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The Quarterly Investment View January 2015
Asset Management |[email protected] 1
Index
1. The oil factor mitigates the incipient global slowdown Page – 2 & 3
2. Executive Summary, Market Outlook, and Portfolio Positioning Page – 4 & 5
3. United States: Fed to remain prudent amidst global growth concerns Page – 6
4. Euro-zone: the old issues are still there, the euro is still too strong Page – 7
5. Japan: concerns over success of “Abenomics” creeping in Page – 8
6. China: central bank turns more dovish as manufacturing slowdown accelerates Page – 9
7. India: reform path progresses but capex cycle needs revival for growth to accelerate Page – 10
8. GCC: low debt and high reserve levels allow to mitigate growth impact of oil price drop Page – 11
9. Appendix: forecast and valuation Page – 12-16
10. Sources and Disclaimer Page – 17
Please refer to the disclaimer at the end of the attached publication
The Quarterly Investment View January 2015
Asset Management |[email protected] 2
The oil factor mitigates the incipient global slowdown
More than six years after the 2008 Global Financial Crisis (GFC) the global economy has given only
little signs of a broad-based and sustained pick-up in aggregate spending. The only large advanced
economy that has seen a significant and continuous pick-up in job creation is the US. Yet, even in
this lonely so-called “champion of growth”, and notwithstanding such protracted employment
growth, salary growth and capital spending (except until very recently energy capital spending)
have remained subdued, telling us something deeper bout the inherent fragility of its very recovery.
Little wonder if consensus growth forecasts from 2011 to 2014 have been systematically, year over
year, revised downward. And little wonder if – come 2015 – with the Eurozone slipping into deflation
and China’s export growth model increasingly unable to perform in a world of excess capacity, there
were many good reasons to expect again a year of less rather than more growth. We were thus
approaching 2015 with a sense of heightened concern, also because equity valuations have
become increasingly unattractive and a lasting equity correction still has the potential of removing
the positive QE-induced wealth effect from the US recovery. From our point of view the increase in
equity market volatility has little to do with rate hikes, much more with global growth concerns.
Yet, and in spite of such growth concerns, the sharp oil price correction of the last months seems to
us still mostly supply, rather than demand driven. As such, it should have a significantly positive
impact on global economic growth. It allows low income households across the globe to stabilize, if
not increase, their consumption spending. It makes it easier for many governments to reduce their
deficits. It also reduces – at least temporarily - inflationary expectations thereby further dampening
yields and making it easier for governments to service their debts without adding fiscal drag.
To be sure, we were sceptical about the consensus forecasts for 2015 and we are certainly not
advocating a return to the high growth rates we were used to before the GFC. Yet, whilst we still
have serious doubts about the consensus 2015 US growth rate at 3%, we are now more confident a
repeat of the 2014 2% performance is possible. China and the Eurozone are still unlikely to reach
respectively 7% and 1% growth in 2015, but the former might now be able to avoid a signification
reduction towards the 5% level, and the latter might be able to avoid outright recession. No little
difference from the viewpoint of financial markets.
Federal Reserve adjusting to the global environment
The US dollar index (the greenback’s exchange rate based on the trade weights of the US’ main
trading partners) is now up 15% versus its average of the last 5 years. Even for a relatively large
and closed economy such as the US this should have a tangibly negative impact on growth and an
already low level of inflation. If one adds to that the (at least initially) disinflationary impact of the
lower oil price, it becomes very hard to see how the Fed could hike rates in 2015 to a significant
extent. We have long argued that the upcoming rate hikes will not alter the basic fact that US
monetary policy will remain largely accommodative, simply because the end of additional QE does
not imply that the Fed will allow its balance sheet to shrink in any meaningful manner. Recently we
have been considering to replace our “not so relevant rate hike” scenario with the hypothesis of “no
rate hike at all”. If anything, some minor rate hikes would be relevant in that they would finally signal
a return to normal monetary policy, thereby boosting confidence into the economic system. But
even small rate hikes seriously risk exacerbating the appreciation of the US dollar. And that’s
precisely why the Federal Reserve might ultimately decide to pass in 2015.
Other central banks picking up the baton of QE and Greece unlikely to exit the
Euro-zone
Bank of Japan Governor Kuroda has - politically alone – little choice but to pursue his very
expansionary monetary policy stance. Given the country’s still very strong external credit position,
as well as the fact that most debt is domestically held, this is for the moment unlikely to destabilize
the Japanese bond market. Now that the ECB’s sole mandate of price stability is in concrete peril,
President Draghi is likely to cook up some scheme for the acquisition of sovereign, supranational
Luciano Jannelli, Ph.D., CFA Head Investment Strategy [email protected] Rahmatullah Khan Economist Investment Strategy Team [email protected]
The Quarterly Investment View January 2015
Asset Management |[email protected] 3
and/or corporate bonds over and on top of the ECB’s already existing buy programs. Rumors to the
contrary notwithstanding, Germany is unlikely to allow Greece to exit the single currency. Germany,
in fact, remains the single largest beneficiary of the monetary union and the benefits that it derives
from the euro are significantly larger than all the money put up (and which it still owns) to help bail
out the various periphery economies. Why would the ever so prudent German government wish to
put such wonderful and advantageous trade-off at an immediate risk by allowing an unprecedented
euro exit, which could then be only the first domino to fall in a longer series of such exits?
