Global Investment and the Fiscal Cliff – The Markets Perspective
Pending the outcome of the next Fiscal Cliff negotiations (which have in all reality been delayed, rather than solved) the Global markets may move into calmer waters as the government inevitably confronts its duty for sustainable spending and a serious deficit reduction plans. Investors in Wall Street remain fixated on the next confrontation between the government and the debt ceiling now that the possibility of a new recession in is looking increasingly unlikely. 2013 will witness a bullish president lead an agreement between democrats and republicans as it seeks to retain its global economic dominance and compete with the rise of China which at the end of 2012 surprisingly saw stocks rise after months of poor performance.
The Shanghai stock market seemed finally to have come back to life: the leading index rose over 4.0% as investors’ risk appetite increased, buoyed in part by better economic news. In Tokyo the stock market advanced further – it has risen some 11% in the last few weeks – as investors bet on a change of government. In the government bond markets, yields ticked marginally higher; whilst on the currency front it was mostly quiet too, although the euro managed to climb three cents, ending close to its 12-month high against the US dollar, supported by slightly better economic data from the region.
The pace of economic change as we begin to 2013 is likely to be rapid and variable, economics always is. However this year may prove to be significant milestone for the recovery of the global financial system and the competing systems of the US, UK, Asia and Europe, let’s examine some of the most recent influential factors in further detail.
A Yen for change
- The Liberal Democratic election victory in Japan boosts the stock market as the yen falls
In Tokyo, shares rose and the yen dipped after the Shinzo Abe-led Liberal Democratic Party won Japan’s general election. The Nikkei 225 Index rose 1% and the Japanese currency fell to a 20-month low of 84.48 yen against the US dollar. Mr Abe has said he will implement measures to help revive the world’s third-largest economy, which has been battling years of sluggish growth, and is on the verge of falling back into recession: the fifth in 20 years. Japan’s economy has been hurt by a variety of factors over the past few years, not least the strength of its currency, the yen. A strong yen makes Japanese goods more expensive to foreign buyers and also hurts the profits of the country’s exporters, which rely heavily on foreign sales for growth.
Before the election, Mr Abe had said that he will implement measures directed at weakening the yen and fighting deflation. Commenting on the results, Kyohei Morita, chief economist at Barclays Securities Japan, said, “The Liberal Democratic Party’s big victory is in line with market expectations and it will help to keep the yen weak and share prices high, at least for now.”
- EU policymakers continue working towards greater Eurozone integration but growth policies still failing
The one piece of knowledge that would have been most useful at the beginning of 2012 was that the euro would be held together by the European Central Bank (ECB). Mario Draghi’s promise to “do whatever it takes” was sufficient to engineer a classic volte face on the part of investors: anyone owning Portuguese ten-year bonds would have made 75%, whilst those also brave enough to pile into European banking stocks would have also made gains of 50–70%. So how much progress has been made in the Eurozone towards greater financial stability and growth? As acknowledged by European leaders at the end of their two-day summit last week, the long-promised transformation of the Eurozone from a simple currency union into an entity resembling a centralised fiscal and economic block is still work in progress and key issues remain unresolved. Deeper fiscal integration, including banking union, is seen as essential if the region is to survive long term; but EU leaders agreed only to address the issues in six months’ time. “We have achieved some things but just as before, we have a tough time ahead,” concluded Angela Merkel.
Apart from greater integration, most observers would probably put growth as a prerequisite for success and this has, in the face of swingeing austerity cuts, been in retreat, with the region as a whole officially in recession. The situation of Europe’s southern states – the so-called ‘periphery’ – was neatly summed up last week by Italy’s former Prime Minister Mr Berlusconi, who is threatening to re-enter the political fray. “The situation today is far worse than a year ago when I left government. We have an extra million unemployed, the debt is rising, firms are closing, property is collapsing and the car market is destroyed. We can’t keep going on like this.”
Quite so – and of course, one could substitute Spain or Greece for Italy. Last week there was, though, a flicker of hope following news that the rate at which economic activity is contracting eased last month. An upturn in Germany’s service sector was the main positive factor and indeed the dour mood lifted after the ZEW survey of German investment sentiment showed a sharp rise for this month.
From an investor’s perspective, European stock markets remain, for obvious reasons, fundamentally cheap, trading on low price to- earnings ratios and offer good opportunities over the medium to long term. Stuart Mitchell, who manages European equities and funds for St. James’s Place, explains his strategy. “There are no signs of emerging market slowdown amongst the companies in the portfolio. Chinese consumer is still very buoyant; the impact of Chinese buying goods overseas is also significant – watch sales in Germany are up 25–30%. Luxury goods companies are still benefiting from emerging world growth, yet valuations remain attractive. Swatch is seeing sales rise at 30% pa, with a third of sales coming from China. Volkswagen has sold 2 million Audis in China and the country is responsible for 47% of VW profits; likewise, Porsche sales are up 30–40%. The key to success for these companies are the manufacture of goods that other companies can’t produce. I also put some European banking stocks in the portfolio a few months ago and these remain relatively cheap despite their sharp rally. So I remain confident that Europe continues to offer some great investment opportunities.”
Slow ship to China
- Chinese policymakers avoid ‘hard landing’ for world’s second-largest economy as growth resumes
Navigating the world’s second-largest economy through economic reform and change was never going to be easy for Chinese policymakers but the current ‘five-year plan’ is aimed at deliberately slowing growth down from a historic 10% to 7.5% per annum by creating a more consumer-driven and thus less investment-dependent economy. Investors have fretted this year that this could lead to a ‘hard landing’, with growth crashing to 3% per annum. The reality has been quite different. In a comprehensive readout on the global economy last month, the Organisation for Economic Co-operation and Development (OECD) said it saw China’s economy growing by 7.5% this year before picking up once more next year to 8.5% in 2013. Recent economic data from the country has been positive, showing a return to growth as government-led policies to stimulate the economy begin to work their way through without, and this point is crucial, stimulating inflation. Recent data show an improvement in trade, industrial production and retail sales, with the latest ‘flash’ purchasing managers’ index, compiled by HSBC, rising to a 14-month high, suggesting a pick-up in factory activity. Investors’ concerns have been reflected in a moribund Stock market but, as mentioned, there is some evidence that the tide may be turning as the likes of insurance companies return to the market. Improving investor sentiment will benefit not just Chinese companies but Asia as a whole, whose economic fortunes are inextricably tied to the continued growth of the region’s behemoth.
US Oil Industry
- Unlocking of huge shale gas reserves becomes the driving force behind America’s new industrial renaissance
- Industry leaders say low-cost energy is benefiting US growth
One of the largest contributors to inflation in recent times has been the increase in energy costs – crude oil continues to trade above $100 per barrel. However, another type of revolution has been taking place in the US: the exploitation of shale gas. Economists are forecasting that the US may well become energy self-sufficient once more within the next decade and this is having huge ramifications for the economy. Manufacturers have announced more than $90 billion worth of investments to take advantage of its new supplies of cheap natural gas, driving an industrial renaissance. Petrochemicals, fuel, fertiliser and steel companies are all committing to multi-billion-dollar investments. Advances in drilling techniques have now made huge gas reserves commercially viable – the price of natural gas has fallen to a 10-year low. Industry executives say low-cost energy and feedstocks are having a noticeable effect on the economy and probably explain why growth surprises are on the upside.
The improving outlook for the US economy probably explains why Wall Street has enjoyed a good year and why many US stocks trade at a premium of around 28% over their European rivals.
Article contributed by St James’s Place Wealth Management.