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| Mensuel : | Edition de juillet 2010 |
| Rubrique : | Finance/Economie |
| Titre : | Bellatrix Market Outlook |
| Article : | Par Daniel Van Hove, CFA, Managing Director Bellatrix Investments S.A.
EQUITY MARKETS U.S. equities, measured by the S&P500 index, posted a 5.39% decline in June 2010 after losses of 8.20% in May 2010 and 10.99% in February 2008. For Q2-10, the index is down 11.86%, marking the worst quarter since Q4-2008 loss of 22.56%. The first half of 2010 (H1-10) showed the index down 7.57%, which is the worst start for the index since 2002 when it lost 13.78%. The S&P SmallCap 600 index declined broadly again in June 2010, posting a 7.17% drop on top of May’s 7.29% loss. It is down 8.97% for Q2-10 and down 1.40% for H1-10. Financial stocks in the S&P500 index have slumped 20.8% since their 2010 peak, while energy shares have fallen 19.8%, the biggest declines among 10 industries. Which factors could explain this sizeable downward directional change in U.S. equities? - Revived concern of a sovereign debt crisis in Europe with a possible downgrading of Spain. - High sensitivity to downward April estimate revision of the leading economic index for China by the Conference Board. - Several important data points in the U.S. failing to meet expectations adding up to a strong reassessment of economic growth. - Technology stocks are suffering some of the U.S. stock market’s biggest losses, sending the Nasdaq-100 index to the longest losing streak in its 25-year history. - On top of these economic data, there is a worsening technical picture of the U.S. stock market as the S&P500 index’s 50-day moving average dropped recently to 1,111.66, compared with the 200-day average of 1,111.77 in a price-chart known as a death cross. All this is generating confusion among investors wondering what is next and driving them to the safety of Treasury bonds. And this explains why bond returns have exceeded equity returns by the widest margin in 9 years during H1-10, as all 10 equity industries dropped. What can be expected for the S&P500 index during the second half of 2010? At 1,022.58 on 3 July 2010, the S&P500 index is valued at 14.9 times projected profits, according to Bloomberg data. Economists predict that U.S. GDP will expand 3.2% in 2010 and 2.9% in 2011, according to a one of their surveys. Profits for companies in the S&P 500 index are projected to rise 32% to a combined $81.72 a share in 2010, according to estimates from more than 2,000 analysts also tracked by Bloomberg. One should not forget indeed that, as reported by the U.S. Commerce Department, while EBITDA profit margins for U.S. companies reached a record 36.4% in Q1-10 as a percent of output, it is very difficult to expect them growing at the same strong pace as governments are likely to restrain deficit spending in 2011, reducing the free flow of cash throughout the rest of the economy. In a nutshell, we think that Q2-10 U.S. corporate earnings will still be satisfactory although we cannot exclude the beginning of a strong deceleration as well as lowered guidance on the part of CEO’s, and we remain very cautious for Q3-10, Q4-10 and the whole 2011. In fact, the U.S. stock market is probably starting to factor this deterioration since mid-April 2010. European equities, measured by the pan-European Stoxx 600 index which fell at 243.42 at the end of the month of June 2010, recorded a 7.7% loss for Q2-10. The narrower indices EuroStoxx 50 and Stoxx 50 lost respectively 12.21% and 10.25% over the same quarter. Out of the first six months of the year 2010, the only one during which a positive return was recorded was March 2010. And July 2010 did not start very well with a negative performance of respectively -1.90% and -2.61% for the two 50-stock benchmarks. Expressed in EUR, most local indices are showing a year-to-date return ranging from -33.93% for the Greek ASE index, respectively -22.52% for the Spanish IBEX index and -2.07% for the DAX index. Only two Nordic equity indexes were positive in local currency and in EUR: +15.94% for the Danish KFX index and +3.32% for the Swedish OMX index. The Swiss SMI index was negative in CHF (-8.73%) but positive in EUR (+1.22%). A Bloomberg survey showed on 23 June 2010 that European stocks were expected to be up 15% by January 2011 as the fastest profit growth since 2004 will materialise. The EUR’s retreat against the USD will boost earnings at least 25% in 2010, according to UBS AG’s Nick Nelson and Goldman Sachs Group Inc.’s Peter Oppenheimer in London. Strategists recommended buying shares because the global economic rebound will overcome concerns that governments will default in Europe. Three consecutive months of declines pushed the Stoxx 600’s price to 14.4 times annual earnings on 25 May. Earnings for Stoxx 600 companies are forecast to rise 70% in 2010, the most since the 82% jump in 2004, according to more than 11,000 analyst estimates compiled by Bloomberg. Peter Oppenheimer estimates a 38% increase in corporate earnings in the euro region while Nick Nelson predicts a 25% gain. These expectations should see a return to 2007’s levels. Meanwhile, the market is some 40% lower to-day than it was at the earnings peak. As a result, they see current valuations as attractive. Their forecasts place European equity market