Yields to remain low, but equities to remain volatile
Sluggish growth will keep yields at bay. Low yields and moderate growth are still positive for
equities but volatility is very unlikely to abate. The rise in the US dollar is a headwind for US equities
in particular. Amongst advanced markets German, and more in general European export-oriented,
equities might be the most attractive in terms of valuation, and in consideration of the fact that the
euro has lost a significant part of the gains it had made earlier in the year against the yen. Amongst
emerging markets we look favorably to equities and bonds of energy-dependent markets such as
India, Turkey and Indonesia. When the oil price will stabilize we expect a consolidation and pick-up
of equity markets in the Gulf Cooperation countries.
Index Snapshot (World Indices)
Index Latest Quarterly change % (Q4-2014)
Change in 2014 (%)
S&P 500 2,002.6 4.4 11.4
Dow Jones 17,371.6 4.6 7.5
Nasdaq 4,592.7 5.4 13.4
DAX 40 9,586.9 3.5 2.7
Nikkei 225 16,885.3 7.9 7.1
FTSE 100 6,437.9 -0.9 -2.7
Sensex 26,908.8 3.3 29.9
Hang Seng 23681.3 2.9 1.3
Regional Markets (Sunday to Thursday)
ADX 4424.6 -11.3 5.6
DFM 3600.3 -25.2 12.0
Tadawul 8175.4 -23.2 -2.4
DSM 11898.2 -10.5 18.4
MSM30 6204.12 -15.2 -7.2
BHSE 1425.2 -3.3 14.2
KWSE 6423.2 -14.2 -13.4
MSCI
MSCI World 1,654.4 0.7 2.9
MSCI EM 934.7 -4.9 -4.6
Global Commodities, Currencies and Rates
Commodity Latest Quarterly change % (Q4-2014)
Change in 2014 (%)
ICE Brent USD/bbl 51.5 -39.4 -48.3
Nymex WTI USD/bbl 48.49 -41.6 -45.9
OPEC Basket USD/bbl 46.7 -44.8 -51.8
Gold USD/t. oz 1213.9 -2.0 -1.4
Platinum USD/t oz 1220.0 -7.1 -11.9
Copper USD/MT 276.15 -6.1 -16.8
Aluminium 1762 -5.2 4.1
Currencies
EURUSD 1.1850 -4.2 -12.0
GBPUSD 1.5138 -3.9 -5.9
USDJPY 119.08 9.2 13.7
USDCHF 1.0135 4.1 11.4
Rates
USD Libor 3m 0.2536 8.7 3.9
USD Libor 12m 0.6338 8.7 7.8
UAE Eibor 3m 0.6771 -4.8 -16.7
UAE Eibor 12m 1.0157 -2.3 -14.2
US 3m Bills 0.0203 -42.0 -46.2
US 10yr Treasury 1.9729 -12.8 -28.3
.
Past quarter global markets’ performance
The Quarterly Investment View January 2015
Asset Management |[email protected] 4
Executive Summary
Federal Reserve will remain very accommodative even after starting to gradually hike rates, ECB to become increasingly
supportive through 2015, BoJ likely to continue quantitative easing.
US growth to remain steady and moderate, likely to pull Europe and Emerging markets
Advanced economies equities have still some upside given accommodative monetary policies
China’s reform, and growth, problems will remain with us for a longer period
Commodity exporting emerging markets such as Brazil, Russia and South Africa will suffer
Emerging markets which are not exposed to commodity prices and where the reform process seems to be more promising,
such as India, are more likely to take advantage of the decline in commodity and energy prices
Selectively emerging markets hard currency bonds offer good value, whereas local currency bonds remain subject to a
scenario of continuing exchange rate volatility
Energy prices are expected to stabilize, and at some point recover from current lows
Industrial metals have still more downside given the ongoing transformation of China’s economy
Precious metals upside to be capped by continuing global disinflation, as well as the permanent shrinkage of emerging
markets trade surpluses.
Market Outlook and Portfolio Positioning
Fixed Income
Duration Avoid the intermediate section of the yield curve
Federal Reserve will only very gradually start hiking rates in 2015. Long-term yields remains capped by secular disinflation.
Advanced economy corporate bonds
Underweight Credit spreads have widened again towards the end of the last year. Widening has come on the back of lower grade corp yield moving up while high grade corp yield has largely trended downward.
EM bonds Selectively overweight Among Emerging Markets we differentiate between commodity exporters and importers, favoring the latter. Commodity exports not only face growth issues but they seem to be prone to currency volatility. In commodity importer country’s bonds, we still prefer USD bonds rather than local currency bonds primarily of continuing currency volatility.
Equity Markets
US Moderately overweight We have so far been confirmed in our call for more accommodative monetary policy for longer and the recommendation to stay overweight in US equities. As growth and policy will remain accommodative, we stay moderately overweight, yet we now expect less upside because of increasingly stretched valuations.
Eurozone Moderately overweight Periphery equities' valuation-based catch-up has now petered out. Growth will pick-up moderately as the ECB enhances support and exports to the US increase. In real terms Eurozone equities are expected to perform in line with US equities.
The Quarterly Investment View January 2015
Asset Management |[email protected] 5
Japan Moderately overweight US recovery and very accommodative monetary policy is still supportive to our constructive view on Japanese equities. However, gains are likely to be limited as compared to the last two years primarily due to disappointing growth and inflation performance.
