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1、 September 2012 Economic Outlook Muddle trouble in Europe The ECBs actions have greatly reduced the near term chances of an escalation in the euro crisis. But unless growth returns to the region, muddling through isnt a sustainable endgame. Chinas Q4-Q2 hard landing getting worse, less than half ove
2、r Facing deflation, capital flight and a vicious profit squeeze, investors underestimate the China effect at their peril Investment Outlook Equities The central bank rally could judder to a halt over China but cheaper UK valuations are tempting; Brazil and Mexico trading places G10 Government Bonds
3、Forces more powerful than QE3 mean Treasuries are still in vogue; temporary stay of execution in Eurozone decreases Bund appeal Emerging Market Government Bonds South Africas pairing of slowing growth and looser policy stands out; Poland could tempt if inflation eases and fiscal reforms deliver Corp
4、orate Bonds US investment grade offers a more attractive means to take US corporate risk than US equities FX USD-positive factors battling against Fed doves; euro should soften as Draghi magic fades; AUD a false-haven Commodities Gold incorruptible; Fed-induced pick-up in oil and industrial metals t
5、o be put down by China LSR Quarterly Outlook LSR Quarterly Outlook September 2012 Asset Allocation 3 Overview 4 Global Outlook 5 Muddle trouble in Europe 5 Chinas Q4-Q2 hard landing getting worse, less than half over 14 Bernankes damp squib leaves stocks vulnerable 18 Investment Outlook 19 Equities
6、19 G10 Government Bonds 28 Emerging Market Government Bonds 33 Corporate Bonds 34 FX 36 Commodities 40 Energy 40 Industrial Metals 41 Precious Metals 42 Model Portfolio 43 Quarterly Outlook is based on the analysis and insights of all LSR economists and strategists. Individual sections have been pre
7、pared as follows: Asset Allocation - Melissa Kidd, Overview - Melissa Kidd, Global Outlook - Dario Perkins, Global Outlook - Charles Dumas, Global Outlook - Charles Dumas, Equities - Melissa Kidd, G10 Government Bonds - Chris Turner, Emerging Market Government Bonds - Chris Turner, Corporate Bonds -
8、 Chris Turner, FX - Chris Turner, Commodities - Melissa Ball and Model Portfolio - Eugenio Montersino. Asset Allocation 3 Asset allocation matrix (12-month view) Bold indicates a change of view (old rating in brackets) September 2012 Stocks Bonds FX vs $ Monetary policy North America US -1 +1 easier
9、 Canada -1 +1 -1 unchanged Developed Europe UK 0 (-1) +1 -1 QE Switzerland 0 -1 FX target is QE Euro Area -1 -1 easier Germany -1 0 (+1) France -1 0 Italy -2 -2 Spain -1 (-2) -1 Asia Japan -1 0 -1 QE Australia +1 -1 interest rates down China -1 0 easier India -1 -1 interest rates down Korea -1 -1 in
10、terest rates down Taiwan -2 -1 easier Latin America Brazil 0 (-1) 0 0 rates down, then up Mexico -1 (0) 0 0 unchanged Emerging Europe and Africa Russia -1 -1 rates up, then down Poland -1 0 -1 interest rates down South Africa 0 +1 -1 interest rates down Key to recommendations +2 = strongly positive
11、0 = neutral -1 = negative +1 = positive -2 = strongly negative Equity sector recommendations can be found on pp.27 Asset Allocation 4 LSR Quarterly Outlook The September ECB/Fed double act, and its anticipation, has cheered risk assets but developments in China could soon bring the party to an end.
