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Jean-Maurice Ladure
Head of Investment Strategy Europe
Julien SeetharamdooBond Strategist
Norman Villamin
Head of Investment Strategy Asia
Georgios TsapourisInvestment Strategist
Alan Higgins
Head of Investment Strategy UK
Henry LancasterSenior Investment Analyst
Carl AstorriGlobal Head of Economics & Asset Strategy
James Butterfill
Equity Strategist
[email protected]
j=f=p~=r~=J=g=OMNNSince the trend of disappointing US economic
data began in late April and the Greek debt
crisis started to escalate, equity markets have fallen as much
as 7% and bonds have rallied.
During the second half of the year, the US economy is likely to
reaccelerate thanks to a
combination of lower oil prices and a restarting of the Japanese
supply chain, which should be
particularly beneficial for the auto and information technology
industries.
The almost 25% rise in oil prices in the three months to the end
of April, triggered by Middle
East unrest, has since been all but erased, partly reflecting
news that the International Energy
Association will release oil from its strategic reserves for
only the third time since it was
founded in 1974. This pullback will boost US business and
consumer confidence, which is very
sensitive to petrol prices. Consumer confidence should also
benefit from a recovering labour
market as small businesses get more access to credit and start
hiring.
apan is experiencing a pronounced V-shaped recovery from its
devastating earthquake and
tsunami. Industrial production rose at its fastest pace since
1953 in May and has in the space
of two months recovered 40% of its post quake fall. Retail sales
have recovered even more
rapidly, already regaining 80% of their earthquake-related
drop.
Although the Greek parliament has voted for further austerity
measures in order to receive
the next tranche of loans from the EU and the IMF, it seems
unlikely that Greeks will stick to
these plans. Consequently, further standoffs between Greece and
the EU/IMF are likely when
its progress is reviewed in September and December. Moreover,
Greece remains insolvent - a
reality that cannot continue to be avoided indefinitely.
With concerns about Greece on the back burner for now and US
data likely to take a turn
for the better over the rest of the year, investors will slowly
become less risk averse and
more willing to focus on value. Equities are better value than
government bonds at current
levels, and we believe willingness to look through the current
uncertainty and hold equities
will be rewarded. Among bonds, emerging-market and corporate
debt, particularly high-yield,
offer the best return potential. After all, company and
emerging-market balance sheets are in
better shape than those of governments in the developed world.
Gold continues to provide
important ballast to portfolios, and its price should rise
further if policy-makers in the
developed world continue giving in to the temptation to reduce
their heavy debt loads by
keeping interest rates below inflation rates and their
currencies falling.
Emerging-market equities have returned around five percentage
points less than developed
markets so far this year, hampered by rising inflation and
interest rates. However, with oil
and agricultural commodity prices well off their earlier highs,
inflation pressure looks set to
diminish in the second half of the year. This will ease
investors concerns of a hard landing and
enable emerging-market equities, which trade at a discount to
their developed-market peers,
to outperform later in the year.
Nevertheless, the outlook is not without risks. Greece remains
unfinished business, the US
will default on its debt if the debt ceiling is not raised by 2
August and the market needs to
digest the implications of QE2 coming to an end in the US.
Disappointment of the past
few months to give way to a
reacceleration in US growth
US business and consumer
confidence should be lifted by
the retreat in oil prices and,
in the case of consumers, job
growth
apan's recovery from a
devastating earthquake has
been surprisingly rapid
An insolvent Greek
government has cleared one
hurdle, but more lie ahead
A temporary calm in the
euro-zone crisis and
improving US data should
boost risk appetite
With inflation pressure
waning, faster-growing
emerging markets should
outpace developed peers
over the rest of the year
But unfinished business in
Greece and a showdown over
the US debt ceiling loom
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If economic data continues to improve as we expect, this will
boost
equity markets at the expense of bonds
An improving labour market will bring with it a rise in
consumer
confidence
US banks have started lending again, which is key to the
recovery
given the recession was caused by a seizing-up in lending
Japan is experiencing a 'V-shaped' recovery from its
devastating
earthquake and tsunami, bringing disrupted supply chains back