on a P/E multiple of 10.7 times 2011 earnings – well below the 10-year average of 18.8 times. European equities also offer the most attractive yields on the global stage, with a 2010 prospective dividend yield of 3.5%, rising to 3.8% in 2011. With 10-year government bond yields at 2.66%, equities represent excellent value relative to bonds, as evidenced by an upturn in corporate activity. We think that these forecasts look generally too positive, because European equities, which may strongly benefit from the competitive boost created by a weaker EUR, will continue to show a strong correlation with the main U.S. equity indices for which it is difficult to be very optimistic. Besides this, most European exporters German companies (BASF, RWE, ThyssenKrupp, VW, Aixtron, etc.) could be temporarily impacted by potential further weaknesses in China growth data and a possible double dip in the U.S.. In any case, we believe that the weak euro and cost cutting undertaken during the recession leave on the plate a series of European stocks which remain nevertheless quite interesting. U.K. equities, measured by the FTSE 100 index, declined 13% in Q2-10 for the same reasons listed above. We tend to look at this stock market as an opportunity set of excellent world diversifiers in the arena of commodity production especially when their stock prices are coming under pressure. We focus our attention on players such as Antofagasta, Anglo American Plc, BP, BHP, Dana (Scottish explorer), Tullow Oil Plc and Xstrata Plc. Of course, the overall technical picture of the FTSE 100 index is not very exciting with the 50-day moving average below the 200-day moving average. We also think that the round of ambitious budget cuts proposed by the Cameron government to reduce the deficit worth 11% of GDP is a good step in the right direction and will help Britain keeping its AAA credit rating. Japanese equities, measured by the Topix index, slumped 17% from their 52-week high on 15 April on concern Europe’s debt crisis and China’s steps to curb property prices will hurt global growth. This year 2010, the index has dropped 8.9%, cutting the average P/E to 16.1 times estimated earnings, the lowest level since November 2008. But, anxiety is prevailing in the market and investors cannot easily believe the fact that fundamentals are improving because they are worried. Japan’s economy is weak, but better than perceived. The Japanese corporate sector is less efficient than its peers, but improving and the equity market is attractively priced. Japan’s exports to China and other BRIC countries are rising rapidly or expected to grow strongly. Major Japanese companies have a sizeable exposure to Asian growth and their strong earnings growth increasingly relies on growing Asian demand. Emerging market equities, measured by the MSCI Emerging Markets index, retreated 8.2% so far in 2010. This is still better however than the 9.6% drop recorded by the MSCI World index including dividends. Brazilian equities, measured by the BOVESPA index, completed their first quarterly loss (-13%) since the end of 2008. The index trades now for 12.4 times analysts’ 2010 earnings estimates compared with 11.4 times for the MSCI Emerging Markets index. Petrobras, the biggest constituent of the index, accounted for 24% of the gauge’s drop amid speculation a planned $25 billion share sale will dilute earnings. But overall, the consumer story is going to remain strong. Domestic demand remains the propelling factor in the pace of growth, helping investment recover and confirming the sustainability of the economic expansion. Russian equities, measured by the MICEX Index, dropped -1.75% in June reaching their lowest level in three weeks. The index exhibits a performance of -4.43% on a year-to-date basis, as lower commodity prices affected the Russian market. Crude oil for August settlement indeed returned -8.36% for the first six months of the year. A $10/bbl sustained drop in the oil price would reduce Russia’s current account by about 1.8%-2% of GDP and fiscal balance by 1.3%-1.5% of GDP. However, a sustainable move higher in the price oil would improve the outlook for RUB (ruble) which looks negative for a while. Indian equities, measured by the Sensex index, performed well in June with +4.46% amid optimism domestic demand growth will not be derailed by higher interest rates. The market is roughly flat for the first 6 months of the year, but was at +13.6% when expressed in EUR. On 2 July 2010, India’s central bank raised interest rates for the third time in 2010. The reverse repurchase rate was increased to 4% from 3.75% and the repurchase rate to 5.5% from 5.25%. Government also raised gasoline and diesel price on 25 June, and this left no choice to rain inflation (at 10.2% in May 2010) again within a certain comfort level. Chinese equities measured by the Shanghai Composite index, have tumbled 28% to lead declines in major emerging markets. China’s manufacturing growth slowed more than economists forecast in June 2010. Goldman Sachs Group Inc. recently cut its real GDP growth forecast for China to 10.1% from 11.9% in Q1-10, joining other economic teams in doing so. The release of the PMI by the Beijing-based National Bureau of Statistics is clearly indicating that economic growth is moderating. The export rebound is weakening and the