Emerging Markets Selectively overweight Emerging equity markets remain a mixed bag. We are overweight those emerging markets that are more reform prone and less dependent on commodities, such as India and some Eastern European and Asian economies, such as Turkey and Indonesia.
Energy and Commodity Prices
Energy Neutral The recent sharp decline in prices seem to have undershot. Yet, volatility is to remain high as long as the direction of US production remains unclear. For the moment we expect as sideward price movement.
Industrial Metals Underweight The full implications of the China transformation story will determine a further reduction in the commodity- intensity of its economy. There may be some recurring technical rebounds in specific metal prices, but globally deflationary downward pressures are likely to continue in this commodity space.
Precious Metals Underweight As most advanced economies maintain their deleveraging course, the USD and Euro in particular are likely to remain strong versus emerging market currencies. Thus the risks of investing in precious metals remain quite elevated.
Currencies
EUR Down A diverging monetary cycle in the two economic regions supports further US dollar strengthening in coming quarters. A more dovish Fed might to some extent mitigate this development, yet not alter its basic thrust.
GBP Down Weakening growth momentum in the UK and anaemic economic environment in the neighbouring Eurozone has negatively affected cable in recent months. We expect this to continue in coming quarters. However, we expect only a marginal depreciation of the pound sterling versus the US dollar as both Fed and BoE rate hikes are expected to be muted.
JPY Down Japanese yen is expected to remain in depreciating trend as the BoJ will continue to inject large amount of money into the system. But the yen being a carry trade currency, it should see temporary rebounds during global risk aversion phases.
The Quarterly Investment View January 2015
Asset Management |[email protected] 6
US recovery to remain modest
Whilst it is true that the economic recovery in the US has
broadened its base, it remains inherently fragile as can be
observed from the fact that wage growth is stalling in spite of
continuing job creation. Normally, at this stage of the cycle,
the declining slack in the labor market should already have
boosted workers’ earnings growth, thereby further enhancing
consumption growth. There is one silver lining in that the
lower oil price raises households’ real income. As such, it
should provide – together with improved household balance
sheets - structural support to continuing consumption growth.
However, even if we expect US real growth to remain decent
(say around 2% annual real GDP growth), we do not expect a
major break-out away from the lower growth rates that have
emerged since the 2008 Global Financial Crisis. A lot of this
has to do with the simple fact that overall household and
government debt stocks remain at historically high levels, and
that the rest of the world continues to struggle to shake of
very strong deflationary pressures.
The US economy is not an island
The US economy, in fact, is not immune of the struggling
Eurozone, recessionary Japan and slowing emerging
economies. This can be very easily observed from below
chart which shows that periods of stronger dollar coincide
with net export dragging GDP growth lower.
We believe that there remains room for further appreciation of
the US dollar and – as such – an additional drag on US
growth.
Federal Reserve to remain very prudent
The strength of the US dollar has not only a negative impact
on growth, it also has a disinflationary impact on the economy
to an equivalent extent as the rise in interest rates (through
the reduction of prices of imported goods). This reinforces the
economy’s disinflationary trend which is already very strong
in view of still significant deleveraging, very well contained
wage pressures, the continuous slide in commodity prices
and – recently – the sharp drop in energy prices.
The short- versus long term implications of the oil price
drop and the Federal Reserve’s patience
First and foremost it is important to note that the overall
stance of US monetary policy will remain accommodative
through 2015 because the Federal Reserve – whilst not
adding additional liquidity in the system – will not reduce the
size of its balance sheet either. Thus the largely
accommodative stance will not be altered by what we have
long expected to be a moderate increase of the Federal
Reserve Funds rate in 2015. The Federal Reserve has now
an additional motive to be prudent since in the short-term the
drop in the oil price is not only deflationary, but possibly also
recessionary because for sure it will reduce energy capital
expenditures (which are the bulk of US capital expenditures).
Over the longer period the drop in oil prices is reflationary
since it increases consumers’ real income by liberating
resources for the acquisition of discretionary items, thereby
also promoting capital expenditure in other sectors of the
economy. As these second order effects need time to work
out, and given also the strong US dollar, the Federal Reserve
will want to err on the side of prudence and raise rates only
moderately, in the order of say 50 basis points, in 2015. A no
rate hike at all scenario is becoming more likely. The overall
yield curve should thus remain contained which is good for
US equities.
5
7
9
11
-200
0
200
400
600
Feb-10
May-1
0Au
g-10
Nov-1
0Feb
-11Ma
y-11
Aug-1
1No
v-11
Feb-12
May-1
2Au
g-12
Nov-1
2Feb
-13Ma
y-13
Aug-1
3No
v-13
Feb-14
May-1
4Au
g-14
Nov-1
4
(Per cent)('000)
A solid improvement in labor market to support consumption further
Change in nonfarm payroll Unemployment rate - rhsSource: Bloomberg
020406080100120140160
-5
0
5
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014
(Index)(Per cent)
Fed is likely to be mindful of dollar strength that affects net export contribution to the GDP growth
Net export contribution to GDP growth (q-o-q, annualized)Trade weighted dollar index - rhs
Source: Bloomberg
0.0
1.0
2.0
3.0
4.0
Nov-1
0
Mar-1
1
Jul-11
Nov-1
1
Mar-1
2
Jul-12
Nov-1
2
Mar-1
3
Jul-13
Nov-1
3
Mar-1
4
Jul-14
Nov-1
4
(Per cent)Inflationary pressure remains subdued
Core PCE, y-o-y Core PPI, y-o-y Average hourly earnings
Source: Bloomberg
United States: Fed to remain prudent amidst global growth concerns
The Quarterly Investment View January 2015
Asset Management |[email protected] 7
Draghi’s balance sheet battle
It is probably important to stress that even if Mr. Draghi
succeeds in increasing the ECB’s balance sheet from 2tn to
3tn euros, overall annual real GDP growth in the Eurozone
will remain subdued at the 1% level. Thus the “mere”
purpose of the expansion of the ECB’s balance sheet is to
prevent the monetary union to slide into a deflationary
recession across all its member-states. In order to bring the
balance sheet as quickly as possible at the desired level – or
more importantly convince the markets immediately that the
3tn euro size is feasible by the end of 2015 – Mr. Draghi will
most likely have to add the acquisition of approximately
500bn corporate, supranational (EIB) and sovereign bonds
to existing buy and lending programs.
