilst keeping troubled loans on lifesupport, claiming higher interest rate margins in the process and notextending credit to new, higher risk borrowers (which is good for their bottomline).Watch the US municipal bond market. US states are struggling (California,Illinois in particular) with both state deficits and public pensions that arerunning out. Meredith Whitney believes there may be 50-100 Muni defaults in2011 which will further strain US finances and will help the kick-out of USyields.Developing World Leveraging2011 will see the continued use of leverage and credit expansion in thedeveloping world and in the BRIC economies in particular. Mindful centralbanks are already imposing restrictions and capital controls to prevent over-heating (China, Thailand).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), with higher volatility2. Emerging market outperformance (equities will beat fixed income)3. Weakening of developed sovereign fixed income markets (US, Eurozone)4. Use of covered bond market by banks as new source of liquidity5. US equity market rally as the little guy returns6. Shocks in the US muni market
  4. 4. Investment Capital will be attracted to;1. Emerging markets (equities in particular after success in fixed income)2. Commodities and commodity producers3. Technology (ʻnew techʼ beating ʻold techʼ hard, soft, web)4. Real assets (real estate, manufacturing) as positioning for inflationInvestment ThemePerforming classes will be based on the macro trends but also represent realchange, real development of markets, real output of products and realdevelopment of tangible 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. 2010 saw EM fixed income indices perform around 13%,building on this success, portfolio managers will increasingly weight towardsequities.Mining, metals and energy stocks will do well broadly as a category on thebasis of continued and rising demand from the BRIC countries. Of course, thesector will see individual winners and losers – note continued recovery in BPshares.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. Note the recent implied $50bn valuation of Facebook after Goldmanʼs$500ml investment, this is double the implied valuation from summer 2010.Needless to say, new tech companies can be defined as those who specialisein wireless, device based technologies that offer users the ability to connect tosocial networking sites as well as communicating on the move. As such, dataservices, transmission and storage will do well.
  5. 5. The old tech companies are those who offer users mainly fixed location (pcbased) IT services from software to hardware. For instance, in 2010, shares inHMV fell by 70% as they failed to adapt their business model quickly enoughto online based services. As a result, new tech company equities will do wellat the expense of old tech in 2011.Commodity Winners:Cereals (wheat, soy), 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 arethirsty with their annual demand for crude oil increasing 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 all markets) and it will be the safe haven ofchoice during any market shocks during the year. Whilst the market mayworry that gold has had a good rally over the past 18 months, investors willalso invest in 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. Whilst copper is at multi-decade highs, it probably has further to run.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. Performance may be 7-9%, in contrast to13% in 2010.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.
  6. 6. This is opposed to securitisation, which is typically off balance sheet anddoes not offer investors recourse to issuing bank 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 basis point (1%-2%) spread to German bunds(German government issued bonds) and are guaranteed by the EU.Currency Winners:RMB, RUB, Euro, JPY2011 LosersEquities:Consumer goods, Banks, Durable goodsOne of the likely losers in 2011 will be consumer goods equities (UK, Europe)as austerity measures squeeze household wallets. Financial services are atrisk from banking system shocks (liquidity, refinancing) as well as regulatoryrestrictions that will squeeze some profit centres.Fixed Income:Gilts (US, UK, Eurozone)Investors will continue to attack weaker fiscal economies in the Eurozone aswell as unwind their hedge against lower US growth. As a result, treasuryyields in the US will rise. UK gilt yields will also be at risk given the potentialnegative effect of austerity on UK GDP.Currencies:USD, GBPDollar weakness as a result of increasing money supply and an unwind oftreasury buying and lower GBP as a result of potentially less UK GDP growth.