Sunday, July 28, 2013

Economic Summary for the week ended 26th July 2013

UK Economy Shows Weak Recovery – Second quarter UK GDP growth of 0.6% may be weak but as it follows 0.3% over the first quarter, many commentators are concentrating on the fact it proves the UK economy is on a forward path.
Mouhammed Choukeir, chief investment officer at Kleinwort Benson, called the momentum from Q1 to Q2 “remarkable” considering fears of a “triple dip” recession have dominated newswires this year. Ian Kernohan, Economist at RLAM, also noted such commentary and said he hoped the debate will now move on from speculation over the potential for triple dips, to whether the weakest recovery on record is finally gathering pace.
Schroders European economist Azad Zangana said the details of the Office for National Statistics report shows almost 70% the Q2 GDP growth came from the services sector. "The estimates released today are preliminary and may be revised up or down. However, it appears that the economic recovery is broadening out with every major sub-sector making a positive contribution."
Marcus Bullus, trading director at stock brokers MB Capital, believes deep down the markets will be disappointed by the weak rate of growth shown in the Q2 figures. "0.6% is double what we had in the previous quarter but it still shows that the recovery is meek, not mind-blowing.”
He pointed out the UK still faces numerous challenges, not the least of which is static or negative wage growth, which will inhibit spending. "To achieve escape velocity, as Governor Carney refers to it, you need a strong consumer but the UK's consumers are still feeling bruised by weak confidence and rising prices.
"There's something artificial about the current resurgence of the economy. It doesn't really correlate to economic reality. It may be more of a lurch forward after years of austerity rather than the beginning of anything sustainable.”
Choukeir believes there are many aspects of this growth to indicate the recovery, while slow by historical standards, is sustainable. The UK Purchasing Managers Index (PMI) monthly survey, a leading indicator of growth, has been demonstrating expansion for each of the last three months; a first since early 2012, he noted. He went on to add that other surveys show exports are at their highest level since 2007 and that confidence in turnover and profitability is high; many businesses are expecting to hire more staff over the third quarter.
Manufacturing Recovery in Europe - Western Europe, and investors who have exposure to the region, finally received some good news. The latest monthly figure for the purchasing managers’ index (also known as PMI) beat expectations, showing that manufacturing appears to be expanding for the first time in two years. While the PMI reading of 50.1 was barely above the threshold that indicates growth, even a flat reading would have been a positive.
Europe continues to try to work its way out of its second recession since the global financial crisis, and it appears to be making progress. A Bloomberg survey of economists predicts a return to economic growth in the third quarter of the year. Germany, the cornerstone of the euro zone, also recorded a return to manufacturing growth in July after months of contraction. German manufacturing, in fact, is one of the most important data points to watch as Europe’s recovery tries to gain traction. If Germany can recover and continue to pull the regional economy along with it, Europe may yet get some lift. Its stock market is already up nearly 10 percent this month, and this latest data might keep the trend going.
Worst over for Vietnam? - As one of the world’s few remaining communist states, Vietnam’s relationship with foreign capitalists is complex. That hasn’t stopped private equity group Warburg Pincus closing the first tranche of a USD 200 million investment in the country’s largest mall owner. It’s early days, but for global investors Vietnam may be back in the game.
Warburg and its associates are buying about one-fifth of Vincom Retail, their first foray in the country. The investment will help parent Vingroup pare its debt load, and follows rival KKR’s decision earlier this year to double its stake in a Vietnamese fish-sauce maker.
It isn’t obvious Vietnam’s retail industry will deliver much juice in the short run. Retail sales grew 12 percent in the first six months, their slowest since 2003. Strip out 6.7 percent inflation, and real growth of retail spending barely beat last year’s 5 percent GDP growth.
Besides, the safety of assets remains a worry. Foreign creditors to shipmaker Vinashin found out that a “letter of comfort” from the government didn’t live up to its billing when the state-owned shipbuilder failed to honour a USD 600 million loan in 2010. After much bickering and a lawsuit – later dropped – from pugnacious U.S. hedge fund Elliott Advisers, the government offered lenders a settlement this year.