Euro deprecation as the key QE reflation lever
Critically the further compression of Euro-zone bond yields
as well as the reduction of periphery spreads will take stress
of the banks’ balance sheets and thereby facilitate lending.
Yet, given the lack of credit demand, and the entrenchment
of the credit crunch in periphery economies, one should not
expect miracles when it comes to increasing lending.
Thus the most effective way by which QE can directly reflate
the Eurozone’s economy is by promoting a further
devaluation of the euro which promotes exports, and makes
the Eurozone’ assets cheaper for foreigners.
A depreciation of the euro will also (through an increase in
the price of imported goods) determine the necessary
increase in inflation, thereby preventing the credit crunch
from morphing into an outright aggregate demand crunch.
Deflation entrenchment and Greece are the key risks
Whilst we believe that Mr. Draghi will succeed in his 2015
balance sheet target, we are not convinced that that will be
sufficient to defuse the entrenchment of deflationary
expectations over the next six months, especially if the euro
does not depreciate further in a significant manner (in this
respect we note that deflation continues to plague Japan in
spite of the significant expansion of the Bank of Japan’s
balance sheet). Uncertainties are compounded by the risk of
Greece having an anti-euro government by January 25 which
would demand a renegotiation of its outstanding debt, as
well as the austerity policies.
-4-202468
1012
Apr-0
4
Dec-0
4
Aug-0
5
Apr-0
6
Dec-0
6
Aug-0
7
Apr-0
8
Dec-0
8
Aug-0
9
Apr-1
0
Dec-1
0
Aug-1
1
Apr-1
2De
c-12
Aug-1
3
Apr-1
4
(Per cent)
Lending to remain modest in euro
Loans to private sector, y-o-y chg.
Source: Thomson Reuters
1.001.051.101.151.201.251.301.351.401.451.501,800
2,000
2,200
2,400
2,600
2,800
3,000
3,200
Dec-0
9
May-1
0
Oct-1
0
Mar-1
1
Aug-1
1
Jan-12
Jun-12
Nov-1
2
Apr-1
3
Sep-13
Feb-14
Jul-14
Dec-1
4
(EUR/USD)(EUR Bn)
ECB balancesheet needs to expand in order to devalue Euro
ECB balancesheet EUR/USD - rhs
Source: Bloomberg
-2-10123456
Dec-9
7De
c-98
Dec-9
9De
c-00
Dec-0
1De
c-02
Dec-0
3De
c-04
Dec-0
5De
c-06
Dec-0
7De
c-08
Dec-0
9De
c-10
Dec-1
1De
c-12
Dec-1
3De
c-14
(Per cent)
Inflation is down in all Eurozone countries
Germany CPI Italy CPI Spain CPI France CPI
Source: Bloomberg
Eurozone: the old issues are still there, the euro is still too strong
The Quarterly Investment View January 2015
Asset Management |[email protected] 8
Growth disappoints, again
The economic recovery has remained elusive following the
April sales tax hike as the economy went into a recession
with declining real GDP in two consecutive quarters. As
economic indicators – both industrial production and the
Tankan producers confidence index – have disappointed in
October and November, there is now a concrete risk that
fourth quarter growth could even disappoint the modest
expectation of 2.8% (QoQ annualized) from the already low
third quarter base. Market consensus expects real GDP
growth to be modest at 1% in 2015 on the back of an
estimated meagre growth of 0.3% in 2014.
Abenomics fails?
While growth is disappointing, the recent downward trend in
inflation is questioning the very success of “Abenomics”, a
policy that is entirely centered on the idea of creating inflation
through quantitative easing so as to induce wage growth that
in turn would sustain domestic demand. In fact, the tax-
induced inflation created early this year seems to be petering
out and the decline in wages in November (year-over-year
basis) confirms how serious the policy failure risk is.
Authorities increasing “Abenomics” measures
Realising the weakness in growth momentum and the
anaemic internal price dynamics, the Bank of Japan (BoJ)
announced a slew of additional quantitative easing measures
in October to support the equity market and further
depreciate the Japanese yen. Whilst, these new measures
have effectively boosted equity prices and depreciated the
currency further, it is not clear yet that they will have the
desired impact on inflation and real growth.
Prime Minister Abe’s recently announced fiscal stimulus
worth of JPY 3.5tn (c.USD 29bn) is for sure unlikely to have
any meaningful impact on economic activity. Moreover, more
significant fiscal stimulus is not an option for the government
as the deficit is already running above 8% of GDP and public
debt is in excess of 225% of GDP.