12、This LSR Quarterly Outlook discusses the flaws in the current Eurozone policy status quo and the scale of painful (and necessary) structural adjustment facing China. In Muddle trouble in Europe (pp.5), Dario Perkins takes apart the argument that incremental policy concessions can provide a sustainab
13、le solution to the Eurozone crisis. The necessary conditions for muddle through are missing affordable access to markets; adequate firewalls; and economic growth and fractures in the currency union have spread far beyond Greece. Draghis recent actions have bought some time in the euro crisis, even i
14、f the beneficial effects may not last. Alongside the softening in Germanys stance towards bailout countries (Greece, Portugal), the currency revaluation boost to Bunds in a euro break-up has been deferred, prompting a downgrade from +1 to 0. Greater political certainty in Spain and a mandate for fis
15、cal reform mean the equity market joins Spanish bonds rated -1, but Italy languishes on -2 in both asset classes. Charles Dumas Chinas Q4-Q2 hard landing getting worse, less than half over (pp.14) outlines why a lurch to deflation, capital flight and a violent profit squeeze mean Chinas hard- landin
16、g has several quarters yet to run. Opaque developments in China pose a serious risk to global asset prices in the midst of a global manufacturing slowdown. Cheap cyclical valuations in Chinese equities are relatively meaningless in this context and the market stays -1, while the regional slowdown is
17、 squeezing corporate earnings among Japanese, Korean and Taiwanese exporters. Cash flow and dividend problems in Taiwan condemn the market to a -2 rating. The likely effectiveness of Bernankes pre-election launch into QE3 in supporting 2013 US growth is discussed further in Charles second article, B
18、ernankes damp squib leaves stocks vulnerable (pp.18). QE3 optimism could soon be overtaken by potentially savage political wrangling over the fiscal cliff, leaving US equities rated -1 (although there are some attractive opportunities among cheap growth sectors in this market). Treasuries retain the
19、ir appeal in a world of excess savings, facing a fiscal policy-induced US slowdown in 2013, along with Bank of England-supported Gilts. Somewhat left behind in recent weeks by US and Eurozone buoyancy, the UK equity market home to several of our favoured equity sectors globally now offers better val
20、ue and is upgraded from -1 to 0. Mexicos close synchronisation with the US and rich equity valuations leave the market exposed to a Q4 sell- off, while Brazil now better discounts China-related risks. Anticipation of looser monetary policy has also puffed up the commodity markets (potentially re-has
21、hing the unintended consequences of QE2 on US growth), but only gold is set to build on these gains over twelve months. Fortunes for oil and industrial metals are tied up with China, although the former could hold onto current levels in the short-term as Middle East tensions bubble. Corporate bonds
22、markets (along with some defensive equity sectors) continue to offer substantial reward given the prevailing slow growth-high political risk environment expected for 2012/13. Melissa Kidd Overview Global Outlook 5 Muddle trouble in Europe Over the past few months, a period of relative calm for the e
23、uro crisis, a new consensus has emerged among investors. Many now believe European policymakers can and will muddle through in the years ahead, possibly indefinitely. The crisis will not be completely resolved, but there will be no major escalation and the situation will not become a systemic threat
24、 to global markets. Avoiding a string of possible disasters in September (notably ESM ratification in Germany and the Dutch elections) has cemented this view. The muddle through scenario rests on three underlying assumptions: (i) The euro will not break up because policymakers will always do the min
25、imum necessary to prevent it at any point in time. Even small countries like Greece will be kept in the euro, at least up until the point where they are not considered to be a systemic risk (the incremental cost of doing so we are assured is low); (ii) European growth will probably be weak during th
26、is period possibly for years to come but investors can ignore this. Europe becomes like Japan over the last two decades. In fact, as investors begin to care less about developments in the region, uncertainty will dissipate and economic activity will improve; (iii) The most vulnerable countries will
27、be in a stronger position over the medium term because of the fiscal and structural reforms they are now putting in place. These assumptions are shaky at best. While there are certainly things European policymakers can do to buy themselves more time (the ECBs latest bond buying scheme is a prime exa
28、mple) and Angela Merkel certainly has an incentive to avoid another escalation in the crisis before the German elections, the situation could be beyond their/her control. There are too many potential accidents in the months ahead. Moreover, muddle through is not a stable endgame for the euro area. A
29、 Japanese-style lost decade is plausible in terms of economic growth, but only with levels of unemployment that make it politically unsustainable. That is not an environment that will foster more Europe. Looking for the exit Lets start with a simple question: under what circumstance will a euro-area
30、 country opt to replace the euro with its own currency? There are three main possibilities1. First, a euro member might be forced to quit the euro because it loses market access and doesnt want to enter an official bailout programme. Maybe the terms of that bailout are too punitive. Second, a countr
