GLOBAL ECONOMIC OUTLOOK: 3RD AND 4TH QUARTER OF 2012
The global economy is slowing, with key European countries entering a recession that is now having an impact worldwide. The outlook for global growth is highly dependent on timely policy implementation in Europe and the U. S. despite some scattered signs of improvement in recent months, the world economic situation and prospects continue to be challenging.
After a marked slowdown in the course of 2011, global economic growth will likely remain tepid until end of 2012, with most regions expanding at a pace below potential. In the baseline outlook, world gross product (WGP) is projected to grow by 2.5 per cent in 2012 and 3.1 per cent in 2013, following growth of 2.7 per cent in 2011. After a deterioration in economic conditions in the first half of 2012, it seems that global scenario envisages a slight rebound in 2013.
The United States is affected by the Euro-zone slowdown, growth is nonetheless projected at an annualized rate of 2.0% in the third quarter and 2.4% in the fourth. Canada is expected to grow at a rate of 1.3% during the third quarter and 1.9% during the fourth. The Japanese economy is forecast to contract at an annualized rate of 2.3% during the third quarter and to hover around a zero growth rate in the fourth quarter of 2012. A number of downside risks threaten the outlook, including the potential for further increases to already high oil prices, excessive fiscal contraction, notably in the United States in 2013, and further declines in consumer confidence linked to persistent unemployment.
Real GDP growth is expected to be only 1.9% on a year-on-year basis in 2012.
Economic recovery in the United States can withstand Europe?s recession unless the Euro-zone experiences a full-fledged financial meltdown.
Non-farm payroll employment gains to average less than 100,000 jobs in each of the remaining six months of 2012. (Source: Russel)
1?year Treasury yield, that the benchmark will end the year at about 1.9%.
If this scenario unfolds, the U.S. economy will not exit Japan-style stagnation expectations until well into 2013.
Inflation outlook: All-terms CPI will increase at an average rate of 1.9% in 2012 and by 2.1% in 2013. Inflation fighting does not appear on the Fed?s radar screen until 2014, at the earliest.
With the Euro area crisis still the most important risk for the global economy, further policy action is needed to instill more confidence in the monetary union. The G7 economies are expected to grow at an annual rate of no more than 0.3% in the third quarter of 2012 and 1.1% in the fourth quarter. The continuing Euro-zone crisis is dampening global confidence, weakening trade and employment and slowing economic growth in OECD and non-OECD countries alike. The global economy is slowing, the leading European countries are slipping into recession and the effects are now being felt globally.
As per the recent reports of OECD it warns that the three largest Euro-zone economies ? Germany, France and Italy ? will shrink at an average annualized rate of 1.0% during the third quarter and 0.7% in the fourth quarter. The outlook for France is slightly better, with a 0.4% annualized rate of decline in the third quarter, followed by a slight upturn of 0.2% in the fourth quarter. In Italy, the deep recession will continue, with annualized decline of 2.9% in the third quarter and 1.4% in the fourth quarter. The report underlined the need for greater coordination at the European level to stem the two-year debt crisis in the currency zone. The economic outlook has weakened significantly since last spring. The slowdown will persist if leaders fail to address the main cause of this deterioration, which is the continuing crisis in the Euro area.
In Asia, the Growth projections seems to be downward due to weak first half outturns and the delayed global recovery. Second quarter indicators have been weaker than previously anticipated due to slowing export growth and weakening domestic demand. Among the region?s larger economies, the slowdowns in India and China have been especially noticeable, with the former having much to do with uneven domestic policy implementation of structural reforms, and the latter owing in part to the effects of previous policy tightening. The region?s more open economies, especially in North Asia, have also seen a pronounced slowdown. In contrast, growth in Southeast Asian economies, especially Indonesia, has continued to perform relatively well. In addition, slowing external demand is spilling over to domestic activity, exacerbating internally generated factors behind the loss of growth momentum, especially in India and China. Projection is that growth to pick up in the fourth quarter on the effects of fiscal and monetary policy support, and an improving global environment. Falling inflation should provide room for further monetary easing in the coming months. Risks to the outlook are heavily tilted to the downside. In particular, if financial tensions intensify in Europe, negative effects in Asia would be transmitted through trade and financial channels, with policy support providing some cushion.
At the peak of the last business cycle in June 2007, interest rates in the U.S. were
at 5.25%. Today, they?re at 0.25%. Likewise, LIBOR (London Interbank Offered Rate) has shrunk from 5.36% to 0.58%, while the European Central Bank (ECB) has slashed its lending rate from 4.0% to .0% . A reduction in interest rates is a common way governments attempt to stem an economic decline. The goal is to make capital affordable enough to entice businesses and consumers to invest and spend. This will only happen when they are confident that capital is cheap, and will remain cheap. Major governments in the U.S., Europe, and globally have sent that message ? loud and clear.