Continuous policy failure warrants caution
If “Abenomics” would fail in promoting economic growth, it
would inevitably raise questions about the sustainability of the
countries’ growth in public debt. Not surprisingly, foreign
inflows in the equity market were “only” around USD 7.5bn in
2014, down by 94% as compared to 2013.
Thus even if the BoJ measures would continue to support
gains in the equity market as the currency depreciation
boosts the earnings for Japanese companies, those gains are
likely to be limited as compared to the last two years. Finally,
any further fiscal stimulus that would shoot the sovereign
debt significantly up could at some point become negative for
sovereign bonds.
-8-6-4-202468
Dec-1
1
Mar-1
2
Jun-12
Sep-12
Dec-1
2
Mar-1
3
Jun-13
Sep-13
Dec-1
3
Mar-1
4
Jun-14
Sep-14
(Per cent)
Both private demand as well as public demand are weak
Real GDP, q-o-q annualized Real Pvt demand, y-o-yReal Public demand, y-o-y
Source: Bloomberg
-5-3-11357
Jan-10
May-1
0
Sep-10
Jan-11
May-1
1
Sep-11
Jan-12
May-1
2
Sep-12
Jan-13
May-1
3
Sep-13
Jan-14
May-1
4
Sep-14
(Per cent)
After a brief jump in inflation downward trend resumed
CPI, y-o-y Producers' input cost, y-o-y Wage growth, y-o-y
Source: Bloomberg
90
95
100
105
110
115
120
125
13,000
14,000
15,000
16,000
17,000
18,000
Oct-1
3
Nov-1
3De
c-13
Jan-14
Feb-14
Mar-1
4
Apr-1
4Ma
y-14
Jun-14
Jul-14
Aug-1
4
Sep-14
Oct-1
4
Nov-1
4De
c-14
(USD/JPY)(Index)
Currency depreciation and rally in stock market do not seem to be adequate for sustainable economic recovery
Nikkei 225 USD/JPY - rhs
Source: Bloomberg
Japan: concerns over success of “Abenomics” creeping in
The Quarterly Investment View January 2015
Asset Management |[email protected] 9
Growth slowdown continuing
The ongoing economic transition in China from investment
led growth, which heavily relied on infrastructure spending
and exports, to domestic consumption driven growth is likely
to continue to weigh on the economic outlook. The sluggish
global economic conditions have weighed on exports while
the curtailment of investments has slowed down
manufacturing, and inevitably also consumption.
The chart below shows how both the secondary (industrial)
sector (which is almost half of GDP) and the tertiary
(services) sector have not managed to keep up with the
growth rates before the 2008 Global Financial Crisis (GFC).
Likewise, the external sector is no longer the support it once
provided to the Chinese economy. Also because of the
Renminbi’s peg to the US dollar, exports are unlikely to
repeat their 2010-11 or pre-GFC performance.
On the domestic side, the recent trend in economic releases
- especially related to the manufacturing sector - confirm the
growth going even further down. All in all the probability of
sub-7% growth in 2015 has risen.
People’s Bank of China more dovish, for now
Slower growth has pushed the People’s Bank of China
(PBoC) to act by reducing, after more than two years, the
one year deposit rate by 40 bps to 5.6%. The market is now
expecting another rate cut in 2015. Another policy
consideration for the central bank would be a lower
exchange rate as the renminbi is scaling new highs in real
terms (REER basis) due to its soft peg with the US dollar.
Therefore, we believe that the central bank could well take
easing action through currency depreciation and liquidity
injection.
Careful with Chinese equities
The local equity market rallied significantly over the last two
months. A most important factor for the sharp rally was likely
the undervaluation of the market, as well as the reform
linking the Shanghai and Honk Kong exchanges. This
created optimism among investors for a further opening up
the financial market. Sentiment got an additional boost from
the surprise rate cut by the PBoC. Going forward further
upside seems to be largely based upon speculation of the
further opening of what remains a very opaque market.
0
5
10
15
20
Mar-0
4
Nov-0
4
Jul-05
Mar-0
6
Nov-0
6
Jul-07
Mar-0
8
Nov-0
8
Jul-09
Mar-1
0
Nov-1
0
Jul-11
Mar-1
2
Nov-1
2
Jul-13
Mar-1
4
(Per cent)
Growth slowdown coming from transition process from secondary to tertiary
Secondary sector growth, y-o-y Tertiary sector growth, y-o-yReal GDP growth, y-o-y
Source: Bloomberg
-25
-5
15
35
55
75
Feb-10
Jun-10
Oct-1
0
Feb-11
Jun-11
Oct-1
1
Feb-12
Jun-12
Oct-1
2
Feb-13
Jun-13
Oct-1
3
Feb-14
Jun-14
Oct-1
4
(Per cent)Foreign trade clearly in a lower trajectory
Exports ImportsSource: Bloomberg
10
15
20
25
30
68
101214161820
Mar-1
0
Jul-10
Nov-1
0
Mar-1
1
Jul-11
Nov-1
1
Mar-1
2
Jul-12
Nov-1
2
Mar-1
3
Jul-13
Nov-1
3
Mar-1
4
Jul-14
Nov-1
4
(Per cent)(Per cent)
Industrial side of the economy to continue to trend down
Industrial production, y-o-y Fixed asset investment, y-o-y - rhs
Source: Bloomberg
5.65.86.06.26.46.66.87.090
95100105110115120125
Jan-10
May-1
0
Sep-10
Jan-11
May-1
1
Sep-11
Jan-12
May-1
2
Sep-12
Jan-13
May-1
3
Sep-13
Jan-14
May-1
4
Sep-14
(USD/CNY)(Index)
On REER basis CNY continues to touch new highs in recent years
REER USD/CNY-rhsSource: Bloomberg
China: central bank turns more dovish as manufacturing slowdown accelerates
The Quarterly Investment View January 2015
Asset Management |[email protected] 10
Capital spending must recover
The upswing in consumer and business sentiments is yet to
be followed by an effective improvement in real economic
data. It is worth noting that the significant downturn in
corporate capital spending – a decline of 8.5% in 2011-12
and a tepid revival of 1.3% in the succeeding year – had
been caused by the combination of domestic policy paralysis
and anemic global growth. Thus the prospect of more
incisive policy action bodes well for at least some structural
pick-up in capital spending, even if global growth would not
accelerate. Also the main cause of low household capital
spending – i.e. a high inflationary environment which
ultimately resulted in a crash in household capital spending
growth from 38.6% in 2011-12 to 5.1% in 2012-13 – seems
now likely to have vanished.
