This section is brought to you by the Luxembourg based online broker Internaxx. Market analysis is provided by Fortis Investments, the asset management arm of the BNP Paribas group.
Weak US data reminder of muted recovery (source: Fortis Investments)
The US released more disappointing data, while the economies of the eurozone and Japan did not show many signs of improvement. The market reaction was actually muted: developed equities fell by only 2.4% last week. This reinforced our view that many investors are still waiting to buy at suitable points. We expect a continued economic recovery, low inflation and stimulative monetary policy to support equities for now. After US services sector confidence data came in higher than expected, investors saw a buying opportunity, allowing the market to reverse most of the correction.
Data showed the US economy shed 263,000 jobs in September, while the August and July numbers were revised lower. The unemployment rate rose to 9.8%. The participation rate and weekly hours worked fell to record lows. This weak report clearly does not fit into our positive near-term view. However, one has to keep in mind that average job losses are becoming smaller. We see the data as a reminder that a strong recovery should not be taken for granted.
August consumption was actually strong, fuelled by high car sales on the back of the “cash-for-clunkers” programme and consumers spending savings. The increase in savings which may be needed to repair household balance sheets has stalled. Thus, the rise in consumption looks to be only temporary. Among the ISM indices, the manufacturing index eased, but held firmly above 50. The non-manufacturing index rose to above 50 for the first time since August 2008. Both signal that the US economy should recover further.
Eurozone retail sales fell, but not by as much as earlier this year. Consumer confidence was weak, given that households have to cope with rising unemployment. But eurozone households should be in a better position than their US counterparts. The rise in unemployment has been less sharp than in the US. Furthermore, households generally do not face falling house prices and savings are higher. However, a consumer-led bounce in the eurozone would be a major change from previous recoveries.
At 54.5, Japan’s PMI reached the highest level in three years. The Tankan survey of business conditions improved for the second straight quarter. The advance has been more pronounced among export-oriented manufacturing firms than among domestic-oriented services companies. Unemployment surprisingly fell in August and household spending surged, making it look as if a domestic recovery has started. But with labour cash earnings declining and consumer prices firmly deflating, we remain cautious.
Australia’s central bank raised interest rates by 25 bps to 3.25%. This is the first increase in one of the larger economies. Australia’s economy has escaped a recession and while unemployment rose to 6.1% in March, it has since fallen to 5.5% in August. One could argue that the RBA was too aggressive by cutting rates from 7.25% in September 2008 to 3% in March, but one has to bear in mind that the cuts were part of global emergency actions to prevent the financial crisis from turning into a depression.
Who is set to follow Australia’s example? Norway is often cited. Its economy experienced a relatively mild recession. Most importantly for oil-exporting Norway, oil prices have surged from their lows around the turn of the year. The Norges Bank’s baseline forecast includes rate hikes early next year. The Bank of Korea might hike rates soon. With the economy rapidly recovering to pre-crisis levels and inflation rising, interest rates of 2% could soon prove to be too low.
In our view, the Federal Reserve and the ECB will need more time. Inflationary pressures should take a while to build. The Fed’s Treasury purchase programme runs out at the end of this month and its programme to buy mortgage-backed securities and agency debt expires at the end of the first quarter. We do not expect the Fed to act before then. The ECB will likely first lower liquidity provisioning to banks. There is one caveat though. Rapid increases in asset prices or debt could force the Fed or the ECB to hike rates earlier than after previous recessions.
Allocation: US equities underweight trimmed, Japan back at neutral (source: Fortis Investments)
Investment climate: the global economy continued to recover from the Great Recession. A growing number of leading indicators is pointing to growth, several even to strong growth. Against this backdrop, risky assets outperformed defensive asset classes. Equities rallied on the back of the improving conditions. We raised our exposure to an overweight position.
We are optimistic about the global economy in the near term, expect a further shift out of low-yielding cash or bonds and think company earnings could surprise to the upside in the third quarter when sales improve. Finally, there is no inflation and monetary policy is extremely accommodative.
Regional allocation: in our rebalancing to an overweight in equities, we reduced our underweight in US equities, but returned our exposure in Japan to neutral from overweight. The improvement in Japan’s manufacturing sector has not spread to the local labour market or wages so far. The foreign capital inflows we had seen into Japanese equities proved to be a false signal. Our largest equity overweight is in emerging markets, which have recovered strongly from depressed levels. The next largest overweight is in Europe.
Small-cap equities (overweight): for small-cap stocks, we regard the near-term economic outlook as positive, monetary policy as slightly positive and the steep yield curve and liquidity conditions as outright beneficial. Risk appetite among investors and market sentiment are slightly positive in our view. The valuations of small caps in absolute terms and relative to other asset classes are neutral.
Real estate securities (neutral): real estate has performed even better than equities so far this year. Momentum in this asset class has remained positive, but we are cautious. Real estate equities may have started to price in too much optimism about the economy, while the underlying fundamentals of this market remain quite weak in our view. We are overweight Asian property due to the improved economic conditions, ample liquidity and signs of stabilising rents in the region. We remain underweight in European real estate where companies have been forced to sell assets to comply with financing covenants.
Furthermore, European real estate has been heavily affected by the UK office market, which has suffered badly in the credit crisis. We are neutral on US real estate.
Investment-grade corporate bonds (overweight): while credit spreads have narrowed notably from their peaks last year, they remain high from a historical perspective. In an uncertain and volatile environment, we like this asset class for its relatively high carry, so we are maintaining a large overweight position.
High-yield bonds (overweight): both the economic cycle and the outlook for corporate profits have improved in our view. Anecdotal evidence shows that the ratio of earnings upgrades by analysts to downgrades is also looking better. According to central bank surveys, bank lending conditions are being relaxed in the major regions. High-yield bond prices have risen in recent months, but with spreads still at relatively high, recessionary levels, we see room for further price gains. Finally, cash inflows into the asset class are relatively strong.
Emerging markets bonds (overweight): we consider the asset class relatively attractive given the aggregate current account surpluses of emerging countries, their falling external and public debt ratios and their high foreign exchange reserves. We are overweight in local currency emerging debt since we expect it to outperform foreign currency debt. Yields are higher in local currencies and there is room for currency gains as a result of the improving fundamentals and monetary policies.
Convertible bonds (neutral): we prefer global convertible bonds to those from Europe. In our view, there are more investment opportunities globally than in Europe, where cash-rich companies do not need to issue convertibles.
Commodities (overweight): commodity prices rose on the whole in September. Crude oil prices were mixed. Industrial metals prices declined, but the prices of gold and agricultural commodities rose. We remain overweight in commodities for cyclical and structural reasons including the likely future capacity constraints.
Internaxx Top ten buys and sells –International Investors Activity summary from Internaxx
Top 10 Buy
|3||General Electric ||NYSE ||Conglomerate|
|5||Commerzbank||Xetra || Finance|
|6||Lloyds Banking ||LSE||Finance|
|7||BNP Paribas||Paris|| Finance|
|8||CIT Group||NYSE ||Insurance|
|9||Bank of America ||NYSE ||Finance|
| 10||Royal Bank of Scotland||LSE ||Finance|
The Top Ten buys and sells are measured as the total number of trades carried out in each stock by Internaxx clients over the previous month. This report is not a recommendation to buy or sell these stocks.
This document has been prepared solely for informational purposes and does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any security or financial instrument, or any investment advice. Prospective investors should conduct such investigations as deemed necessary and should seek their own legal, accounting and tax advice to determine independently of the suitability and consequences of an investment.