Archive for September 12th, 2012
Wednesday, September 12th, 2012
by Mark Mobius, Franklin Templeton Investments
As we cross the mid-way point of the year, you might say the equity and fixed income markets have been a lot like the recent weather in much of the world: uncertain, and tending toward extremes. The perception of a stormy economic climate has driven some equity valuations to extremely low levels, particularly in Europe, and investors have been pouring into fixed income despite extremely low yields.
For a temperature check of Europe and emerging markets, we turned to Dr. Mark Mobius, executive chairman of Templeton Emerging Markets Group, and Dr. Michael Hasenstab, co-director of Franklin Templeton Fixed Income Group’s® International Bond Department, for their long-term perspective on where shifts in the changeable economic climate could occur.
- There’s no question the status of economies in Europe is weighing on the entire financial system, but my view is that the situation should get better with time.
- Looking at companies around the world generally, we are finding valuations looking rather cheap right now.
- Despite the possibility of somewhat slower growth in the Chinese economy this year, there are a lot of companies with what we believe are good valuations and good earnings growth potential in China.
- In my opinion if Greece can privatize state-owned enterprises, collect unpaid taxes and reduce the size of the government, it should have no need to raise taxes.
As Mobius sees it, emerging markets are generally in a good fiscal position right now compared with some of the more debt-laden developed markets, and going forward, he believes economic growth rates in emerging markets should outperform developed markets.
“There’s no question that the status of economies in Europe is weighing on the entire financial system. Emerging markets have been reducing their exports to the U.S. and to the EU, although economic problems (in the U.S. and EU) going forward could still bear significant impact. Eastern Europe of course has been affected by what’s happening in the rest of Europe. We are finding a lot of the opportunities there from companies where valuations have dramatically wiped out, many unfairly, and provide opportunities for long-term holdings.
My view of the European situation is quite different from a number of economists. My view is that the situation should get better with time and as the Europeans solve their fiscal problems. A case in point, of course, is Greece. Greece was originally part of the emerging markets realm until it joined the European Union, so we therefore have had some past experience investing in Greece. The challenge for the government now is to make some giant steps toward reform. This means privatization of state-owned enterprises that have been a drag on productivity and government finances, collection of taxes that are owed but not paid, and reducing the size of the government. If those three measures are taken, in my opinion there should be no need to actually raise taxes. Moreover, entrepreneurship should be encouraged. Greece has very strong tourism and shipping industries which I think can be the launching pad for growth in the future.
Looking at companies around the world generally, we are finding that valuations look rather cheap right now. The price-earnings ratios of emerging markets averaged about 9.6 ( based on the MSCI Emerging Markets Index 12-month forward P/E), compared to a world index of 11.4 (based on the MSCI World Index 12-month forward P/E) and the U.S. average of 11.9 (based on the MSCI US Index 12-month forward P/E), as of July.1 The dividend yield average for emerging markets was 3.0%, while the world average was 2.9% and the U.S. was 2.2%, as of July, based on the MSCI EM Index, World Index and US Index.1 So, as value investors, our team has been finding lots of opportunities in these markets that we think should bode well longer term.
Despite the possibility of somewhat slower growth in China’s economy this year, there are a lot of companies in China with what we believe are good valuations and good earnings growth potential. Southeast Asian countries are also doing very well in our view, particularly Thailand, because the economy has been growing at a good pace and it is benefiting from China’s expansion.”
Some other markets on Mobius’ radar screen include places less adventurous investors may not even be considering right now.
“We believe taking a bottom-up, company-oriented approach is best because we can find opportunities in places other people are ignoring. We are excited about frontier markets, particularly Africa, because African countries have been growing at a fast pace. Of the 10 fastest growing economies in the world in the last 10 years to 2010, six of those were African.2 And in a country like Pakistan, which many people consider to be a very risky place, we are still finding opportunities simply because it’s so unpopular.”
- Some of the markets that traded off pure contagion and ‘Armageddon’ fear have now begun to recover.
- We see a lot of value in many emerging countries, but need to be cognizant of possible inflation risks longer term.
- Emerging markets are probably the most vulnerable to the immediate inflationary impacts of massive global quantitative easing.
- We don’t see value in the countries that are printing money and debasing the value of their currencies.
The Eurozone crisis whipped up quite a market storm this year, but Hasenstab has held steadfast in his belief that leaders there would find solutions, and that sky-falling forecasts were probably not warranted. He’s not ruling out more market chop for the rest of the year, but is seeing signs of calmer conditions.
