On-going issues in the Eurozone and the looming US ‘fiscal cliff’ will create an uncertain environment for investors until the beginning of 2013, according to Marino Valensise, chief investment office at Baring Asset Management (Barings). However, Barings believes that improving fundamentals around the US housing market, a potential shift in sentiment towards the US’s vast natural gas reserves, appetite from US pension funds for emerging market equities and debt and stabilization of fundamentals in China could help the global economy and provide the necessary catalysts for growth and for a positive market dynamic…
We believe that the US will play a significant part in the global recovery story. We are convinced that the US will be one of the main drivers of growth in 2013 despite the looming ’fiscal cliff’. We expect that the ‘fiscal cliff’ is resolved relatively easily and quickly in 2013, with little permanent damage to consumer or business sentiment.”
Housing affordability in the US has steadily improved since 2007 and there the system is suffering a declining number of mortgage delinquencies. Low financing costs, stable house prices, attractive rental yields and declining inventories is a powerful cocktail which would support consumer confidence. Nevertheless, caveats remain with a significant number of mortgage holders still in negative equity with neither the ability to refinance nor move to a new house. This is evidenced by the Federal Reserve targeting its latest quantitative easing programme at the residential mortgage-backed securities market.
Barings also believes that the increasing availability of US Natural Gas could have highly positive repercussions on the US economy. Historically low prices, coupled with the fact that the country has over 75 years of recoverable gas reserves, should benefit US manufacturing, with positive consequences for the US economy as a whole. Barings warns, however, that while repercussions for the economy are significant, there is currently a lack of political focus, with many interest groups showing a preference for clean renewables instead of natural gas.
The underlying conditions in the US are good, in fact better – considerably better, than any other major developed economy. The banking sector is recovering and is moderately expanding lending, also the consumer is generally more confident and the housing market has stabilised.
US pension funds currently hold an average of 5% in emerging market equities and 2% in emerging market bonds. Given emerging market assets currently represent around 20% of global investible assets and emerging market economies make up approximately 36% of global GDP, we should see significant future flows from US pension funds into emerging market equities and emerging debt. Indeed, Barings believes that emerging market assets should represent a significant percentage of an investment portfolio. We would complement this exposure with a position in Agricultural stocks, an asset class which should be doing well given the increased unpredictability of the weather and given the demographic trends.
Outside of the US, Barings believes the outlook is still bleak in developed markets. In Europe, the French economy is showing significant signs of strain. An outright recession looks likely next year which, taken together with the structurally high unemployment rate, may cause severe headaches for a government committed to improving its competitive position and also reducing the budget deficit. Italy is also floundering and risks following a similar path to Spain over the next 12 months.
Across Europe and indeed across the globe, the outlook is being increasingly dominated by the political environment. So markets may not be the next catalyst for the crisis, but the reaction of electorates might well be. The European Central Bank’s bond buying programme has at least removed the immediate threat of a bond buyers strike tipping a government into a crisis, but the underlying economic trends of austerity combined with a lack of competitiveness are remorseless.
Barings also believes there are some tentative signs that growth in China is beginning to stabilise. Unlike 2012, when the outlook for the Chinese economy was one of the major uncertainties surrounding markets, there seems a clearer picture for 2013, though growth may still be below what we have become accustomed to. The Chinese economy has been disappointing but there are now tentative signs that it has achieved a softer than anticipated landing and may yet see growth accelerate towards what has been perceived to be the trend growth rate in 2013.
The new party leadership may direct more positive sentiment toward the market in the months ahead as they announce further initiatives. The administration does face challenges, however, as it seeks to rebalance the economy away from exports and investment, towards more domestically-focused production and consumption.
For now, news that the economic growth rate has stopped slowing could do much to boost sentiment towards those areas that have performed poorly, in our opinion. This could be supportive not just for China, but other emerging markets too.