Poor contract enforcement and endemic corruption won’t go away soon, but Warburg and KKR may be right in betting that the economy is on the mend. Inflation – which peaked at 23 percent in August 2011 – is under control. And that’s giving the authorities wiggle room to revive growth: large companies will see their tax rates fall to 22 percent next year, from 25 percent at present. Developers like Vingroup can now improve their cash flows by paying land costs to the government in instalments.
Credit is also reviving as the government starts to tackle bad debt, at almost a fifth of total bank loans. Vingroup’s cost of local borrowing has fallen from above 20 percent early last year to around 13 percent, while the stock market is up 42 percent from January 2012. The worst may be over for Vietnam; investors should pay attention.
Spotlight On: Where Have All The Safe Havens Gone?
Midway through 2013, strategists, economists and analysts have taken pause to weigh up the events that have dominated investor sentiment over the first six months of the year and predict what will cast shadows over the second half. With markets still reliant on central bank liquidity and the erosion of safe havens in recent months, conditions are expected to remain challenging - although some commentators see opportunities emerging.
Charles Stanley investment analyst Rob Morgan says the stand-out trend of 2013 so far has been a high correlation between asset classes. While it could be argued this undermines diversification within portfolios, Standard Life global thematic strategist Francis Hudson sees it as a positive development.
“It signifies a healthier market and provides scope to do fundamental bottom-up analysis. It also shows a move away from risk-on, risk-off trading, due to liquidity flooding in from central banks,” she says.
So-called safe assets have also been affected. Gold and cash have seen a turnaround, with the former experiencing poor fortunes in the market – signified by the worst drop in value in 34 months – and cash being seen as the only safe asset left. Hudson says: “It is interesting that cash is seen as a safe asset because it used to be quite risky. That is a change that tells us about the outlook for inflation.” Morgan adds: “Apart from cash we have not got a safe asset class anymore. That is a problem for investors because the benefits of diversification worked well in the past.”
However, Legal & General global equities strategist Lars Kreckel sees gold’s fall from favour as a positive sign. He says: “It is one of the most promising signs that we are not looking at the start of a bear market. If people have been worried about inflation getting out of control, we would not have expected the gold price to fall so much.”
The main event so far is arguably Federal Reserve chairman Ben Bernanke’s suggestion that the pace of quantitative easing in the US could slow later this year, which brought the stockmarket rally to a halt and ushered in a global sell-off. F&C director of global strategy Ted Scott says: “There was a big rise in bond yields everywhere, especially emerging markets. We also saw an enormous withdrawal of capital from riskier products and a move into safe havens.” This showed just how vulnerable markets still are to sentiment. Newton global strategist Peter Hensman says: “We are expecting markets to remain skittish. There was confidence at the beginning of the year around central banks and this has diminished as we have gone on. “As some of the certainty starts to reduce then we will continue to have a more difficult period. The excessive optimism starts to reverse a bit.”
Investors also continued to be driven by a hunger for yield. With QE impacting yields and the outlook improving, many expected a great rotation out of bonds and into equities. However, now the end of QE may be on the cards, there is the possibility there will be another mass movement of money. Morgan says: “That fear manifested itself with Bernanke’s comments and there was a potential policy change all of a sudden. All that risk got taken off the table again. We are back to November and December levels in a way. I think people will still look to add risk because there is an underlying demand for it. Potentially, we will have a more stable period. It will it be a stockpicking environment going forward.”
Kreckel believes that if markets become more confident and signs of global economic expansion return, asset classes will see a shift in favour as investors move from more defensive, income-focused parts of the market towards growth. “The acceleration in global growth will begin in the second half. If this picks up it will be more about growth than the dividend,” he says. “With bonds yields rising, such income characteristics are not as attractive and investors will want economic beta and exposure to economic cyclicals.”