“I think the recovery has been somewhat apprehensive thus far and really has not returned full fair value to a lot of these markets, but clearly we are on that path. We still think there’s a long way to go, but just about 10 or 11 months ago we were in a period of much greater uncertainty. It was during that period that we really highlighted our long-term conviction that the eurozone wouldn’t split apart because the European Central Bank (ECB) ultimately would be the lender of last resort (despite ongoing problems in Greece), and that China’s growth rate would moderate but would not face a hard landing. As the year progressed, we saw increased evidence that those core convictions were holding. I think now we’re moving closer to further clarity that the ECB will likely prevent breakup of the Eurozone, and the key countries such as Spain and Italy are taking some steps to improve their long-term finances. The fact that ECB support will likely be conditional is good for two reasons: it can help prevent a vicious cycle and provides liquidity, and it provides some sort of fiscal discipline. This has given a bit of calm to markets and as a result, some of the markets that traded off pure contagion and ‘Armageddon’ fear have now begun to recover.
In a world where there are no risk-free assets anymore, I think one has to accept some degree of market volatility, but I think our ability to hold onto our long-term convictions and not panic, not flip around because of market volatility, has been beneficial.”
Turning our Doppler radar back to China, a market some predict is heading for a crash-landing, Hasenstab believes that, toward year-end, growth there should gain a bit more altitude or at least stay on a stable course. Structural changes in the economy are creating new challenges, he says, but notes China has “more powder,” should it need to engage in further stimulative measures.
“In China, there are some very important long-term structural reforms that are underway. The reforms in China that began in the late 1970s are now entering their fourth phase. The first phase was the reform of the agricultural sector, the second phase was the reform of state-owned enterprises, the third was the opening of free trade, and this next, close-to-the-final phase would be the liberalization of the financial markets. It’s probably one of the most exciting phases of their reform, and if China can succeed in this—and we have every reason to believe that China should —it really has the potential to elevate China from a middle-income to a high-income country over the next decade or so.”
Like Mobius, Hasenstab sees value in many emerging markets right now. However, he’s cautious about taking longer-term interest rate exposures there because the easy monetary policies many central banks around the world have been engaging in for years could leave emerging economies vulnerable to trickle-down inflation.
“These emerging countries generally do not have the indebtedness problems that developed countries in general currently have, and even though their absolute growth is slowing on a relative basis, emerging growth rates remain much healthier than developed growth rates. There are exceptions, but by and large we see a lot of value in many of these countries, but we would be cautious that there are going to be inflationary risks. We think it’ll be good for currencies but we would be cautious about taking a lot of interest rate risk.
We have the Bank of England, the Federal Reserve in the U.S., the Bank of Japan, the ECB, the Swiss National Bank, all printing an unprecedented amount of money. Never in the history of central banks have we experimented with this amount of printing, and to think that there are no longer-term consequences would be naïve. Those effects may not be felt immediately, but ultimately the money that is printed in those countries will flow globally. Emerging markets are probably the most vulnerable to the immediate inflationary impacts of this massive quantitative easing.
On the currency side, we don’t see value in the countries that are printing money and debasing the value of their currencies—we continue to look for opportunities in countries which are not printing money.”
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What are the Risks?
All investments involve risks, including potential loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability, and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial instability of some countries in the EU, including Greece, Italy and Spain, together with the risk of that impacting other more stable countries may increase the economic risk of investing in companies in Europe.
1. Source: MSCI Emerging Markets Index, MSCI Emerging Markets World Index, MSCI US Index, July 2012. Indexes are unmanaged and one cannot directly invest in an index. All MSCI data is provided “as is.” MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. Past performance is not indicative of future results.
The price-to-earnings (P/E) ratio for an individual stock compares the stock price to the company’s earnings per share. (This figure is often calculated using trailing 12-month earnings, but some use forecasted earnings.) The P/E indicates how much the market will pay for a company’s earnings. A high P/E can indicate a strong belief in the company’s ability to increase those earnings. A low P/E indicates the market has less confidence that the company’s earnings will increase.
The dividend yield is the sum of a company’s annual dividends per share, divided by the current price per share. It is often expressed as a percentage.
2. Source: International Monetary Fund; 2001-2010.
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Wednesday, September 12th, 2012
Yesterday, the iShares high yield corporate bond ETF (HYG) made a nice breakout. The breakout pushed the ETF above key resistance at the $93 mark — resistance that had been in place for more than a year. With the resistance out of the way and now acting as support, the technicals certainly look strong for junk bonds.
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Wednesday, September 12th, 2012
It has been a long time since US territory abroad, i.e., a US embassy, was openly attacked. It has been even longer, or about 33 years, since a US ambassador was last killed in the line of duty in 1979 Afghanistan. Both happened last night. Below, courtesy of Reuters, are pictures of the event.
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Wednesday, September 12th, 2012
David Rosenberg appeared on Bloomberg yesterday with Tom Keene to discuss his outlook for the U.S. economy, and markets.