slower domestic demand is leading to a build-up of finished-goods inventories. We share the views of certain economists expecting a sustained output contraction over several months as China will continue to be hurt by a decelerating world recovery and (welcome) government measures aimed at cooling the economy. FIXED-INCOME MARKETS The U.S. Treasuries yield curve, as measured by the yield difference between 2- and 10-year bonds, has become very flat and is near its lowest level since October 2009 as the market is submerged with negative economic numbers. The benchmark 10-year note yielded 2.95% at the end of the month of June 2010 at stayed below 3% for a fourth day, according to BGCantor Market Data. The 2-year dropped at a record low of 0.5856% on 30 June 2010. The spread between the two securities was at 227 basis points, the least since 2 October 2009. Overall Treasuries returned 5.9% in H1-10 according to Bank of America Merrill Lynch indexes against -7.57% for the S&P500 index as indicated earlier. This represents the biggest first-half rally in 15 years. U.S. 30-year fixed mortgage rates declined to a record 4.69% in June, according to Freddie Mac. The difference between 10-year Treasury notes and Treasury Inflation Protected Securities (TIPS), a measure of trader expectations for consumer prices, was at 1.79%, dropping from the record pf 2.49% in January 2010. The U.S. inflation rate is headed toward zero, as indicated in a Goldman Sachs report, and for Hideo Shimomura, chief fund investor at Mitsubishi UFJ Asset Management Co., the U.S. may fall into deflation in the next two years. On 1 July 2010, President Dennis Lockhart of the Federal Reserve Bank of Atlanta indicated that the U.S. economic rebound is not strong enough to warrant raising rates or shrinking the central bank’s near-record balance sheet. In spite of this comment, 10-year yields are expected to advance from 2.95% to 3.70% by year-end 2010, according to a Bloomberg survey. On the USD-denominated corporate bond side, yields also fell. At the end of June 2010, investment-grade bonds offered in average an extra yield of 207 basis points, according to the Bank of America Merrill Lynch U.S. Corporate Master Index. In addition, the average spread on high-yield (high-risk debt with a rating below Baa3 by Moody’s Investors Services and BBB- by Standard & Poor’s) was close to 689 basis points (bp) at the end of June 2010, after touching 668 bp on 21 June 2010. In Europe, German 10-year bonds were quite volatile over the month of June 2010, starting the period at a yield of 2.66% to reach a low of 2.512% on 6 June, rising to 2.766% over the following 9 trading sessions, and resuming their yield decline to finish the month at 2.579% as investors were again willing to focus on the safest fixed-income assets. This demand was triggered by speculation that China’s expansion may be slowing and the release of a draft European Union document saying that bank stress tests should assess the effect of sovereign-debt shocks, reigniting concern that regulators consider defaults to be a possibility for nations such as Greece. But the ECB stepped up purchases of Greek, Portuguese and Irish debt. Overall, Germany’s government debt returned 4.1% in Q2-10, according to Bloomberg and EFFAS indexes. Spanish bonds lost 4.5%, while Greece’s debt recorded a -18% return. The yield difference between 10-year and 2-year German debt fell to 188 bp, the narrowest since December 2009. As shown in the accompanying table, the Greek-German 10-year bond spread and the Spanish-German 10-year bond spread reached respectively 7.85% and 1.98% at the end of June 2010. Early in July 2010, German 2-year notes declined, pushing the yield higher by 0.07% to 0.67% (even 0.71% at some stage during the session) on speculation a decline in the amount financial institutions are borrowing from the ECB heralds higher interest rates. The yield on the euribor futures contract maturing in March 2011 rose 0.06% to 1.17%, indicating increased bets on higher borrowing costs, as commented on Bloomberg News. While the ECB no longer offers banks 12-month loans (EUR 442 billion), the debt crisis forced it to reintroduce unlimited lending in 3- and 6-month refinancing operations and to start buying the bonds of the most indebted nations. But surprisingly, the ECB only lent EUR 131.9 billion for 3-months, compared with a median forecast of EUR 200 billion. This is quite a significant drain which should put a bit of upward pressure on the short end of the curve, according to Mark Schofield, head of interest-rate strategy at Citigroup Inc. in London, as reported by Bloomberg News. It is clear that the difficulty in meeting fiscal targets will mostly probably lead Moody’s to lower Spain’s Aaa classification by as much as two grades. Spain’s 5-year note started rising 2 bp to 3.81% on 1 July 2010. COMMODITY MARKETS Crude oil traded for August delivery on the NYMEX finished the quarter at around $75. Futures, down about 6% in 2010, lost 9.7% in Q2-10. The market is in its longest pullback since a 6-day drop through 18 May 2010. The continuing oil spill from BP’s Macondo well in the Gulf of Mexico remains the major energy specific news item. The blowout and the subsequent events have had significant stock impacts with BP down 17.6%, Transocean down 21.5% and Halliburton