Thu, 10/05/2012 - 20:41
Following the Japanese earthquake in March 2011, major industrial sectors were plunged into turmoil. So far 2012 has seen no repeat of the surge in oil prices in the first half of 2011 when they jumped more than 50% compared to the average 2010 price.
The steep fall in US confidence levels seen in mid-2011 is unlikely to reoccur as long as jobless figures continue to fall at a sufficient pace.
Central banks meanwhile, are still actively intervening in the developed world. In a sharp contrast with 2011, the ECB has in fact stepped up intervention and helped reduce systemic risk in the eurozone.
Developed economies are suffering from the consequences of both too much private and public debt and, in some cases, from inflated asset prices. It will take some time to adjust after the unprecedented debt cycle that ended in 2007. But the process is underway and even if the way forward is littered with deflationary pitfalls, some countries have managed to make good progress. By helping banks to fulfil their traditional mission, central banks played a decisive role in preventing the financial system from exploding after the Lehman crisis.
Above all, they created the conditions that could steer the global economy back to health.
In the US, the financial system has returned to normal working conditions and banks are now once again lending. But the US government deficit is the source of concerns: given the political gridlock in Washington, how can a reasonable solution be found? 2013 will be very tricky as trying to cut the deficit will not only be very complicated but will also threaten growth. The property market is still fragile as inventory overhang is putting prices under pressure. Fortunately, according to a wide range of indicators, the situation has already started to stabilise. There has been a sharp rise in apartment building due to rising rents and increasing investor interest in the sector.
Europe has not yet emerged from the crisis but the situation from one country to another varies. Recessionary clouds will persist throughout 2012 amid government efforts to reduce public deficit. As can be seen in Spain, these measures will probably be difficult to implement. There will inevitably be disappointments with such a difficult process but what matters most is keeping policy on track. Similarly, the degree of difficulty varies in each country; moreover, Europe is not a self-sufficient zone and its economic health is heavily dependent on global growth trends. So we should expect poor economic data for a time that will hit investor sentiment. Banks are clearly the weak link in Europe. The ECB has been intervening efficiently for some time, but management of sovereign debt will continue to fuel concerns. Bank balance sheets in Europe are also a problem and in no way comparable with the situation of US banks.
In the emerging zone, investor concerns are focused on China and this year’s political transition has only exacerbated worries. There are signs everywhere that the economy is slowing down but this was orchestrated by the government and first quarter figures show that the decline is limited. We expect the economy to pick up speed again in the second quarter. More generally, leading emerging economies have enough leeway to ensure growth remains vigorous and most have started to act.
Inflation is under control
High inflation was a serious concern in 2011 but looks less problematic this year as it has slowed sharply in most countries. This has given central banks more leeway to ease monetary policy. Brazil’s central bank started to reduce benchmark rates in 2011 and continued to do so at the beginning of 2012. Even India’s central bank, which had been tightening monetary policy for two years, has reduced both its benchmark rates and the reserve requirement ratio to inject liquidity into the banking system.
Structurally high growth
Looking beyond specific eurozone problems, concerns over global growth have partly abated due to positive surprises from the latest US macroeconomic statistics. Due to long term structural factors like superior growth profiles and relatively low public and private debt, we remain positive on emerging markets.
Emerging economies are being transformed more by domestic growth than by exports. This means they are less vulnerable to an economic slowdown in the developed zone. Moreover, with PEs of around 10 times, emerging markets are underpinned by attractive valuations.
Concerns have already been factored in by the markets
The European debt crisis, worries over global growth and the impact they might have on risky assets are still the biggest risks facing emerging equity markets. However, any global economic slowdown was clearly factored in by equity markets in 2011.
Emerging Europe covers large, fundamentally robust economies like Russia, Turkey and Poland and developing frontier countries which have huge upside thanks to an emerging middle class and narrowing earnings gaps with the West.
The leading emerging Europe economies rapidly recovered after the 2008-2009 crisis and are set to grow twice as fast as Western Europe in coming years.
Performance in the region will mainly be driven by: ‐Strong domestic demand; ‐Large-scale government investment programmes; ‐An emerging middle class which will drive consumption in coming years; ‐Abundant natural resources at a time of rising commodity prices; ‐Cheap and highly qualified labour; ‐Low taxation which should continue to attract foreign direct investment and underpin growth in the zone.
Our preference for Russian equities
In Russia, Vladimir Putin’s election as President was a positive factor for the market as it brought an end to a period of political uncertainty that had weighed on the market since the parliamentary elections at the end of 2011. Improvements in corporate governance in Russia’s big groups along with higher dividends could drive the market this year and lead to an expansion in market multiples which are still relatively low compared to global emerging markets. High oil prices will also underpin the market.
Latin America is famous for its abundant natural resources and as such benefits from constantly increasing demand for oil from the US and China’s huge needs for copper and iron ore. Genuine diversification comes from each country’s specific features.
Transversal growth themes
We believe that Brazil could recover this year and post growth of 3.5%. Consumption will be the main driver, spurred by a 14% rise in the minimum wage and historically low unemployment. Moreover, lower inflation over the last two quarters has allowed the central bank to ease monetary policy significantly. Its first move to reduce benchmark rates was in August 2011.
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