Scott is more sceptical of equities being given a boost in the second half of the year and believes bonds may start to receive more attention, especially if the demand for yield still dominates investors’ vision. “A lot of high-income assets were changed up to find yields. There was actually the reverse this time. As bond yields went up, the worst performers in equity markets were high-yielders,” he says. “There was also a bubble in dividend-paying stocks. Looking ahead, the question is the strength of company earnings and the strength of the market.”
If nothing else, so far this year has reiterated how big a part sentiment plays in global markets. With asset classes behaving in a highly correlated way, and investors prioritising yield yearnings, the biggest stand-out theme that has a lot of people on their guard is what the Fed will do next. Hensman says: “We are expecting some of the more challenging conditions that recently appeared to continue through the second half of the year.”

Monday, July 15, 2013

Economic Summary for the week ended 12th July 2013

US Markets - Minutes of the Federal Reserve's last policy meeting say officials want more evidence of a jobs market recovery before winding up stimulus measures. The minutes show that "about half" of the Fed's board felt the USD 85bn-a-month stimulus programme could be phased out by the end of 2013. Speculation that the Fed might halt quantitative easing within a couple of months had unnerved Wall Street. But the news that there would be no immediate exit sent US markets higher.
Africa’s Economy “seeing fastest growth” - Africa's economy is growing faster than any other continent, according to the African Development Bank (AfDB). A new report from the AfDB said one-third of Africa's countries have GDP growth rates of more than 6%.
The costs of starting a business have fallen by more than two-thirds over the past seven years, while delays for starting a business have been halved. The continent's middle class is growing rapidly - around 350 million Africans now earn between USD 2 and USD 20 a day. The share of the population living below the poverty line in Africa has fallen from 51% in 2005 to 39% in 2012. Africa's collective gross domestic product (GDP) per capita reached USD 953 last year, while the number of middle income countries on the continent rose to 26, out of a total of 54.
The AfDB's Annual Development Effectiveness Report said the growth was largely driven by the private sector, thanks to improved economic governance and a better business climate on the continent. "This progress has brought increased levels of trade and investment, with the annual rate of foreign investment increasing fivefold since 2000. For the future, improvements in such areas as access to finance and quality of infrastructure should help improve Africa's global competitiveness," the report said.
The AfDB points to the increase in regional economic co-operation and intra-African trade as being the drivers of growth in the future. However, the AfDB said inadequate infrastructure development remained a "major constraint" to the continent's economic growth. "Africa currently invests just 4% of its collective GDP in infrastructure, compared with China's 14%," the bank's report said. "While sustainable infrastructure entails significant up-front investments, it will prove cost-effective in the longer term."
Despite the improving picture overall, the AfDB cautioned that substantial differences in incomes remained. "The challenge will be to address continuing inequality so that all Africans, including those living in isolated rural communities, deprived neighbourhoods, and fragile states are able to benefit from this economic growth," it said.
US Borrowing - Americans are once again spending more on credit, increasing their borrowing by USD 19.6 billion in May, according to the US Federal Reserve. It is the biggest increase in borrowing in more than a year and reflects renewed confidence among US consumers. More debt could help increase consumer spending, which accounts for more than 70% of US economic activity.
The total amount of borrowing reached a record USD 2.84 trillion, with student loans reaching USD 1 trillion.Borrowing in the category that includes credit cards was at its highest level since 2010. Economists say that is significant as credit card debt is often quickly translated into economic activity.
Gold Mining Shares - Shares in gold mining companies have fallen 64% since their peak in August 2011 and are trading below their net asset value for the first time since 1980, potentially reaching a point where investors will find them attractive once more, according to Hargreaves Lansdown’s senior investment manager Adrian Lowcock.
The metal itself has fallen 35% from its peak of USD 1,900 in September 2011 to USD 1,235 as at 8 July, and both of these declines compare with a rise of 35% for the MSCI World Index from August 2011 to June this year. Trying to call the bottom of the gold market is a bit like trying to catch a falling knife. However, all investments have a price at which point they become very attractive to investors. Momentum remains very much against gold mining shares and as Sir John Templeton once said ‘if a particular industry or type of security becomes popular with investors the popularity will always prove temporary and, when lost, may not return for many years’.