Highlights of the appearance:
Rosenberg says what’s happening right now in banking is we’re putting up 8 stop signs at every corner. The pendulum has begun swinging the other way. In the period from 2006-2008 we had leverage ratios in the banking industry of between 30-50 times, and now we’re going to run leverage ratios much lower than that, and its going to create much more stability, which is true. It’s also going to be creating less economic growth.
This was the debate that was going on in Canada during that time, when the ‘Wild West’ was being created in the U.S., and there were bankers that wanted to have a situation where we had subprime mortgages, unlimited leverage ratios, for the greater good in terms of economic growth and full employment, and we know how that finished off in the U.S.
Tom Keene brings up the fact that equity markets are up 24% in the last 12 months.
As for equities, Rosie says 90%-95% of this rally everyone’s talking about started in March 2009 and ended last April (2011), and since that time 5%-10% of this rally has basically been the ‘bulls’ fighting over the crumbs … with the support of central banks – you get the QE, you get the intervention by the ECB, and then you get a rally, and when the intervention dissipates, you get the markets rolling over.
There are sections/segments of the stock market that he likes – Dividend Growth, Dividend Coverage, Dividend Yield, there is probably 20-30% of the stock market he likes.
Rosie then asks why they don’t have more bond analysts on the show, and comments that the best performing asset has been 30-year Strip Coupons or Zero Coupon bonds, which returned nearly 50% over the past 12 months. … Keene admits that Rosenberg hit the ball out of the park on the bond call.
Keene says that the majority of people say that the bond rally is done.
Rosie retorts with “They were saying that a year ago, Tom. They were saying that two years ago, three years ago. “I would say that if the stock market, the S&P 500 had returned 50% over the past year, most viewers would know about that. The zero coupon bond … it doesn’t even make it to like page C10. The whole thing is about the stock market. Its not about ‘What have corporate bonds done? What has gold done? We’re going on 13 years in a row of it going [straight] up. And we’ve got the bond market.”
On the U.S. Economy:
Rosenberg has been right about the economy too and on inflation.
He said Fisher was wrong, Plosser was wrong, Lacker was wrong. We’ve got a Fed meeting, with a legitimate debate over what will they do. Keene asks Rosie – “What will they do?”
He replies that at the Jackson Hole meeting, Bernanke mentioned the words ‘labour market,’ ‘jobs,’ ‘employment,’ no fewer than 34 times. And then we get that coup-de-gras, which is that horrible employment number last Friday, so his sense is there is going to be some sort of announcement extending zero percent interest rates beyond 2015. QE is already priced in; the question is, “In what form?” will QE be announced.
If you go back to the 2002 “What If?” meeting, one of those options might be an “explicit interest rate ceiling for the long bond,” and that would imply not that we’re going to buy $500-600-billion of MBS which is what many Wall Street firms are talking about, but the Fed following in the footsteps of the ECB, and moving toward ‘unlimited’ expansion of the central bank balance sheet.
What does that mean?
The financial repression means that we have interest rates at zero, savers are being penalized. If you go back to Newtonian physics, which says that every reaction has an opposite and equal reaction, so you’re going to penalize pensioners, and you’re going to penalize people who don’t really spend too much in the economy, to benefit borrowers.
And that is what the Fed is grappling with, because what you want to do is, and “i’m not going to defend the Fed,” but what I am going to do is explain what they’re trying to do, which is to get the marginal propensity to spend in the overall economy, UP. To get borrowers to spend at the expense of the loss of interest income to savers …
There is going to be less credit growth for each of unit of GDP, and that means that potential GDP Growth is going to be much slower than it has been in the past 20 years. Its not as bad as ‘euro-schlerosis’ but it means that you are talking about GDP growth of 2%-2.5%, instead of 4%-4.5%.
The reason Rosenberg is still hanging on to his deflationary outlook, is because demand growth currently stands at 1%-1.5%.
He is sympathetic to PIMCO’s “new normal,” however, it does not take into account the deflationary output gap that occurs when aggregate demand growth is 1%-1.5% vs. GDP growth is 2%-2.5% (an output gap of 6% over 4 years).
Wednesday, September 12th, 2012
I am using the UUP ETF as a stand in for the actual dollar since it charts real time on stockcharts.com but as you can see below, the U.S. dollar is in an extremely oversold position. I believe the general thinking of the market is since (a) Draghi will do “whatever it takes” to keep the euro together, you have the euro breakup scenario off the table and (b) the Fed will be doing a pure QE while the ECB will be doing sterilized actions, hence the dollar loses the ugly duckling contest.
And as we know, when the dollar pukes usually every risk asset rises. That said, things can get to an extreme – so it is interesting this is happening just before a Fed meeting.