Policy measures must lead the way
The recent liberalization of the Land Acquisition Bill and the
increase of the FDI limit in the insurance sector from 26% to
49% confirm the government’s intention to expedite the
reform process and attract investments. However, one needs
to be cautious as these ordinances have yet to pass through
both houses of parliament where the ruling coalition does not
have a majority in the upper house. To look for a revival in
the corporate capex cycle, we are amongst others closely
monitoring credit growth. The downtrend in credit growth;
however, has yet to reverse. A significant pick-up in credit
off-take is usually a precursor for a turnaround in the capex
cycle and industrial growth.
But fundamental economic factors have already
improved
Whilst growth has not yet picked up sufficiently, very
important structural factors, such as the high current account
deficit, the high fiscal deficit and persistently high inflation
have improved remarkably over the last months and
quarters. The current account deficit has declined as low as
1.1% of GDP in the second quarter of 2014 and the
government remains credibly committed to the targeted fiscal
deficit of 4.2% of GDP in the fiscal year 2014-15, helped also
by the recent slump in oil prices. The decline in commodity
prices has also significantly helped in cooling off inflation.
Indeed, inflation is expected to undershoot the Reserve Bank
of India target of 6% in March, inducing the central bank’s
Governor, Raghuram Rajan, to adopt a more dovish stance.
Many market participants expect a rate cut as early as in
January. However, the governor could wait for fiscal budget
announcements before he takes a call on the policy rate. In
this respect it is worth noting that the high level of inflation
over the last few years has had its toll on the real effective
exchange rate, and thus the country’s competitiveness. This
warrants some more depreciation which – however – is
inflationary in nature.
Moderately positive on equities
The still very good growth prospects warrant a positive
stance on equities which is somehow mitigated in the short
term by the stretched implicit earnings expectations.
(40) (20) - 20 40 60
- 5
10 15 20 25
2005-0
6
2006-0
7
2007-0
8
2008-0
9
2009-1
0
2010-1
1
2011-1
2
2012-1
3
2013-1
4
(Per cent)(Per cent)
Investment cycle to pick up for growth to accelerate
Total capital formation, y-o-yReal GDP growth, y-o-y
Source: CSO
-100
10203040
May-0
6No
v-06
May-0
7No
v-07
May-0
8No
v-08
May-0
9No
v-09
May-1
0No
v-10
May-1
1No
v-11
May-1
2No
v-12
May-1
3No
v-13
May-1
4No
v-14
(Per cent)
Industrial production and credit growth yet to show turnaround
Credit growth, y-o-y Industrial growth, y-o-ySource: Bloomberg
90
95
100
105
110
115
Jun-05
Dec-0
5Jun
-06De
c-06
Jun-07
Dec-0
7Jun
-08De
c-08
Jun-09
Dec-0
9Jun
-10De
c-10
Jun-11
Dec-1
1Jun
-12De
c-12
Jun-13
Dec-1
3Jun
-14De
c-14
(Index)Rupee remains over valued on REER basis
Trade weighted Real Effective Exchange RateSource: Bloomberg
India: reform path progresses but capex cycle needs revival for growth to accelerate
The Quarterly Investment View January 2015
Asset Management |[email protected] 11
Sound fiscal management allows GCC to rationalize
government spending so as to mitigate growth impact
Since government spending is still the main driver of
economic growth in the Gulf Cooperation Council countries,
the recent sharp decline in oil prices has created concerns
about its sustainability in the medium term. It is worthwhile to
note that government spending had risen sharply since 2008-
09 as governments in the region undertook a countercyclical
fiscal policy in the wake of Global Financial Crisis, embarking
on rapid infrastructure development. This has significantly
increased the fiscal break-even oil price for countries in the
region.
The current oil price is lower than the fiscal break-even price
for almost all countries in the GCC. This means that if the
average oil price remains around the same level in the
coming quarters, each member country will have a fiscal
deficit. As a result, many market participants expect cuts in
government spending which will have a negative impact on
the growth outlook in the region. We believe that the impact
of current lower prices would not be significant in the medium
term primarily for the following reasons.
