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. Our commentaries are meant for investment professionals and we appreciate your confidentiality with respect to communications sent from us.