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February 2013
Consultant Note
Last year we engaged in a perilous prediction exercise by describing 12 surprises that could have happened in 2012. These forecasts were fairly clearcut or even astonishing, yet a review of the actual results at the end of the year has shown that, at the end of the day, our score was not that bad. At a time when the astrologers and forecasters have already put away their crystal balls, compasses and other instruments of alchemy, SYZ Asset Management is again offering you some surprises that might mark this year 2013. These events or developments which are both economic and financial could have a definite impact on asset allocation and therefore on the performance of the portfolios by the end of this year.
A publication of the Global Macro & Fixed Income Strategy team SYZ Asset Management Tel. +41 (0)58 799 10 00 info@syzgroup.com Authors: Adrien Pichoud Fabrizio Quirighetti This document is based on elements, information and data available on February 12, 2013.
Insights
February 2013
The world was obviously and unfortunately not spared by natural disasters, terrorist attacks or new armed conflicts. However, we can pride and congratulate ourselves on having, as it were, anticipated that the end of the world was not (yet) on the agenda. In the end, our failures will not have been as numerous and severe as that. We have listed (only) two: The dollar did not appreciate significantly against the euro and did not return to 1.15: it ended the year at the same level it had started at (1.32) and did not even come close to the level of 1.20.
Gold did not go down in value in 2012. Perhaps we got carried away a little too quickly and anticipated this movement too much In the end, with a score well above 50% according to our scale, we think the result is conclusive enough to repeat the experiment this year, and above all, if possible, to improve your chances of success for well-informed investments in 2013 as well.
Insights
February 2013
previous surprise), we consider that with an expanding US labour market, the market will begin to expect a less accommodative US monetary policy in the future (in other words, a rise in interest rates could be envisaged for 2014), thus triggering cyclical support from the growth and interest-rate differential in favour of the greenback. Fourthly, the structural burden that has weighed on the dollar over the past decade has vanished. The current-account deficit, which is merely a reflection of the trade balance, has fallen from 5-6% to less than 3%. True, it will not disappear but it has returned to perfectly manageable proportions, thanks to less dynamic domestic demand in relative terms, it is true and lesser energy dependence, which is also relative In 2012 US crude oil imports amounted to 3.1 billion barrels, the lowest level since 1997! Fifthly, the development and exploration of shale gas and oil is not only helping to reduce the United States energy dependence and therefore to reduce their external deficit,
but will also help to attract direct investment flows to the land of Uncle Sam, in particular for reasons of competitiveness among the most energy-guzzling industries Like what happened during the TNT bubble, such investment flows usually help to support the host currency. In the longer term, and in a certainly less perceptible manner, the end of the globalization process (it will not be possible to relocate indefinitely and there is even already talk of reindustrialization of the United States) and the rebalancing of the global economy should also be synonymous with less downward pressure on the greenback. Finally, the euro can hardly appreciate sustainably without automatically digging its own grave. That means an even gloomier economic outlook, since the only path to salvation remains the zones exports to the rest of the world and therefore a further cut in the ECBs interest rates, unless there is another round of unconventional easing, so as to combat increased risks of deflation
Insights
February 2013
4. After seeing its price rise for 12 consecutive years, gold will (at last) slide in 2013
Although 2012 did not confirm our prediction about the yellow metal last year, we are coming back to the subject once again. Indeed, in an environment of a return to normal of the cycle that should see the US economy finally see the light at the end of the tunnel, risky assets again post some good performances, the dollar appreciate and investors begin to anticipate a change of course in the Feds monetary policy, we think the gold price will no longer go up and is likely to fall from its present level. As we have said and repeated many times, the gold price is sensitive to the trend in real interest rates or rather to the expectations thereof. It is therefore likely to suffer from an expectation that the Feds key interest rate will rise and we might see a sharp correction on the yellow metal during the last few weeks of the year
5. Irish government bonds will again become almost as readily accepted as French Treasury bills
At first we had thought of predicting the interest-rate spread between German and Italian 10-year bonds, but we thought that in the end it was too ordinary and too easy a bet... Nevertheless we are offering you our forecast free of charge: the yield should narrow to less than 200 basis points by the end of the year. Those who are familiar with this type of exercise will have noted in passing the advantage of venturing to forecast an interest-rate spread rather than the interest-rate itself This surprise might come true even in the absence of a sharp drop in Italian interest rates, simply as a result of German rates rebounding On the other hand, we find it much more interesting to take a look at the two extreme countries of the Euro zone in terms of dynamics. They are Ireland, which has already been on a diet of austerity, and France, which has not yet embarked on such a diet (in fact, the country doesnt follow that type of diet). Not wishing to get involved in facile predictions, we are not going to spend time being overly pessimistic about France. One need only look at the publication of the latest PMI indices, the health of its automotive sector, the lack of any leeway in fiscal terms and, even more worryingly, the diffuse denial by politicians of the fact that the wall, or rather the great wall, is really not very far off. The turnaround of the Irish economy, in contrast, has gone almost unnoticed, obscured by the heavyweights of economic and financial news - Italy and Spain. In a word, the Irish have done everything right since 2009 and without complaining. Instead of using sticking plaster here and there, the Irish authorities have from the outset opted for very large-scale measures in order to stop the haemorrhage at the level of the carotid. The result: the banks have now been restructured, the adjustment on property is completed, GDP is back on the growth track (+1% foreseen in 2013), the current account balance is now recording large surpluses and public finances are now on the right track (the primary balance will be in equilibrium next year). It is true that this Irish miracle has been helped a lot by the improvement in the outlook for the global economy (last year its exports accounted for 120% of its GDP). In short, it is a safe bet that the rating of Irish sovereign debt will gradually rise in the coming years, while that of France is more likely to tend to decrease. This dynamic should be manifested increasingly clearly in the prices and yields of these instruments. In our opinion, it is quite likely that the French 10-year rate will stand at above 2.5%, or even higher, at the end of the year while that of Ireland will fall below 3%...
