by Ron D’Vari
Economically, 2013 will be a pivotal year for the nation and the world. Our baseline forecast for 2013 is overall positive, but the risk of certain events, such as a total fiscal stalemate or Euro breakup, could dramatically change the optimistic outlook.
Unique Opportunities, Albeit With Higher Risk
The shifting global economic landscape presents unique opportunities that will be complex to analyze and come with higher risks. The general investors' attitude is already leaning toward "risk-on." Barring any major geopolitical or natural catastrophe, investor sentiments are expected to remain constructive. The sustained positive expectations will propel the markets up and valuations tighter.
In aggregate, investors' positive sentiments are driven by: a) the Fed's historic expansionary monetary policies, b) U.S . housing stabilization, c) early signs of the return of Chinese economic reform and acceleration, and d) a lesser probability for Euro break-up. These factors, combined with a prolonged non-existent yield on cash and investors' desperate search for yield, will fuel the risk taking appetite.
State of the Economy Today
2012 offered no real resolution of key uncertainties despite the exhaustive efforts of policy makers. These included deep European Union structural issues and corresponding recession, Chinese economic growth slowdown, deepening US fiscal puzzle, high unemployment, and looming ambiguous and potentially costly financial regulations and higher taxes.
With all the unprecedented fiscal and monetary stimuli and low interest rates, the US economy is expecting to end up with only 2.3% GDP growth and an unemployment rate still hovering around 8%, though this is gradually improving. The real unemployment rate is of course higher as the official unemployment numbers do not count those that have left the job pool. While 2.3% GDP is satisfactory in a normal year, it represents a lackluster recovery that still is still plagued by damages of the credit crisis.
2013: Resolution of Key Uncertainties?
The current economy reflects just what has passed, while the markets strive to reflect the collective expectation of future changes in economic conditions and corresponding uncertainties. The key drivers for 2013 will burn away obscuring clouds, allowing rays of sunshine to resolve uncertainties and lead investors and corporations to see a clearer path to a faster global growth.
Powerful Economic Factors On The Horizon
Numerous and extremely powerful economic factors will play out in 2013, rendering it difficult to predict the path of the recovery. The table below summarizes both positive drivers and key inhibitors of accelerating economic recovery:
Consumers Are Key
Consumers will continue to play a critical role as they constitute over 70% of the U.S. GDP. Consumer staying power will depend on job growth from the current 150,000 per month to 250,000 on average, and growth of their discretionary income. While corporations are enjoying healthy balance sheets and plenty of cash, they have been reluctant to add employees due to fiscal and tax uncertainties. Any resolution of tax and spending policies will help to unleash over $1.5 trillion in corporate cash.
U.S. Housing Markets Will Lead
Housing markets have stabilized but by no means are near their normal levels. With over 12 million residential mortgages in the negative equity status, low interest rates go only so far despite GSE programs to refinance them. The lending standards remain relatively tight, and only borrowers with the strongest credit and reasonably high down payments can trade-up or refinance. Nevertheless, greed is coming back to the market and many large and small private equity firms are investing in single-family properties with the hope of double digit returns and conversion of the investments into REITs. That seems to be driving REO and non-performing loan pool prices near an all-time high.
Corporations Will Gradually Hire
The global economic landscape changes have directed the focus of many corporations away from the US and Europe to Asia and other growing regions. Five years of tough economic times have gradually shifted US output towards goods and services that are more "exportable." The trend is not likely to be transient and is becoming the new norm. The US economy will gradually become more competitive because of several factors coming together. Some examples of these factors include more focus on exports, the rise in wages elsewhere in the world, continued productivity growth domestically, appreciation of Asian currencies, and creativity in new product design and development.
Clear Skies Ahead?
We expect some of the economic and structural uncertainties to be de-emphasized by the end of the first half in 2013. These include US fiscal gridlock, regulations and tax uncertainty, and European Union structural issues. New Chinese leaders have already started to advance various domestic projects to stimulate China's own economy. These will open up the way for corporations to start hiring which would also further boost consumer confidence.
Markets will act ahead of actual economic improvements and will drive valuations tighter in both stocks and credit spreads as early as the end of the first quarter.
Fixed Income: While US Treasuries and Agencies will remain popular with sovereign investors, continued low interest rates will send other investors searching for yield in many directions, but they will remain cautious and will tend to require a lot more disclosures and transparency:
- higher yielding corporates and emerging markets
- higher quality structured products such as new issue ABS, CMBS and CLOs
- leveraged loans with and without leverage
- distressed RMBS and CMBS and re-REMICS
- distressed and newly originated residential and CRE loans
- mezzanine corporate and CRE loans
- legacy and new esoteric securities such as timeshare, aircraft, and subprime auto
- specialty finance
- clean-energy securitization
New issue non-agency RMBS securitization will start up again but will be constrained by the lack of clarity in securitization regulations, confused capital requirements, and unresolved questions surrounding RMBS waterfalls and servicing limitations. As a result, investors will apply more aggressive residential loan recovery assumptions to legacy distressed RMBS, and drive prices even higher.
New CLO issuance is expected to continue to grow due to demand but will be constrained by the spread tightening of the underlying leveraged loans as well as skinny equity IRRs.
New-issue CMBS will also continue to grow but supply will be limited by subordinated capital. We expect underwriting standards in CMBS to continue to gradually ease but informed investors will keep them in check for the time being.
Investors with proper capabilities will invest directly in whole-loan corporates, residential, and commercial loans, both distressed and new origination.
Asset managers will continue to introduce more ETF products and investors will buy into them as a way of accessing more diversified portfolios. Sophisticated investors also seek opportunities in the private equities across all sectors yet also in disruptive technologies. Agriculture, commodities, energy, clean-technology, project finance, and infrastructure will continue to be of interest to investors with proper knowledge or advice.
A rising tide lifts all boats, but 'risk-on' does not mean investors should not be cautious of potential disappointments in macro trends. With a unique inflection point in the economic trends, long-term investing will ensure better chances of achieving lasting success more than any time by open-minded analysis of key global drivers:
- Global banking and finance continues to transform to survive
- Governments, by necessity, reform and enhance ties with the private sector
- Emerging markets will drive marginal growth
- Continental and demographic shifts alter the investment opportunities
- Rapid technology innovation creates opportunities and pitfalls
- Cleantech will gradually become a factor, albeit slower than many would like
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: NewOak is a financial advisory and investment banking firm providing clients with strategic insight, transparency and risk management. This article was written by CEO and Co-Founder Ron D'Vari. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.