GlobalReach Securities. Investment Newsletter

Transcription

1 GlobalReach Securities Investment Newsletter GlobalReach Securities November 2008

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3 GLOBAL ECONOMIC OUTLOOK The US economy finally contracted in the 3rd quarter of 2008, by 0.8% on an annualised basis, but was showing significant weakness as the quarter ended. This trend continued throughout October and into early November, although it was probably accentuated by the global financial crisis. Recent indicators have been particularly weak -consumer confidence at lowest ever level in the 40 year history of the survey and the recent US purchasing managers report at levels last seen in the 1970 s. In Euroland, economic indicators have also weakened further throughout October. The European Commission Economic Sentiment Indicator hit a 15 year low in October while the manufacturing surveys made new lows with Spain, Ireland and Italy reporting numbers below 40, signalling a sharp contraction. In the UK consumer confidence has reached levels last seen in the 1970 s while house prices continue to fall at a near 20% year on year rate. The economy contracted for the first time in 16 years in the 3 rd quarter of Consumer Confidence US monthly car sales for October were the lowest since 1983, when both the economy and the car market were much smaller than they are today. The car sector is in particularly poor shape now both in the US and globally as sales, which to a large extent depend on credit, have fallen very sharply compared to production schedules. In Ireland the October budget highlighted the deterioration in the public finances and some corrective action was taken. The folly of the excesses of years past has now been revealed though, as the government has been forced to execute a pro cyclical budgetary stance at a time of economic contraction. It is likely that the budgetary position has not yet been stabilised as revenues may continue to fall below expectations as unemployment rises sharply and consumer spending weakens further. A more draconian cutback in spending is likely to be necessary in the New Year. The US economy is likely to contract by the order of 3% to 4% per quarter on an annualised basis over the next 2 quarters. The new President will likely introduce a stimulus package by the Spring of 2009 in an attempt to revive the economy. 1

4 GLOBAL ECONOMIC OUTLOOK (contd.) The Western economies have been badly affected by the credit crunch as the price of credit has jumped and its availability has diminished sharply. Despite the efforts of the US Federal Reserve in cutting interest rates US corporates are still paying historically high rates. US Corporate Bond & Treasury Yields Source: Data Source November 2008 Japan is worthy of special mention this month as the economy also seems likely to experience a severe contraction over the next 6 months. The collapse in external demand and the forced repatriation back to the Yen has squeezed corporate Japan to such an extent that the Japanese Small Business Confidence Survey is near the all time low rate set in Industrial production is expected to contract by 15%, and GDP to fall by 4% at annual rates this quarter. Emerging market economies started to show significant weakness during October as demand for goods and commodities from the Western economies sagged. The Chinese purchasing managers survey released Nov 3 rd, fell to a contractionary level of 44 for the first time in the short history of the survey while there is much anecdotal evidence of closures of Chinese manufacturing plants which had expanded dramatically in capacity in recent years. As previously flagged world trade growth has stalled as proven by the near 90% fall in the cost of shipping goods as shown by the Baltic shipping cost indices. In the UK mortgage approvals are running at a rate of 30,000 per month compared with a peak rate of about 120,000 per month and about 90,000 per month throughout the 1990 s. This shows the severity of the retrenchment in the UK banking system which may constrain growth for years to come. The recent Bank of England Stability Report highlighted how, in the last several years, UK banks had loaned 800bn more than domestically generated resources with the gap being filled by wholesale money markets and securitisation. The challenge in the UK will be to keep the banks lending, even as they pull back on external resources. This has been the main motivation for the Government in recapitalising the banking system. Global central banks are finally moving fast to cut interest rates and measures to thaw the money markets and ease the credit crisis finally seem to be working. Lower energy and commodity prices will eventually be a boost to spending as confidence returns. As the financial crisis dominated news in October it may have exaggerated the collapse in business sentiment and consumer confidence. However given the synchronisation of the downturn across the global economy and with most business surveys at 3 decade lows, this recession looks likely to be as damaging as that of 1974 and certainly the worst of the modern era. 2