First, the oil prices might well have undershot which could
determine a rebound later in the year as the supply outlook
gets clearer and demand gets support from the recent lower
prices.
Second, member economies except Bahrain enjoy a strong
fiscal environment as reflected by an extremely low level of
public debt and high levels of reserve assets. Gross public
debt in Saudi Arabia (which alone constitutes roughly half of
the GCC countries’ economic size) is less than 2% of GDP
while it is less than 12% of GDP in the UAE.
Saudi Arabia in its budget for 2015 has indicated that the
current low level of oil prices will not affect its spending plans
in the medium term. Even after an estimated deficit of USD
14.4bn in 2014, it announced a budget with an intention of
increasing spending, though modestly, in 2015. A budgeted
deficit of USD 39bn or higher actual deficit could be easily
managed by the government having around USD 427bn
deposits with the central bank and around USD 750bn as
foreign reserve assets. Oman increased its spending plan by
4.5% to USD 36.6bn for 2015 despite a widening of the
deficit. The country expects to manage this from state
reserves, previous years’ surpluses and international grants
& loans. Dubai also revealed an increase in its expenditure
plans by 9%. Despite the rise in planned expenditures, the
Emirate expects the budget to be balanced this year on an
expected rise in revenues. This reflects confidence that
Dubai’s economy, largely driven by trade and tourism, will be
unaffected.
Given our belief that the recent dip in oil prices should not
have in 2015 a very strong impact on government spending,
the growth outlook, especially for the non-oil sector remains
stable. Stable or slightly lower crude production could have
some moderating impact on headline GDP growth numbers
for 2015. Moreover, lower oil prices will result into lower
nominal GDP.
Moderately cautious on equities
We are cautiously positive on local equity markets, as
participants will realize that overall economic growth should
remain stable. We do see downside risks to our expectations
as long as the oil price does not fully stabilize. Equity
markets could also be affected by the potential rate hikes by
the Fed, which regional central banks will have to follow due
to the currency peg.
020406080100120140
020406080
100120140
Bahrain Saudi Arabia UAE Kuwait Qatar
(US$/bl)(US$/bl)
Fiscal break-even oil prices have shotup over the last few years
2008 2014ESource: CEIC, Thomson Reuters Datastream, IMF
0
20
40
60
80
0
10
20
30
40
50
Bahrain Kuwait Oman Qatar Saudi Arabia United ArabEmirates
(USD Bn)(Per cent)
Low level of public debt can sustain fiscal deficit in the medium term
Govt gross debt (% of GDP) Gross public debt - rhs
Source: IMF, October 2014
GCC: low debt and high reserve levels allow to mitigate growth impact of oil price drop
The Quarterly Investment View January 2015
Asset Management |[email protected] 12
Bond Market Spreads
GDP forecast 2014 CPI forecast 2014
Estimates Consensus ADCB Consensus ADCB YoY Estimates Consensus ADCB Consensus ADCB
US 2.30% 3.0% 2.8% US 1.70% 1.5% 2.2%
Eurozone 0.80% 1.1% 1.5% Eurozone 0.44% 0.6% 1.3%
Japan 0.20% 1.0% 1.4% Japan 2.80% 1.5% 1.5%
China 7.40% 7.0% 6.7% China 2.10% 2.0% 2.5%
India 5.20% 5.5% 6.3% India 6.40% 6.7% 6.1%
2015 2016 2015 2016
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
Dec-0
7
Dec-0
8
Dec-0
9
Dec-1
0
Dec-1
1
Dec-1
2
Dec-1
3
Dec-1
4
(Per cent)
EM IG corporates v/s US Treasury 10yrs
ML USD Investment Grade EM Corp.-US Treasury 10 yrs spread
Source: Thomson Reuters
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
Dec-9
9
Dec-0
0
Dec-0
1
Dec-0
2
Dec-0
3
Dec-0
4
Dec-0
5
Dec-0
6
Dec-0
7
Dec-0
8
Dec-0
9
Dec-1
0
Dec-1
1
Dec-1
2
Dec-1
3
Dec-1
4
(Per cent)
World large corporates v/s US Treasury 10yrs
City World BIG Corporate, AA-US Treasury 10 yrs spread
Source: Thomson Reuters
0.01.02.03.04.05.06.07.0
Dec-0
6
Dec-0
7
Dec-0
8
Dec-0
9
Dec-1
0
Dec-1
1
Dec-1
2
Dec-1
3
Dec-1
4
(Per cent)
ML Global HY corporates v/s US Treasury 10yrs
ML Global Broad Market Corp. & HY Index-US Treasury 10 yrs spread
Source: Thomson Reuters
0.02.04.06.08.0
10.012.014.016.018.0
Dec-0
0
Dec-0
1
Dec-0
2
Dec-0
3
Dec-0
4
Dec-0
5
Dec-0
6
Dec-0
7
Dec-0
8
Dec-0
9
Dec-1
0
Dec-1
1
Dec-1
2
Dec-1
3
Dec-1
4
(Per cent)
ML EM corporate plus index v/s US 10yr Treasury
ML EM Corporate Plus Index-US Treasury 10 yrs spread
Source: Thomson Reuters
Appendix
in agreement
expect moderately less
expect moderately more
expect significantly less
expect significantly more
Source: Bloomberg Source: Bloomberg
The Quarterly Investment View January 2015