down 19%. We believe that these price drops are in some cases overdone and that a basket of stocks of reputable oil and gas drilling as well as some oil and gas equipment & services companies is worth to consider either through a specific stock selection or through a global energy fund characterized by a superior long-term track record. Gold bullion has climbed 10% so far in 2010 and recorded its best quarterly advance since end of 2007 with a jump of 12% month of June 2010 while reaching a record $1265.30 an ounce on 21 June 2010. Bullion is headed for a 10th annual advance as the financial crisis, through downgrading threats of a series of sovereign credit ratings, erodes the value of the EUR. The fear factor is still there but gold price will probably be contained in a relatively tight range. The short-term outlook for gold price is currently mixed. A negative element is that gold imports in India, the world’s biggest consumer, may fall as much as 36% in 2010 as higher prices and volatility slows demand. We believe that the most recent uptrend in the price of gold which started on 13 November 2008 at $700.57 an ounce is still intact. A pull-back at $1175 is very much possible. If the global macroeconomic picture does not deteriorate too much, we may see from there a new move up to $1400. Rather then attempting to time the market, we consider that a permanent gold exposure of 5% to 12% will continue to contribute efficiently as an asset diversifier in any mixed portfolio. FOREIGN EXCHANGE MARKETS The USD has probably reached a plateau in terms of appreciation against the EUR unless the sovereign debt issue resurfaces with the admittedly poor situation of Spain and its creditors. The USD may be due for a respite, according to John Taylor, CEO of FX Concepts Inc. The trade-weighted Dollar index gained 9.57% from the end of 2009, its best start to a year since 2005. Taylor is waiting for evidence that the European Union’s $1 trillion bailout plan is not working before pushing America’s currency higher. “We are scary, scary owners of euros”, he said hoping that the EUR’s appreciation last through July and into August. But then the euro is just going to get crushed. Futures traders are unwinding record bets that the USD will rally. He added “The period we are in now is the euro’s swan song”. The EU’s bailout package is making people think things are OK and maybe all will be alright. When the reality hits us in September it will be miserable”. He expects the EUR to go to 1$ by the end of the year. CONCLUSIONS April and May 2010 were very difficult months for equities worldwide and this has changed the mood of many investors. But this cannot probably continue indefinitely. Contrarian investors thinking that stocks of solid companies are oversold are probably right. In spite of worrisome technical levels reached in some major equity indices, at this level of bearishness, the mood may turn up quickly. It is therefore still very much possible to see some important companies announcing surprising positive earnings. So in spite of many uncertainties, is it not the time to keep a reasonable exposure in equities? European stocks offer currently some attractive valuations even though corporate earnings forecasts remain quite positive. Emerging markets will also probably continue to benefit from the strong economic expansion and local government and monetary authorities seem not afraid to impose tighter policies. We nevertheless remain conservatively positioned and we tend to limit our equity exposure to special situations and stick to shares of corporations offering high visibility in their cash flow generation, a solid balance sheet and an excellent management. We are not afraid of inflation risk in the months to come and we continue to invest in a set of high quality corporate bonds. We continue to be exposed to convertible bonds exhibiting preferably a low delta. We keep a reasonable portion of our bond exposure in relatively solid sovereign debt. In terms of currency exposure, we think that a diversification out of the EUR is unfortunately a necessity during the second half of 2010. However, we are not so overly bullish on the USD. We therefore continue to recommend a reasonable allocation in NOK, SEK, CAD and gold-related instruments (either ETFs or pure physical gold and investment funds focusing on shares of world gold producers). DISCLAIMER: This document released on 5 July 2010 was prepared by Bellatrix Investments S.A.. Many data and comments came from Bloomberg News. Its purpose is to provide a relatively synthetic and analytical perception about the recent macro-economic and financial market developments. All the forecasts and statements should be treated as unbinding opinion. Bellatrix Investments S.A. or its members shall not be held accountable for any inaccuracy of those sources used or for any failure of opinion to prove accurate. There may be instances of information reproduction from certain sources, but in these cases we take all precautions to mention the name of the writer or related websites. Bellatrix Investments S.A. does not receive any compensation for mentioning any name, brand or investment funds in this document. Any investment decision should be made after obtaining a specific professional advice. |
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