online
f=p~==mThe oil price is well below its April highs amid some
stabilisation in
Middle-East politics and release of strategic reserves by the
IEA
Lower oil prices should similarly lift business confidence,
which was
also dented by supply-chain disruption from Japan's quake
Lower oil and hence petrol prices should give a boost to US
consumer confidence, which is sensitive to prices at the
pump
Easier credit conditions should help small businesses start
hiring and
investing again
All charts are as at 04/07/11
-15
-10
-5
0
5
10
15
20
25
95 99 0 07 11
-18
-16
-14
-12
-10
-8
-6
-4
-2
0
Small business hiring plans index (Lhs)
Small business availability of loans index (Rhs) Source:
Bloomberg
NFIB SMALL BUSINESS SURVEY: LOANS
AVAILABILITY & HIRING PLANS
-60
-40
-20
0
20
40
60
04 06 08 10
-80
-60
-40
-20
0
20
40
60
80
100
120
Michigan confidence expectations (Lhs, inverted)Gasoline price
(Rhs) Source: Datastream, Bloomberg
US GASOLINE PRICE &
CONSUMER CONFIDENCE
% yoy % yoy
-100
-50
0
50
100
150
98 00 02 04 06 08 10 12
35
40
45
50
55
60
65
WTI (Lhs, adv. 1year, inverted) Global PMI (Rhs) Source:
Bloomberg
GLOBAL PMI & OIL PRICE% yoy
020
40
60
80
100
120
140
160
180
200
70 73 76 79 82 85 88 91 94 97 00 03 06 09
0
2
4
6
8
10
12
Consumer confidence current conditions (Lhs) Unemployment (Rhs,
inverted)Source: Bloomberg
US UNEMPLOYMENT & CONSUMER CONFIDENCE %
30
40
50
60
70
80
90
100
110
120
Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10 Jan 11 May 11
Source: Bloomberg
WTI OIL PRICE$ / bl
monetary policy
+ stronger growth
risk premium
-150
-100
-50
0
50
100
04 05 06 07 08 09 10 11
Source: Bloomberg
CITI SURPRISE INDEX
Above av. Below av.
Increasing 6.2% 2%
Decreasing 1.8% -0.2%92
94
96
98
100
102
Jan 11 Feb 11 Mar 11 Apr 11 May 11
80
85
90
95
100
Retail sales (Lhs) Industrial production (Rhs) Source:
Bloomberg
JAPANESE RETAILS SALES &
INDUSTRIAL PRODUCTION
800
900
1000
1100
1200
1300
1400
1500
1600
1700
04 05 06 07 08 09 10 11
Source: Bloomberg
US COMMERCIAL & INDUSTRIAL LOANS &
LEASES OUTSTANDING
$ bn
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GoldGold is a hedge against geopolitical risk as well as
inflation and depreciation of major currencies, though
returns are likely to come under pressure from rising interest
rates.
AgricultureA reversion to more normal harvests and weather
conditions should reverse record prices, providing an
opportunity to add exposure to a long-term theme driven by both
global warming and rising emerging-
market demand.
Asset Class Outlook
EQUITIES Developed-market
Emerging-market
Given the current lull in the euro-zone crisis and expectations
of stronger US growth over the balance of
the year, investors should be more willing to look through the
current uncertainty and focus on value.
Equity valuations are more attractive than those of government
bonds, and should therefore outperform.
Recent cooling of commodity prices and policy tightening has had
an impact on CPI which is likely to peak
in coming months, EM remains in a secular bull market driven by
superior return on equity. The key
potential catalysts for a reversal are relative inflation and
monetary policy trends. Consequently we see a
return to outperformance in 2H 2011.
High-yield
3-month cash rates
Government bonds
Index-linked
Emerging market bonds offer attractive yields with a good chance
of currency appreciation as well. In
addition, investors are putting money back into EM bonds as a
significant part of emerging market central
bank tightening has already been priced in.
Expected to outperform government bonds in a positive growth
environment, and as investors search for
yield, but more exposed to rising inflation expectations than
equities or high-yield.
PROPERTY
Emerging-market
Investment-grade
Oil
UK commercial
COMMODITIES
Attractive yields and a better outlook for markets should drive
positive returns, particularly for Central
London offices and industrial property. While overall rents are
still falling, there are clear signs of
stabilisation.
Continued global economic recovery will drive demand and prices,
led by emerging economies. While
supply fears have faded, spare capacity is at very low
levels.
NOJj==^=`~=l
Better placed than government bonds to provide a positive
absolute return as inflation expectations rise
and default rates remain low, due to higher absolute yield.
In stark contrast to emerging markets, the combination of large
output gaps and large fiscal deficits will limit
the extent of rate rises in developed economies.
Bond yields should rise along with inflation expectations and
stronger economic data, but the rise will be
limited by a surfeit of spare capacity in developed economies
and low policy rates.
In an environment of gradually rising inflation expectations
inflation-linked bonds should outperform
nominal bonds, when adjusted for duration.
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