“There may be further to fall before we reach the bottom, however, investors who are willing to accept the risks might find some attractive long-term opportunities by investing in gold mining shares,” said Lowcock. He explained that analysis of the World Datastream Gold Mining Index showed the price to book of gold miners is 0.95 having been at 1.61 a year ago.This implies that gold mining companies’ current market price is lower than the value of their assets. Many of the miners have appointed new management, which Lowcock said could lead to further write downs of the valuations of many projects. “They are likely to write down the valuations to the lowest possible level as they can attribute the overvaluation to the previous management – throw out everything including the kitchen sink. “Book values are likely to fall further still, however, with gold shares having fallen 64% they are already pricing significant further falls in the book values of gold mining companies,” Lowcock concluded.
Spotlight on: the Prospects for the Chinese Economy
Napoleon Bonaparte said “Let China sleep, for when she awakes, she will shake the world”. In the following two centuries, the country has indeed spent much of the time in a fairly dormant state. Alongside Japan and the rest of East Asia, China accounted for over half of global activity and 60% of world industrial production in 1820; by 1875 their overall share had fallen below 20% - similar to that of the United Kingdom.
Through a combination of wars, occupations, revolution and political upheaval, China remained in this state until well into the 20th Century. But since “waking up”, following a series of reforms in 1979 and entry into the World Trade Organisation in 2001, the global impact has been profound. China’s share of world exports rose five-fold during this period, to just over 5% of global GDP, as its economy has consistently expanded at 8-9% annual rates. The impact of this major new trading partner has been felt both in global goods and commodity markets, with substantial weakening of price pressures in the former and rising prices a feature of the latter.
More recently, however, China’s growth rate has slowed; interbank lending rates have risen to record highs; and worries have begun to emerge about a “hard landing” for the economy. Are these concerns justified?
One worry has been the fact that rapid credit growth in China has not translated into stronger economic activity. In 2013 Q1, credit expanded at an annual pace of over 20%, more than twice the rate of nominal GDP growth. This “gap” has been widening since early 2012. It could be that there is just a natural lag between borrowing and investment, implying a pick-up in investment growth in 2013. However, there is little sign of this in the latest data: fixed-asset investment decelerated to a below-expectations annual growth rate of 20.6% in the first four months of the year from 20.9% in the first quarter. One concern is that, rather than financing productive investment, new credit is being used by corporates and local government to refinance old debt – creating potential risks for both the official banking sector and the burgeoning ‘shadow’ financial system of wealth management companies, insurance companies and trust loans.
Precursors to a ‘hard landing’ for China, which could reduce annual GDP growth to a 3% annual pace at its height, could therefore include an acceleration in ‘shadow’ borrowing, at increasingly short maturities and higher rates; reports of financial problems in local government or companies; and developments that increase the risk of a policy error.
China’s demographics have also been causing concern. An exceptionally rapid transition from high to low birth and death rates, thanks in part to the “one-child policy”, means that China’s population is ageing faster than that of most other countries. As a result, the size of the working-age population is set to shrink rapidly, which could drag down China’s ability to grow.
But it would be wrong to get overly gloomy. While the growth of China’s shadow banking sector is a concern, the government is showing an increasing appetite to regulate its more “frothy” aspects. The authorities’ urbanisation strategy should also provide some offset to the effects of population ageing through efficiency gains from population concentration and infrastructure development. Using US experience as a benchmark, Chinese cities arguably have the potential to add a full percentage point to cumulative GDP growth over the next ten years.
China may not achieve double-digit growth rates in the decade ahead, but a 7% annual pace – in line with the government’s target – remains plausible, if dependent on a relatively smooth reform process. Challenges lie ahead for China, but we’re some way from being sleepy yet.