31、y again after losing market access might not be able to secure an official bailout. That could occur either because the country is failing to comply with the terms of previous bailouts (e.g. Greece) or because there are insufficient funds available (e.g. Italy). Third, it is possible that even if a
32、country can fund itself inside EMU, it will decide to quit the single currency in order to devalue its currency and regain control of monetary policy. That certainly isnt likely in the short term, but it becomes a more realistic possibility over time. 1 These scenarios concentrate on deficit countri
33、es since those are typically the focus of the muddle through hypothesis. There is also a chance Germany the largest and most important creditor nation decides to quit the euro (see Germany should not, maybe cannot, afford the euro. Monthly Review, August 2012). At that same point all talk of muddlin
34、g through becomes irrelevant. Global Outlook 6 LSR Quarterly Outlook Policymakers in Europe are understandably worried about the consequences of quitting the euro and reintroducing their own domestic currencies. The short-term costs of doing so are large but difficult to quantify with any degree of
35、confidence. On the evidence of the last few years, a struggling country will always seek an official bailout once they lose access to markets or financing becomes prohibitively expensive. Greece, Ireland and Portugal have all followed this template. Spain will probably be in this position by the end
36、 of the year. But official bailouts come with their own costs. The Troika always insists on aggressive fiscal consolidation and deep structural reforms. Domestically they are deeply unpopular and politically embarrassing for those countries forced to seek them. And ironically, these policies will on
37、ly work if economic growth recovers, yet they make recovery less likely. If weak growth persists, public opinion shifts against the euro, making euro exits more likely over time especially if a succession of bailouts and new austerity policies follow, as has been the case in Greece. The Greek econom
38、y has contracted more than 20% since the start of the crisis. It is questionable whether the economy would have performed worse had the country quit the euro three years ago it would at least now have some prospect of recovery. Eventually, this situation will prove unsustainable. Either it will beco
39、me unbearable for those countries needing the bailout, or unacceptable to those countries providing the funds. Greece is already there, Portugal, Spain and Italy are headed in that direction. In fact, for those larger euro-area economies this progression might be more rapid since the funds they requ
40、ire particularly in the case of Spain and Italy are much larger. Still, our objective at this point is not to make forecasts or figure out which of these scenarios is most likely. Instead it is to highlight the minimum policymakers must do in order to muddle through. What muddling through requires T
41、o muddle through, it is clear European policymakers must: 1. Ensure EMU members do not lose access to markets (at affordable interest rates); 2. Provide an adequate firewall of official financing (in case 1. fails); 3. Restore economic growth to the region. These are the basics. Yet because policyma
42、kers have dithered in recent years, they will probably have to do more. Recent market stress highlights how interconnected the euro system is and how vulnerable it is to systemic risk. Policymakers will have to manage these risks more effectively than they have in the past. In particular, they must
43、break the adverse feedback loop between vulnerable government bonds and their weak national banking sectors. Not only are European banks deeply exposed to sovereign stress but those same banks are effectively a contingent liability for the state. Stress feeds on itself. As a further complication, it
44、 might now be too late to keep Greece in the euro. The policies and disagreements of the last few years have created animosity and political friction. Greeces medium-term outlook remains bleak. The German public want Greece out. Either European policymakers will have to pull Greece back from the bri
45、nk (which might be beyond their control) or they will have to manage Greek exit and prevent contagion to other economies. Global Outlook 7 1. Providing affordable funding European policymakers have become more serious about this recently, thanks largely to the ECBs intervention. Its latest bond-buyi
46、ng programme (Outright Monetary Transactions, OMT) will surely be more effective than its failed Securities Markets Programme (SMP) because it is on a much larger scale. Critically, ECB officials are not diluting its impact by labelling it temporary and limited. They have learnt from those mistakes.
47、 In reducing borrowing costs, this scheme makes it less likely a country will be forced out of the euro in the short term. Muddling through becomes more plausible. Yet, the ECBs interventions are focused on the short end of the yield curve and will have a less powerful impact on long-term interest r
48、ates. So it is not clear how much time this scheme actually buys. The ECB has said it will buy bonds with a maturity of up to three years, but hasnt said how long the scheme will be in place. Plus the ECB has threatened to suspend the OMT for those countries failing to meet their austerity/reform re
49、quirements. Because these policies dont work, there is a strong possibility these targets will be missed. The ECB cant provide a permanent solution because it is determined to avoid anything that looks like debt monetization. This should be a powerful negative signal for investors. The ECBs refusal to buy long-dated bonds leaves the European Stability Mechanism (ESM) as the sole provider of official long-term support. Yet the ESM has insufficient and strictly