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Weekly Financial Focus: 13th December 2010

Japan
Strong growth but risks looming
Figures out on Thursday showed that Japan’s economy grew by more than estimated in quarter three due to stronger-than-expected capital spending by Japanese companies, but analysts warned of risks ahead. The upward revision to growth amplified the impact of a rush by car buyers to use expiring subsidies, and smokers who stocked up on cigarettes ahead of a tax hike during the period. The hottest summer on record also drove sales of items such as air conditioners, helping spur growth in the quarter. Private consumption accounts for around 60% of gross domestic product.

India

Production set to expand dramatically
India’s industrial production is likely to expand at the fastest pace in three months, prompting anlaysts to predict the central bank may resume raising interest rates as early as next month to curb inflation. Finance Minister Pranab Mukherjee raised the government’s economic growth forecast for the current fiscal year to 9.1% this week, the most in three years. India’s economy may expand more than China’s in the next 10 years if the world’s second-most populated nation lifts curbs on foreign investment and boosts spending on roads and bridges, New York University Professor Nouriel Roubini, who predicted the global financial crisis, said last week.

Australia

Jobs data improves investor sentiment
Employment in Australia reached a 10-month high in November, driving up the local currency and stocks as investors predicted an improvement after a decline last quarter. Payrolls gained 54,600 from October, the statistics bureau said in Sydney on Thursday. The jobless rate fell to 5.2% from 5.4%, even as more people entered the workforce. A stronger labour market may help bolster consumer spending after the economy expanded at the weakest pace in almost two years in the third quarter. Reserve Bank of Australia Governor Glenn Stevens held the benchmark interest rate at 4.75%, citing little sign of inflation pressure, an outlook that may shift in 2011 should the pick-up in hiring persist.

Europe

Greece may be given more time with repayments
Top European Union economic official Olli Rehn says the region is taking a ‘positive look’ at extending the repayment period of bailout loans that saved the country from default. Greece is in negotiations to get more time to repay loans worth up to €110bn from the EU and International Monetary Fund (IMF). EU governments had earlier said they were considering pushing back the start of repayments by 4½ years from the current 3 years. Meanwhile, France backed Germany in refusing to add to the EU’s €440bn rescue fund and rejecting joint euro-area bonds, deepening bloc-wide divisions before next week’s summit of EU leaders.

UK
Bank of England leaves well alone
The Bank of England kept its emergency stimulus program unchanged on Thursday after recent data suggested the economy may be strong enough to weather the government’s impending spending cuts, undermining the case for more aid. The nine-member Monetary Policy Committee, led by Governor Mervyn King, held its bond-purchase plan at £200bn. Manufacturing and services data indicate the recovery-sustained momentum in the fourth quarter. While spending cuts to tackle the record budget deficit may curb expansion, inflation remains above the bank’s target and policy makers have split three ways on whether to raise rates to tame price growth or add to stimulus.

Brazil
Brazil’s growth slowing down
Brazil’s economy slowed less than economists forecast in the third quarter on soaring investment and consumer spending. Gross domestic product grew 0.5% from the previous quarter and 6.7% from a year earlier, the national statistics agency said on Thursday. The pace of economic growth slowed from the revised 1.8% quarterly expansion in the April-June period and 2.3% expansion in the first quarter. It was the slowest expansion since Latin America’s biggest economy emerged from the global financial crisis in the second quarter of 2009.

Commodities
Gold & Silver fall as dollar rises
Gold and silver futures tumbled on Thursday as the dollar climbed, eroding the appeal of precious metals as an alternative asset. The dollar rose for the third straight day against a basket of six major currencies on speculation that an extension of tax cuts will spur the US economy. Gold has gained 26% this year, reaching a record $1,432.50 an ounce on Wednesday.

Spotlight on: China Learning From the Past
By Gareth Maguire, the Hansard Group

Could the China story be nearing its peak? This is what some commentators are wondering with the impending launch in January of the Investment Management Association (IMA) China/Greater China sector. When the IMA launched the Technology & Telecoms sector in 2001, it came just after the technology bubble had begun to burst. A similar situation occurred with the Property sector. Will the China sector repeat this scenario?

David Coombs, the head of multi-asset funds at Rathbone Unit Trust Management, sees similarities with the technology story. “In the long term China will clearly be a major part of the MSCI index,” he says. “Over the next 10 years I’m very bullish on the Chinese economy, but not necessarily Chinese equities.” In the short term, investors should be cautious about China, Coombs says. “It’s similar in some ways to the tech bubble, although we’re not seeing valuations as high. If you look at correlations between commodities and equity markets, it’s been almost one. That’s the China effect. It reminds me of 1998 and 1999 with tech names. There’s that euphoria; any stock with a Chinese distribution arm is highly rated. But a lot of companies have crashed and burned in China.” “There’s a lot of hot money chasing China; a lot of portfolios are skewed towards it. The ‘Asia creep’ in a lot of funds is pretty high. I’m conscious of trying to diversify away the China story. People probably are overexposed to China in the short term – valuations are pretty fair at the moment. I would like to see some of the euphoria come out of it and a return to reality.”

Hans Hamre, a research director at FundQuest, a multi-manager firm, is upbeat on China’s prospects. He says there is still the potential for a rally in the next three to six months. “The Chinese domestic A-share market is trading at about 20% below its mid-2009 high,” says Hamre. “The key consideration is that valuations are cheap. The forward price/earnings (P/E) ratio is about 14.5 times, which is at the bottom of its historical and volatile range.”

The only significant market sector that is expensive is consumer stocks, many of which are on ratios of 35-40 times, Hamre says. “These companies are enjoying rapid growth and the consensus suggests that they deserve to be highly rated. However, the risk of disappointment is high. Other sectors are cheap: investors have been wary of the global economy and hence cyclicals, while the banks are on P/E ratios of eight to 10 times. Non-performing loans are rising, but this appears to be priced in.” Hamre notes that for at least two decades many Western observers have predicted a crisis in China, arising either from its system of economic management or from its communist political system. He adds: “China has exceeded expectations. The country is the most successful example of early-stage industrialisation ever. This is despite obvious problems including a chronic imbalance between consumption and investment, stubbornly high savings because of poor health and social security systems, the negative demographic consequences of the One Child policy and environmental degradation.”

Another problem, Hamre says, concerns incomes. “GDP per capita in prosperous southern and eastern cities is about £13,000, but it is only a little over $1,000 in the poorest western provinces. Many local fund managers refer to a widespread sense of injustice. The authorities are concerned, and policy reflects this: higher minimum wage rises in the poorest regions, backed by transfers and infrastructure investment.”

However, Hamre says that if GDP growth of at least 6-7% can be maintained – and there is clear evidence it can – the social strains should be manageable. “A cursory review of history would suggest that social problems boil over when the ‘pie’ is static or, worse, is shrinking. Continuous and substantial growth in GDP per capita is a wonderful pressure reliever, allowing government significant latitude to address the worst problems as they emerge.”

Unfortunately, an increasing number of managers, like Coombs, admit the correlation between economic growth and equity returns may be vague at best.

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