Despite the strong technical backdrop of the corporate bond market, the recent string of positive quarters for companies may be at risk due to results from second quarter earnings. Some of the Institutions? High Grade Strategy team suggests that the recent earnings season has ?left much to be desired from the fundamental perspective?. Given the headwinds of slowing growth, corporate earnings in the coming quarters may be impacted which could in turn negatively affect performance and corporate bond holders. Investment Grade Corporate bonds have had a tremendous run as evident by the decline in yields which has led to outperformance relative to Treasuries. Furthermore, inflows into corporate bond funds and ETFs have skyrocketed due to investors seeking high quality assets that provide some pickup in yield relative to Treasuries.
U.S. Treasuries (as of 11.09.2012)
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An underwhelming third quarter suggests that slower growth may be starting to impact earnings. Top line revenues were weak, but margins remained strong. The issue seemed to be with the setting of expectations. From a historical context one has to go back to the third quarter of 2011 to find a quarter where analyst estimates were off by so much, and that quarter was impacted by the tsunami and the debt ceiling negotiations.
Earnings weakness usually does not affect corporate bond holders to the same degree as stock owners for investment grade corporate issuers since their credit worthiness in the grand scheme of things, remains fairly intact. However, the recent trend of companies catering to shareholders first may ultimately hurt bondholders. Specifically, Dividends which reduces cash on hand to service debt holders have been increasing. Furthermore, share repurchases which increases leverage ratios for a company since it reduces the amount of equity outstanding while debt levels remain the same can hurt bondholders. As a result, fundamentals are at risk for turning sour as we approach the end of 2012. If such a scenario plays out, the potential for corporate bonds to underperform is high given the current environment of limited liquidity for corporate bond players. What?s more, the possibility that a similar narrative unfolds in the fourth quarter appears to be quite high.
Bottom up consensus estimates envision a third quarter that?s relatively flat to the second in terms of revenue and earnings, but the expectations for the fourth quarter of 2012 and 2013 as a whole are far higher. Consider varied sources of fixed income. This might include U.S. corporate investment grade securities, U.S. Corporate high yield Bonds, Emerging market corporate and selected Sovereign Debt. Limit exposure to TIPS and floating rate bonds. If inflation stays in check there is less reason to own inflation-protected instruments.
As in 2011, country weights will be important. The last couple of months witnessed dwindling investor confidence in global capital markets, as a result of some discouraging news flows from the Euro-zone and other countries around the globe. After the Greek debt crisis, renewed fears about Spain’s debt concern weighed on the financial markets along with indications of a likely economic slowdown. These concerns took a toll on the regional markets as well.?
As in most economic environments, there will be continued opportunities for investors in 2012 and 2013. In our view, investors can position their portfolios in these ways: Emphasize larger U.S. companies. These are more defensive in nature, have cheaper valuations, a global footprint and higher dividends ? in many cases, higher yields than on 10-year Treasury bonds. Keep some exposure to mid- and small-sized companies. Earnings and sales results have been strong here and prices pulled back in 2011. Pay careful attention to the financial sector in Europe and selectively in the U.S. Stay neutral to slightly positive on emerging markets. Interest rates are coming down in several countries and growth remains decent.
As per the economists note, one really can?t form a complete earnings outlook for late 2012 or 2013 without taking a view on the actions of policymakers. While stocks are near their recent high with the S&P 500 trading near the 1400 level, there is a certain air of complacency as if all is well with the economy. However, the fact is that economic data has been tepid at best and the Fiscal Cliff and its potentially crippling effects on the economy, is fast approaching. European equities are cheap relative to the US and will become cheaper if the crisis worsens.
S & P 500 INDEX
The S&P 500? has been widely regarded as the best single gauge of the large cap U.S. equities market since the index was first published in 1957. The index has over US$ 5.58 Trillion benchmarked, with index assets comprising approximately US$ 1.31 Trillion of this total. The index includes 500 leading companies in leading industries of the U.S. economy, capturing 75% coverage of U.S. equities.
S&P 500 Stock Index Forecast
Index Values, Average of Month.
HEDGE FUNDS MARKET:
We believe that the current period of deleveraging will create interesting opportunities, and we prefer managers who can wait for these to take hold, rather than look to apply hefty leverage to ordinary spread convergence opportunities. In the US and Europe, looming corporate debt maturities combined with market uncertainty may result in attractive investment opportunities in Private Equity placements and Fund of Funds in the coming years. Investors continue to seek safety and stability. While funds remain cognizant of the potential for an adverse market reaction in the ongoing European banking and sovereign debt crisis, recent developments have been constructive. As a result, hedge funds have modified defensive positioning to consider a continuum of positive and negative scenarios, increased options and volatility implications of the Euro sovereign debt crisis, as well as a broadening of focus to include the US elections and Chinese growth considerations.
