Bubble, bubble toil and trouble? 15 February 2011 facilitating debate on the outlook for the markets
Kumar Palghat ag a Managing Director Kapstream Capital
Two sides to every story 3
2010 bottom line Right Rates unchanged Stimulus to continue High unemployment Surprises Equities outperform bonds European Debt Crisis (gets deeper) Aussie equities underperform US Weak growth Asia continues to grow 4
What we thought last year The solution to the problem 5
What happened US summer? Source: Bloomberg 6
2010 = European winter? European 10-year bond spreads to bunds bps 01-Oct-09 07-May-10 30-Nov-10 26-Jan-11 27-Jan-11 Greece 138 965 919 827 818 Ireland 160 306 669 576 572 Portugal 71 349 430 395 378 Spain 64 164 283 225 227 Italy 96 147 200 161 161 UK 33 103 56 51 49 Netherlands 34 26 27 16 16 Belgium 51 72 133 110 111 France 37 35 48 35 36 Source: Bloomberg 7
Debt load capacity = nearly full! US DEBT TO GDP, BY SECTOR 350 CORPORATE HOUSEHOLD 300 FINANCIAL TOTAL* % GDP 250 200 150 * INCLUDES PUBLIC SECTOR LATEST DATA POINT Q2 2009 100 50 0 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 Source: Morgan Stanley 8
Sovereign crisis? Source: Morgan Stanley 9
Rates steady as she goes Low interest rates Leverage Housing boom Sub prime Poor lending and underwriting standards Financial engineering (CDOs/CLOs) Caused financial systems to collapse Brought economies to their knees ~ governments stepped in to bail out Source: Bloomberg 10
Housing Under water everywhere literally Cumulative house price change, by purchase vintage 50 % Change 40 30 20 10 0-10 -20-30 -40 2006 2005 2004 2003 2008 BASED ON CASE-SHILLER INDEX. 2007 ASSUMES AVERAGE MORTGAGE IN GIVEN YEAR SET AT AVERAGE HOUSE PRICE FOR THAT YEAR. 1 7 13 19 25 31 37 43 49 55 61 67 73 Months since purchase N SAAR M 4.5 4.0 3.5 3.0 2.5 20 2.0 US home supply: Starts and foreclosures FORECLOSURES COMMENCED IN THE PERIOD. BOTH SERIES SHOWN AT ANNUAL RATES * MBA DATA ** REALITY TRAC DATA, WITH MS-CALCULATED TREND SERIES NEW HOME STARTS MONTHLY FORECLOSURES** 1.5 1.0 0.5 QUARTERLY FORECLOSURES* 0.0 198 80 198 83 198 86 198 89 199 92 199 95 199 98 200 01 200 04 200 07 10 20 Source: Morgan Stanley 11
Reflate? = problem solved Source: JP Morgan 12
Depreciate = problem solved 150 US dollar trade weighted value 140 130 Nominal USD TWI (narrow) Broad TWI (real) Index 120 110 100 90 80 70 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: JP Morgan/Bloomberg 13
The aftermath ~ US job losses US unemployment rate has risen from 4.6% to 9.6%, and is likely to remain over 8% for a long time US needs over 15 million jobs over the next 5 years to get back to pre-recession levels Source: Bloomberg 14
Cheap money = new bubble Source: JP Morgan 15
Cheap money = new bubbles 200 BASE METAL PRICES 150 INDEX 100 50 900 GOLD AND TREND US INFLATION 20 0 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 US$ 800 700 600 500 400 300 200 100 REAL GO LD PRICE 10YR CPI (RHS) 15 10 5 0 10 YR CPI AVER RAGE % 0 1880 1900 1920 1940 1960 1980 2000-5 Source: JP Morgan 16
Cheap money = China in a bubble? By 2025, China will build ten New York sized cities By 2025, 40 billion square meters of floor space will be built in five million buildings. 50,000 of these buildings could be skyscrapers the equivalent of ten New York Cities. Mckinsey, Preparing for China s urban billion
Impact of the GFC on Australia Source: Bloomberg 18
Impact of the GFC on Australia The Australia unemployment rate has held steady: Australia has created jobs every year in the last decade! Source: Bloomberg 19
Outlook US equities, the lost decade 20
Outlook Aussie assets, the sweet spot Source: Bloomberg 21
Conclusion Crystal ball! US recovery looks to be gaining traction European debt problem should find a solution Global geo-political risks impacts, oil prices, unemployment and regime changes Asian economies to continue to surge (bubble formation) Investment implications Adding long-dated sovereign bond exposures actually adds to risk to balanced portfolios Avoid sovereign exposure and reduce duration (maturity) of bond portfolios Prefer floating rate assets to fixed rate assets Long debt of Asian corporates DO NOT SHORT THE US$ Strong growth in Asia, US recovering while Europe is the laggard 22
Key risks The US cannot afford (i.e. can t fund debt with debt): a drop in GDP a fall in equity markets a rise in interest rates European Economies in a mess: Greece, Spain, Italy, Portugal and Ireland all in trouble They have to cut spending and increase taxes ~ when economic growth is on shaky ground! RBA a little too trigger happy: domestic economy is good shape global backdrop remains tricky Source: Bloomberg 23
Bubble, bubble toil and trouble? 15 February 2011 facilitating debate on the outlook for the markets