5 GLOBAL ECONOMIC OUTLOOK (contd.) Threat of deflation On November 3 rd Dallas Federal Reserve President Fisher, a high profile inflation fighting hawk, said inflation has subsided, in fact it has vaporised. The inflation concerns of mid Summer have fallen as quickly as financial markets and the global economy have fallen into recession. Very soon the fear may well be of dropping prices or deflation. We have been living with deflation in certain goods for many years - TVs and DVDs for example as technology has created more efficient manufacturing processes and economies of scale have been achieved. These will continue to be sources of deflation as there has been major investments in new plant and machinery, especially in emerging economies, in the last few years. However over the next 12 months there is likely to be a major dislocation between demand and supply as the western economies enter a deep recession caused by the deleveraging of the banking system and subsequent fall in consumer and business investment demand. This combination is likely to be toxic for the pricing power of companies producing generic goods. Already petro chemical prices (naptha and derivatives) are at 5 year lows as demand for plastic products has collapsed. Key factors of production like oil and copper are down in price in year on year terms. Australian iron ore producers will be forced to accept price cuts in the annual contract negotiations around the New Year. It seems that the rapid collapse in demand combined with an unprecedented build up in capacity are likely to create a major goods price deflation right through What else is deflating? Nearer to home residential property is down by 30% and rents are falling. Commercial property is in oversupply especially in the City of London which is unlikely to need new space for a number of years as the banking sector downsizes. Labour costs in the large open US economy are now showing very weak growth. Bargaining power of labour is going to fall through German industrialists may resist the IG Metall wage demands with a strike if necessary. Taking account of base affects, US headline inflation may turn negative next spring. The car sector is going to be in particular stress as demand has fallen sharply and second hand car prices are deflating rapidly. New car prices are now also starting to fall. 3

6 EQUITY MARKET SNAPSHOT Global equity markets exhibited record levels of volatility during October as the realisation dawned that the global economy was entering a deep recession. Amongst the worst performers was the Japanese Nikkei Index falling 23% in local currency terms in the month as its global demand sensitive exporters slumped. Markets ended the month down another 15% to 20%, following on from the 10% to 15% losses incurred in September. By the end of October most indices were about 10% off their lows as emergency interest rate cuts were instigated by global central banks and additional measures were introduced to ensure the liquidity and solvency of financial institutions. Forced deleveraging by the hedge fund sector seemed to be a particular problem in the first half of October as investors redeemed funds. The rally in the last few days of the month was helped by significant rebalancing of portfolios as equities had severely underperformed other asset classes. Rolling 12 month performance of the S&P ended the month at 35%, historically a very oversold level while the VIX volatility index ended at 60%. Table 1: Indices Percentage Change (denominated in Euro) INDICES Current Level October Move YTD ISEQ % -56% Dow Jones % -20% S&P % -27% Nasdaq % -26% FTSE % -37% DAX % -38% CAC % -37% Eurostoxx % -41% Nikkei % -28% MSCI World % -31% 4

7 BOND MARKET SNAPSHOT Table 2: Bond Yield Basis Point Change 10-year Yield 3 Month Change 6 Month Change 1 Year Change US UK Eurozone Japan Over the past month bond yields have also exhibited significant volatility with long dated yields initially rallying as stocks collapsed but then selling off as huge financial sector bailouts transferred risk to government deficits. This is particularly seen in intra Europeanspreads with new highs being seen against Germany for Italian, Greek and Irish bonds. The big move again in October though was towards steeper curves with for example European 2 yr yields falling by nearly 100bp. Table 3: Interest Rates Policy Rate 6 Month Forecast US 1.0% 0.5% UK 4.5% 2.5% Eurozone 3.75% 2.5% Japan 0.3% 0.1% 5

8 FX MARKET SNAPSHOT Table 4: Currencies Percentage Change Current 3 Month Forecast October YTD EUR / USD % -12.5% EUR / GBP % 9.3% EUR / JPY % -22.9% GBP / USD % -19.9% The Dollar rebound continued in a vicious fashion for most of October triggered by massive deleveraging and repatriation. The Yen also appreciated sharply as Japanese domestic investors panicked out of overseas investments. The perception of European and emerging market economies being afflicted with a sharp slowdown added to the flows. Sterling showed particular weakness mid month when the Governor of the Bank of England said it was overvalued. Euro v Yen Chart 6

