Newsletter 15 April 2015 - Armstrong Investment Managers

Newsletter
15 April 2015
DR. ANA CUKIC ARMSTRONG
TEL :
020 7464 4330
MOBILE : 07918691139
EMAIL : [email protected]
Overweight Equities
Value Vs. Growth
- We are overweight growth sectors versus value in as economic growth slows.
Europe
- Quantitative Easing has already started having an impact in the form of compressed
yields, appreciating equity markets and a depreciating euro. We look to be long
exporters. Eurozone GDP is forecast to be 1.5% in 2015.
- A sharply weaker euro is troubling for European luxury goods companies. As the
price gap for their products in Europe and China widens they may have to
rebalance prices globally, which could hurt earnings. European luxury goods have
historically been priced almost 40% more in mainland China compared to Europe
(though this is partly due to high import duties and consumption tax). To maintain
margins in China, the price differential is now between 60% and 80%.
China
- Strong credit growth has exceeded economic growth, without credit problems.
Government entities are the main participants. However, external debt has risen
from 5% of GDP in 2008 to 12% in 2013.
- While China has massive foreign reserves it is not resilient to corporate defaults. A
lack of overseas funding will add pressure on developers and the property market.
Despite this, domestic consumption is improving across the mainland, with official
figures reading at 35% of GDP. This number should only increase as investment
growth falls.
- Monetary easing in China will help Chinese growth and the growth of emerging
markets, although EM is too closely correlated to commodities. A rate hike in the
US, we feel, will not be supportive of the emerging markets. China needs reforms
that focus on social security more than it needs monetary stimulus.
US
-
A 6 year rally has been accompanied by strong EPS growth. Margins are also
increasing, supported not only by higher productivity but also lower tax rates.
The FED’s monetary easing has supported multiples, and US companies are
increasing their global market share. China, however, is slowing down, while
Eurozone and Japan are both recovering, albeit at a slow rate.
A combination of the strong dollar and low oil prices are increasing the purchasing
power of the US consumer.
Japan
- The key issues here are corporate reforms, GPIF and foreigners buying. Japan is
on the path out of deflation and increasing domestic demand. There is a strong
focus on increasing wages with a number of companies implementing the base
wage increases. The Abenomics reflationary policy seems to be working.
- Current forecast for GDP is 2.5% and inflation at 1% (supported by wage growth).
A slowdown in fiscal consolidation in Europe
Greece has sent a list of measures it is looking to implement to convince its creditors to
release much needed cash. The EU and IMF lenders need to approve the measures to
save the country from bankruptcy. The measures do not include wage or pension cuts (but
seek) to improve the conditions for investments and a tax reform as well as curbing of
corruption. The proposal is forecasting a budget surplus of 1.5% in 2015, which is below
the 3% target expected by the creditors.
We expect the negotiations will last until the end of the summer, as all the points in the
latest proposal will need more negotiation. The repayment of the debt will be postponed.
We also believe that Greece will indeed leave the euro.
If there was no risk of a contagion, it is likely that the ECB would not mind the Greek exit.
However, by electing Syriza, Greece is setting an example for the remaining periphery
countries. Podemos’ approval is rising in Spain based on the promise of similar measures
as Syriza’s. Parties are "buying" the voters by promising anti austerity measures. This
could result in a slowdown in fiscal consolidation across Europe.
US Interest Rates
-
Aside from the economic outlook, key considerations the FOMC must take into
account for their rate policy outlook include the impact on financial conditions and
the uncertainty of using an untested exit toolkit.
Employment levels are nearing full capacity and the Fed could seek to acknowledge
this with a hike towards the start of summer.
Assessing the potential impact on the market is especially challenging at present
due to a large gap in rate forecasts. The market implied forecast for the end of 2017
is 2.3%, whereas the FOMC is forecasting 3.625%. The Fed will want market
expectations to move closer towards its own forecasts, but in a somewhat
comfortable manner to avoid triggering additional tightening requirements.
-
-
Beginning to tighten in early summer should provide the Fed with an ideal scenario
of market expectations gradually shifting higher with each consecutive rate hike.
From the Fed's perspective, they could lower their own forecasts for the end of
2017, which would allow for a slightly longer period of convergence. Alternatively,
they could hike in the summer and then lower year-end forecasts, which would also
allow the market to reprice its outlook more steadily this year.
Finally, the exit toolkit at the Fed's disposal has been extensively tested under a
zero-rate environment but it may well perform entirely differently at non-zero rates.
There is still a while before the effective fed funds rate trades within the target range
but an early hike this summer ensures the Fed does not fall behind on rate policy
and provides crucial breathing time to test its programs.
USD
-
-
Sovereign and corporate borrowers outside America owe a record $9 trillion in the
U.S. currency, much of which will need repaying in coming years, data from the
Bank for International Settlements show.
Central banks that had reduced their holdings of the USD and are buying again.
The dollar’s share of global foreign reserves shrank to 63% from 73% percent a
decade earlier. There also is another structural factor that’s underpinning the dollar:
the U.S.’s shrinking current-account deficit.
The decline in oil prices has helped the U.S. reduce its trade shortfall to 2.3 percent
of GDP. That’s down from a record 5.9 percent in 2006.
Finally there has been a rise in dollar-denominated debt across the globe. The $9
trillion owed by borrowers outside the U.S. has increased from $6 trillion at the end
of 2008. This was boasted by the Fed cutting its benchmark interest rate to near
zero, making it cheaper to issue in the currency.
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