Page 4 This document has been produced purely for the purpose of information and does not therefore constitute an offer or a recommendation to invest or to purchase or sell shares, nor is it a contractual document. The opinions expressed reflect our judgement on the date on which it was written and are therefore liable to be altered at any time without notice. We refuse to accept any liability in the event of any direct or indirect losses caused by using the information supplied in this document.
Insights
February 2013
7. The Mexican peso will appreciate, while the Australian dollar will fall
In terms of exchange rates, the winning forecast could be to bet on the Mexican peso appreciating, while betting on the Australian dollar depreciating. The long leg on the Mexican currency does not merely reflect, indirectly, our positive sentiment about US consumption and the process of re-industrialization of Mexicos northern neighbour. The Mexican peso is benefiting above all from sound fundamentals: strong economic growth of the order of 3.5% to 4% and thus higher than, for example, that of Brazil, still-positive real interest rates, regained competitiveness (the gap in unit labour costs between Mexico and China has fallen from more than 300% in the early 2000s to less than 30% today) and above all the absence of major imbalances (sound public finances and no external deficit). In addition, the arrival in power of Pea Nieto last December is opening up new horizons for the Mexican economy. If, as he has promised, he carries out the structural reforms needed to further improve productivity: liberalization of the energy sector, investment in education and infrastructure. As for the short leg, on the Aussie dollar, it serves as protection against the recurrent fears - but which will necessarily become a reality one day - of a forced landing for the Chinese economy in an environment of a necessary and logical slowdown in its growth. This episode will reveal for all to see the illusion surrounding the Australian miracle and the fragile nature of its currency. The deficit of the Australian current account balance will begin to deepen again if its ogre of a neighbour loses its appetite, the banks and the Australian market - which managed to avoid the bursting of the TNT and subprimes bubble - will no longer benefit from the continual increases in industrial metal prices and the Australian real-estate bubble will at last burst at that time. If you add to this picture interest rates that have melted like ice in the sunshine in recent years, you get the recipe for a real headlong flight. There is a double attraction to this recommendation. Firstly, it reflects a deep, structural change: we have reached the end of the relocation process caused by globalization and that has characterized the last 10 to 15 years. Chinas growth will from now on be less high and different in nature. It is thus certainly also the end of the boom in industrial metals (we do not necessarily foresee an abrupt drop but simply the end of the increase) and as an indirect consequence, the end of the great mining investments in Australia, as was illustrated last summer by the abandonment of BHPs project to enlarge the Olympic Dam mine, which would have involved USD 30 billion and 15,000 jobs. Secondly, it overcomes a recurrent problem when one wishes to express a negative view about the Australian currency: the carry generally acts against us. By taking the Mexican peso as a boosted proxy for the greenback, we will certainly be able to afford to be a little more patient
Page 5 This document has been produced purely for the purpose of information and does not therefore constitute an offer or a recommendation to invest or to purchase or sell shares, nor is it a contractual document. The opinions expressed reflect our judgement on the date on which it was written and are therefore liable to be altered at any time without notice. We refuse to accept any liability in the event of any direct or indirect losses caused by using the information supplied in this document.