9 COMMODITY MARKET SNAPSHOT Table 5: Commodities Percentage Change COMMODITY Current October YTD Crude Oil 66-33% -26% Gold % -16% Copper % -43% Oil continued its slide despite OPEC production cuts as fears of recession intensify. As global industrial production is expected to be very weak for the next 6 months there seems little reason to expect any recovery in prices for a while. Gold has sold off as expected as inflation fears transfer to prospective disinflation. Copper prices have continued to fall sharply in the last month as global industrial production slows sharply. Copper is now 45% below prices one year ago. Copper Chart 7

10 OUR RECOMMENDATIONS The investment scenario over the next 6 to 12 months is going to be dominated by the global economy entering a period of sub par growth. Central banks have made good strides in cutting interest rates and starting a thaw in credit markets but the fallout in the real economy has been swift and dramatic in the last 3 months. As the slowdown is synchronised across the globe there is little scope for exports to provide a source of new demand. The default provider of final demand, the US consumer, is likely to focus on repaying debts and rebuilding personal balance sheets rather than buying a new car or flat screen TV. Given the exaggerated volatility of October there is some chance of a continuing corrective rally in stock markets although this has already extended by 15% from the lows in the S&P. Markets always bottom out before a recession is over but as it effectively only started in most economies in the3 rd quarter it s much too early to say we have seen the worst levels in stock markets. We would thus retain a very defensive posture but would now recommend investors start to rebuild portfolios by investing a portion of their funds in our Income Protected Portfolio. This portfolio has been designed to offer protection against deflationary times ahead by selecting companies with good pricing power, strong balance sheets and good dividend yield. The portfolio of 10 shares is shown in the table below and for further information please contact the broking desk at GlobalReach. INCOME PROTECTED PORTFOLIO Company Name Market Price Market Cap P/E Ratio Dividend Yield 52 Week Stock High 52 Week Stock Low British American Tobacco GBP 1691 p 43.2 bn 14 4% GBP 2060 p GBP 1350 p BP GBP 500 p bn % GBP 657 p GBP 370 p Diageo GBP 943 p 29.6 bn % GBP 1122 p GBP 775 p France Telecom bn 9 9.7% GSK GBP 1198 p 75.5 bn 13 6% GBP 1403 p GBP 686 p Mc Donalds US$ bn % US$ 67 US$ 46 Nestle Sfr bn % Sfr 55.5 Sfr 38 Unilever GBP 1451 p 50.0 bn % GBP 1947 p GBP 1249 p Verizon US$ bn 12 6% US$ 45.9 US$ 23.3 Eon bn 9 4.7% In bonds we recommend being short European 2 yr notes at 2.5% versus being long US ten year notes near 4%. This captures our theme of potential deflation ahead while the European curve may have moved too far ahead of ECB rate cutting potential. Continue to avoid emerging markets and commodities. 8

11 OUR STANCE The table below reflects our current market recommendations: Negative Neutral Positive Equities Emerging Markets UK Europe Ireland Japan Income protected portfolio Bonds European 2 year notes UK and Japan US 10 year notes FX EUR / USD GBP / USD EUR / JPY EUR / GBP Commodities Oil Gold Copper Disclaimer: GlobalReach Securities is authorised by the Financial Regulator under the Markets in Financial Instruments Directive (MiFID). This supervision does not, however, imply that the Financial Regulator is responsible in any way, or has any views on, the merits of the products or services offered by GlobalReach Securities. Past performance is not indicative of future results. This is for information purposes only and not a solicitation to do business. 9

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13 GlobalReach Securities Ltd Block 1, 7th Floor, Grand Mill Quay Barrow Street, Dublin 4, Ireland TEL: info@globalreach.ie WEBSITE: GLOBALREACH SECURITIES LIMITED IS AUTHORISED BY THE FINANCIAL REGULATOR. COMPANY REGISTRATION NUMBER