Asset Management |[email protected] 13
Equity Market Valuations
0
10
20
30
40
50
Dec-6
0
Dec-6
6
Dec-7
2
Dec-7
8
Dec-8
4
Dec-9
0
Dec-9
6
Dec-0
2
Dec-0
8
Dec-1
4
(X)
Absolute valuation US equities
Shiller S&P 500 PE ratio
Source: multpl.com
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
Dec-8
0De
c-82
Dec-8
4De
c-86
Dec-8
8De
c-90
Dec-9
2De
c-94
Dec-9
6De
c-98
Dec-0
0De
c-02
Dec-0
4De
c-06
Dec-0
8De
c-10
Dec-1
2De
c-14
(Per cent)
Relative valuation US equities v/s US 10yr Treasury
Fed Model - (Earning yield-Bond yield)
Source: Thomson Reuters, multpl.com
6789
10111213141516
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)Euro Stoxx 12m forward PE
12m forward PE Average
Source: Bloomberg
-6
-5
-4
-3
-2
-1
0
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1No
v-11
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
Euro Stoxx 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
6
11
16
21
26
31
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)Nikkei 225 12m forward PE
12m forward PE Average
Source: Bloomberg
-12-10-8-6-4-202
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
Nikkei 225 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
The Quarterly Investment View January 2015
Asset Management |[email protected] 14
6789
10111213141516
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)FTSE 100 12m forward PE
12m forward PE AverageSource: Bloomberg
-9-8-7-6-5-4-3-2-10
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
FTSE 100 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
6
8
10
12
14
16
18
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)DAX 12m forward PE
12m forward PE Average
Source: Bloomberg
-4.5-4.0-3.5-3.0-2.5-2.0-1.5-1.0-0.50.0
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
DAX 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
68
1012141618202224
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)Nifty 12m forward PE
12m forward PE Average
Source: Bloomberg
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
Nifty 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
The Quarterly Investment View January 2015
Asset Management |[email protected] 15
61116212631364146
Dec-0
5
Jul-06
Feb-07
Sep-07
Apr-0
8
Nov-0
8
Jun-09
Jan-10
Aug-1
0
Mar-1
1
Oct-1
1
May-1
2
Dec-1
2
Jul-13
Feb-14
Sep-14
(X)
Shanghai Composite 12m forward PE
12m forward PE Average
Source: Bloomberg
-15.0-10.0-5.00.05.0
10.015.020.025.030.0
Dec-0
5
Jul-06
Feb-07
Sep-07
Apr-0
8
Nov-0
8
Jun-09
Jan-10
Aug-1
0
Mar-1
1
Oct-1
1
May-1
2
Dec-1
2
Jul-13
Feb-14
Sep-14
(X)
Shanghai Composite 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
6
8
10
12
14
16
18
20
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)Jakarta Composite 12m forward PE
12m forward PE Average
Source: Bloomberg
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
Jakarta Composite 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
6
11
16
21
26
31
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
Taiwan stock exchnage 12m forward PE
12m forward PE Average
Source: Bloomberg
-10.0
-5.0
0.0
5.0
10.0
15.0
Jun-05
Jan-06
Aug-0
6
Mar-0
7
Oct-0
7
May-0
8
Dec-0
8
Jul-09
Feb-10
Sep-10
Apr-1
1
Nov-1
1
Jun-12
Jan-13
Aug-1
3
Mar-1
4
Oct-1
4
(X)
Taiwan stock exchnage 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
The Quarterly Investment View January 2015
Asset Management |[email protected] 16
5
7
9
11
13
15
17
Dec-0
5
Jul-06
Feb-07
Sep-07
Apr-0
8
Nov-0
8
Jun-09
Jan-10
Aug-1
0
Mar-1
1
Oct-1
1
May-1
2
Dec-1
2
Jul-13
Feb-14
Sep-14
(X)Istnabul stock exchnage 12m forward PE
12m forward PE AverageSource: Bloomberg
-8.0-7.0-6.0-5.0-4.0-3.0-2.0-1.00.0
Dec-0
5
Jul-06
Feb-07
Sep-07
Apr-0
8
Nov-0
8
Jun-09
Jan-10
Aug-1
0
Mar-1
1
Oct-1
1
May-1
2
Dec-1
2
Jul-13
Feb-14
Sep-14
(X)
Istnabul stock exchnage 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
579
111315171921
Dec-0
6
Jun-07
Dec-0
7
Jun-08
Dec-0
8
Jun-09
Dec-0
9
Jun-10
Dec-1
0
Jun-11
Dec-1
1
Jun-12
Dec-1
2
Jun-13
Dec-1
3
Jun-14
Dec-1
4
(X)Bovespa 12m forward PE
12m forward PE AverageSource: Bloomberg
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
Dec-0
6
Jun-07
Dec-0
7
Jun-08
Dec-0
8
Jun-09
Dec-0
9
Jun-10
Dec-1
0
Jun-11
Dec-1
1
Jun-12
Dec-1
2
Jun-13
Dec-1
3
Jun-14
Dec-1
4
(X)
Bovespa 12m forward PE - S&P 500 12m forward PE
Discount from S&P 500 12M forward PE Average
Source: Bloomberg
The Quarterly Investment View January 2015
Asset Management |[email protected] 17
Sources
All information in this report has been obtained from the following sources except where indicated otherwise:
1. Bloomberg
2. Wall Street Journal
3. RTTNews
4. Reuters
5. Gulfbase
6. Zawya
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