Insights
February 2013
8. Emerging debt in strong currencies will be the least good fixed-income segment
As we come to the last few surprises predicted for this year, we need to do something to help our success rate We are therefore certainly not taking too many risks in making this forecast, which should sound obvious to all those who have spent a little time studying this asset class. Yield spreads can no longer decrease, especially on emerging sovereign debt, while the risks remain. The carry is so low that it will probably not even cover any increase in interest rates with and/or without credit risk. Moreover, these risks are certainly even greater than one thinks (another way of saying that prices are much too high or yields too low). Since the crisis, it has been more than tempting to buy sovereign emerging debt since those economies benefited both from strong economic growth and a very low level of (government) debt as a percentage of GDP. The problem is that these two trees can conceal enormous forests of private debt, all kinds of levers and other real-estate bubbles. If you have any doubts, try to recall which were the two Euro-zone countries that during the period from 2005-2007 were posting strong GDP growth with a very low level of (government) debt Given the excessive infatuation there has been with this asset class since 2009, an ordinary economic accident (or semi-accident) in one of the BRIC countries could lead to a massive outflow of funds. As often in this case, stampedes can be more dangerous than the ill itself. In our opinion, it is no longer necessary for European investors to seek to complicate matters since a basket of Italian, Spanish and, of course, Irish debt with a mixture of first-rate sovereigns and bank debt (the national champions), denominated in both euros and dollars, will give you as many thrills but probably more performance than emerging debt in strong currencies. As far as emerging debt denominated in local currencies is concerned, it would obviously not be protected against the scenario described above, but at least its expected yields are relatively higher and it would also be able to benefit from the appreciation of the currency (in a favourable scenario). In short, with debt denominated in local currency, one is paid for the risks taken - less than before, it is true, but still decently.
9. 2013 will at last be the year in which Japan moves out of deflation
The Archipelago has been plunged in a deflationary spiral for nearly 20 years, which has led to an uninterrupted decrease in the general level of prices and has greatly limited real growth. GDP measured in current yen is today (5%) lower than it was in 1995, whereas real growth (excluding price variations) has been +15% over the period (less than 1% per year on average)! It is, of course, a spiral to the extent that the decrease in prices renders the traditional monetary policy tools ineffective: even with interest rates at 0%, the real yield is positive if the inflation rate is negative. It also encourages companies and households to be cautious (distribution of profits, savings) rather than to invest and consume. A shock therapy is needed to stop this spiral and reverse the trend. This is what the new Prime Minister, Mr. Abe, promised to win the December elections. To do everything that has been done up to now, but on a larger scale So the public debt blithely exceeds 200% of GDP and the public deficit has been hovering at around 9% of GDP for four years? To hell with austerity, long live budgetary stimulus with a plan to support the economy amounting to JPY 10.3 trillion (USD 116 billion). So the Bank of Japans balance sheet exceeds 30% of GDP after more than 10 years of unconventional monetary policy? The moderate approach has proved its ineffectiveness and it is time to switch to a higher gear: an explicit inflation target of 2%, an acceleration of Quantitative Easing planned in 2014 and a new Governor for the BoJ, who will be chosen for his ability/determination to implement the reflation plan dictated by the government. By injecting more liquidity into the economy and by increasing public spending in the current environment, the signal is now intended to be less ambiguous than it may have been in the past: this time, its serious. We will not be backpedalling at the first signs of an improvement or positive inflation figures! This has been manifested immediately in a sharp drop in the value of the yen, which could be the first domino in the process of climbing out of deflation. Depreciation of more than 15% in a few months will have positive repercussions on exporting companies
Page 6 This document has been produced purely for the purpose of information and does not therefore constitute an offer or a recommendation to invest or to purchase or sell shares, nor is it a contractual document. The opinions expressed reflect our judgement on the date on which it was written and are therefore liable to be altered at any time without notice. We refuse to accept any liability in the event of any direct or indirect losses caused by using the information supplied in this document.
Insights
February 2013
through a resumption of investment and recruitments capable of halting the slide in prices and salaries. But the first, more immediate effect of the yens depreciation will be the surge in prices of imported goods, among which energy ranks first. If this runs the risk of penalizing Japanese households purchasing power, it will probably result in pushing up the price indices and therefore help to achieve the objective of reflating the economy. It is to be hoped that the additional activity of exporting companies and that generated by the public
stimulus plan will offset this loss of purchasing power with new jobs and higher salaries Thus while the true climb out of deflation (resumption of a virtuous cycle of investment/jobs/growth) will probably take several years, 2013 might see the annual inflation rate already return to positive territory, under the influence of imported inflation caused by the depreciation of the yen. This in any case is the meaning of the economic policies currently being put in place in Japan.
Insights
February 2013
European countries are going through. While the latter are inflicting an austerity cure upon themselves to restore their competitiveness after having spent without counting the cost, it would be good form for Germany to allow itself to spend part of the revenue that it earns from its exports.
This would help the ongoing rebalancing in the euro zone and might, in addition, make German households happy accustomed as they have been to tightening their belts for 15 years.
With our best wishes for success. Global Macro and Fixed Income Strategy Team SYZ Asset Management Adrien Pichoud and Fabrizio Quirighetti
Page 8 This document has been produced purely for the purpose of information and does not therefore constitute an offer or a recommendation to invest or to purchase or sell shares, nor is it a contractual document. The opinions expressed reflect our judgement on the date on which it was written and are therefore liable to be altered at any time without notice. We refuse to accept any liability in the event of any direct or indirect losses caused by using the information supplied in this document.