I can’t see too many instances the past few years where the UUP is fully below the lower bollinger band … also it has a RSI below 30. Both are secondary indicators showing extreme pessimism. When a bounce of any sort happens – dead cat or otherwise – it will be interesting to see how the market handles it, especially the hot spot of the (half week) i.e. commodity stuff.
Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog
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Wednesday, September 12th, 2012
Ten days ago, when describing the latest casualty of the ongoing South African miner revolution, we said: “Expect more South African mines to shutter, as gold production in the world’s third largest gold producer grinds to a halt, and the local workers grasp they had the leverage all along. Should the South African example spread to other countries, then expect the price of gold to soar regardless of how much printing the central planners engage in the coming weeks and month.” Fast forward to today: “Labour unrest sweeping across South Africa’s mining sector hit top world platinum producer Anglo American Platinum on Wednesday, with striking miners blockading roads leading to shafts belonging to the mining giant, police said. The platinum price jumped as much as 1.5 percent to $1,624.74 an ounce, its highest since mid-April amid fears of more disruption to supplies of the precious metal used in jewellery and vehicle catalytic converters.” The good news: the complete mining shut down has not spread to other countries. Yet. The bad news: as expected, one after another South African mine is going offline. Why is this an issue? Because Chinese demands is soaring, even as the world is about to lose its third largest producer of gold. Not even the CME hiking gold margins to infinity will do much to prevent what will inevitably be a surge in precious metal prices. Factor in what is likely to be more easing by Bernanke tomorrow, and it may be time to eye the all time nominal high of just over $1,900 gold hit a year ago.
South Africa is home to 80 percent of known reserves. The platinum price has jumped more than 17 percent since police shot dead 34 protesters at the Marikana mine of world No. 3 platinum producer Lonmin on Aug. 16, the bloodiest security incident since the end of apartheid in 1994.
The “Marikana massacre” has poisoned industrial relations across the mining sector and become a potent symbol of the ruling African National Congress’ (ANC) failure to deliver on promises of a “better life for all” in the post-apartheid era.
The bloodshed and the government’s inability to ease unrest undermining already shaky growth in Africa’s biggest economy is also fuelling a campaign against President Jacob Zuma, who faces an internal ANC leadership battle in December.
“Around 1,000 mineworkers had a confrontation with mine security last night at the Siphumelele shaft and the situation has spread to other mine shafts this morning,” regional police spokesman Thulani Ngubane said of the trouble at Amplats.
He declined to give any details of the size of the security operation, the latest police deployment in more than five weeks of union violence in the “platinum belt” around Rustenburg, 100 km (60 miles) northwest of Johannesburg.
Amplats’ four Rustenburg mines represent almost 17 percent of total production by the company, which accounts for 40 percent of world platinum output. They employ more than 19,000 people.
The strikes, which stem from a challenge by the small but militant Association of Mineworkers and Construction Union (AMCU) to the dominance of the ANC-affiliated National Union of Mineworkers (NUM), are also spreading into the gold sector.
The NUM said workers at the Beatrix mine, run by world No. 4 producer Gold Fields were set to strike this week, compounding wildcat industrial action this week by 15,000 workers at the company’s KDC West west of Johannesburg.
ANC renegade Julius Malema – the de facto face of the unofficial ‘Anybody But Zuma’ rebellion in the ANC – is also fanning the flames, appearing twice at KDC to speak to striking workers. He called on Tuesday for a national mining strike.
Hopefully events like those above should explain why precious metal miners and the underlying commodity have now terminally disconnected, because in this, and all future cases, Anglo American’s loss is platinum’s gain. Extrapolate to other metals.
The open question is how soon until the South African labor disputes spread to other gold miners.
Wednesday, September 12th, 2012
Brian Belski, Chief Investment Strategist, BMO Capital, and David Rosenberg, Gluskin Sheff, appeared on Bloomberg yesterday, weighing in on markets and their similar calls but very different perspectives – both have been right in their calls – Belski says “our gut feeling is that the highs are in for the year” four of five months ahead of his call.
In addition, Belski believes equity markets will be driven by mulitple expansion from here on, and that despite lower earnings growth, the market will rise on account of higher quality, more stable earnings, that produce stronger cash flows. That said, he believes that retail investors will return to equities when they realize that they are losing money in bond funds, and the “greed factor” sets in, and “after two or three years of equities going up, that’s when you’ll see people getting back into equities…, but from a mass basis, a retail basis, we’re still about two years away from that.”
Rosie says its all been driven by QE, and on the other hand says that yields on 30-year bonds could continue lower below 2% (resulting in higher bond values, thus his call for investors to look at bonds for total return). Its math. As long as policy rates stay at zero, and inflation expectations remain where they are, and the Fed continues to buy bonds farther out on the yield curve, its a matter of time.