From an equity perspective, parts of Europe are, even on very conservative cyclically adjusted valuation metrics, already very cheap. They will become cheaper still were the crisis to worsen further. But in that case, given the size of the Euro-zone and its debts, it would be very surprising indeed if valuations elsewhere did not also fall. Cheap valuations are splendid so long as do not hold them before they got cheaper. Therefore stick to companies with sustainable and high dividends and stable market shares.
Hedge funds can be tactically positioned for the equity, fixed income and commodity developments in the coming years, with many funds having strategically increased equity net exposure, reduced short Euro currency positions and appropriately hedged fixed income exposure through mid-summer to end of 2012. Thus we forecast a positive result for the 4th quarter and the beginning of 2013.
GCC EQUITY MARKET:
Gulf hydrocarbon producers basked in a massive current account surplus of nearly $322 Billion in 2011 because of a sharp rise in their oil exports due to strong crude prices, according to a bank study. The surplus accounted for as high as 23 per cent of the combined GDP of the six-nation Gulf Cooperation Council (GCC) and is projected to remain large through 2012 and 2013 as crude prices are expected to remain firm. ?Oil prices are forecast to remain high in 2012-2013, resulting in continued strong current-account surpluses around 20 per cent of GDP.
The GDP of the GCC has almost quadrupled since 2001 and is likely to reach US$1.5 Trillion in 2013 as the hydrocarbons sector drives growth, assuming average Brent- oil prices of US$108 per barrel in 2012-13. Strong government spending has encouraged diversification, leading to expansion in non-oil sectors will be key to boosting real GDP growth to 4.6% in 2012-13. GCC’s real GDP growth is forecast to reach 4.6 per cent in 2012-13, outperforming the global GDP growth, which the IMF expects at 3.6 per cent. Gas production growth at 4.3% will outpace oil production growth at 0.4% due to stable global demand. OPEC caps and an investment focus on the gas sector. Non-oil industrial growth of 9.0% will be driven by manufacturing, particularly heavy investments into petrochemicals, fertilizers and metals production in Qatar and Saudi Arabia. In the construction, high levels of public expenditure will drive growth of 5.6% in services in 2012-13, which is largely made up of Government and financial services and is expected to account for 36.0% of nominal GDP.
GCC government spending surged by 22.0% last year ? in part a response to the social protests that swept the region. Yet the combined GCC budget surplus actually rose to 11.0% of GDP thanks to a 49.0% jump in oil revenues. While the aggregate fiscal position is sound, rising spending commitments have increased vulnerabilities to lower oil prices. Budget breakeven oil prices now range from $72-115 per barrel, compared to around $30.0 per barrel in 2005. A sustained period of lower oil prices would increase the need for fundamental fiscal reform. But as governments look to address social issues, such reform has slipped down the political agenda.
Economic activity is attracting foreign workers to the region resulting in population growth that is almost triple the world rate with about 50 million people expected to be living in the GCC by 2013. Gulf stock markets are vulnerable to a pull-back if central banks in the United States and Europe signal more stimulus steps in the next quarters, although high oil prices may cushion any fall.
GCC stock markets were always about large caps; hence, There are top 20 companies listed in the GCC stock markets (measured by market capitalization), certain themes emerged. They are dominant (48% of market cap, 23% of total value traded, 61% from KSA, 70% from just two sectors banking and chemicals) and therefore they enjoy large government ownerships (averaging 45%) and therefore sap liquidity (turnover velocity averages just 12%) & Offer high dividend yields (5.0% on average). However, the muted market performance during the last few years has seen them not deliver positive shareholder value. Measured in the short-term (last one year), only 3 of the 20 managed to beat their stock market index in terms of performance.
Market Ratios as per ZAWYA (12.09.2012)
*P/E: Price Earnings Ratio, P/BV: Price to Book value, DY: Dividend Yield
Liquidity in the major Gulf Cooperation Council (GCC) markets suffered considerably in the last month due to the over-reaction of investors to the global circumstances irrespective of the stable outlook for the GCC markets. The most the GCC country’s budget balance reached a huge surplus. Huge fiscal balances will further elevate spending and support the economic growth and corporate earnings. Corporate profitability remained healthy during the first three months of the year with the GCC companies posting collective earnings growth of 4 per cent compared to first quarter of 2011, according to an industry report. Incremental growth in earnings was driven by contributions from Saudi Arabia, UAE and Kuwait. Hope that GCC markets will continue to demonstrate signs of stability showing revival in line with the regional markets.
References: Russel Investments, GIC, Markaz, Gulf Base, , Zawya Research Reports