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Investment Market Themes for 2011

Investment Markets in 2011

 

The holidays are over. In between the chocolates, fairy cakes and biscuits, I have had the chance to do an unusual amount of reading (which only comes really at this time of year). As a result, (in addition to the turkey), I have absorbed and digested economic reports and news to the point that I have formed a world and investment market view.

 

The key investment market trends of the year will be symptomatic of the underlying macro position and changes in the global economy.

 

Macro

 

1. Two-speed global economy

 

The rapid growth in the BRIC economies and the emerging world will continue with China acting as an engine and largest source of demand for commodities. Growth pains will be felt in China in particular with inflationary pressure a key metric, note the recent sneaky hike in base rates before Christmas whilst the rest of the world was distracted. 

 

These pains will continue to be addressed through government policy which is aware of the need to develop stronger internal markets, consumer spending and local development as a gradual shift away from the export led economic model. RMB devaluation will continue – at a snails pace.

 

Developed world economies in Europe and the US will find some stability post-crisis but with high levels of unemployment, public sector budget cuts and low levels of inflation from spare capacity continuing to supply dis-inflationary pressures. The US will have a good ear with stronger growth than 2011, the UK will likely under-perform as a result of ‘front loaded’ spending cuts in 2011 so that the coalition government has 4 years in office if it goes wrong.

 

The global imbalance of spenders and savers persists. Trade imbalances between developing and developed world also still persists and will do so for the next 5-10 years. This will present additional challenges to developed world economies (US, Europe) in reducing trade and budget deficits and to developing countries in stimulating domestic consumption.

 

2. Demand-led commodity price rally

  (...with isolated supply shocks)

 

The rapid growth of EM and large BRIC economies in particular will feed the commodity price rally in 2011. This, coupled with continued supply shocks in certain markets (cereals, oil, iron ore) will see continued price rises for key commodities.

 

This is coupled with dollar weakness and concerns over the expansion of the global monetary base will see metals such as gold, silver and bronze continue to appreciate. Gold may strike $1500 in 2011 with Silver laying catch-up.

 

Whilst the global demand for commodities is unbalanced, the global price is the same. To this end, the developed world economies will have to pay higher oil and cereal prices as a result of the rising demand in the developing world.

 

This will provide some inflationary pressure and has the potential to create a stagflationary environment. However, given that there is some 25% spare capacity in European economies in particular from 2007 levels, this may be contained.

 

3. Developed world de-leveraging

  (...and developing world leveraging)

 

De-leveraging at the household, corporate and sovereign level coupled with high unemployment will continue to sap aggregate demand in the developed world which will in turn hold back economic growth below trend.

 

The bond market will continue to attack those economies which have weak fiscal positions with Portugal and Spain to be tested in Q1 2011. The effect of austerity measures in European economies will start to be seen in 2011 with key tests for GDP in Q1 and Q2. We will know the results of these tests in April and July respectively with higher market volatility across asset classes around these dates.

 

If growth starts to weaken markedly, 0.25% change or higher, markets will enter a period of volatility similar to 2008. Key measure of market volatility will be the CBOE Vix Index.

 

The potential for further financial shocks within the banking system should also be monitored carefully as a result of continued deleveraging. Various government support mechanisms will be withdrawn in the UK and Europe in 2011 that will see banks forced to seek new sources of liquidity.

 

Lending to both households and corporates in developed world will remain subdued compared to 2006-7 levels. A lot of the so-called 'new lending' is actually refinancing of outstanding loans to existing borrowers through 'new' loans. This enables banks to project their ‘willingness’ to lend whilst keeping troubled loans on life support, claiming higher interest rate margins in the process and not extending credit to new, higher risk borrowers (which is good for their bottom line).

 

2011 will see the continued use of leverage and credit expansion in the developing world and in the BRIC economies in particular.

 

 

This will be closely monitored by central banks but is a necessary part of the development of consumer spending and the consumer class. Inevitably, credit markets will either expand too quickly or too slowly which will provide shocks but these will most likely be seen in 2012 and beyond rather than in 2011.

 

Investment Markets

 

The global macro position will feed the performance of various investment classes in 2011. The strongest trends will be;

 

1. Rising commodity prices (cereals, oil, metals)

2. Emerging market outperformance (debt, equities)

3. Weakening of developed sovereign fixed income markets

4. Use of covered bond market by banks as source of liquidity

5. US equity market rally as the little guy returns

 

Investment Capital will be attracted to;

 

1. Emerging markets (all classes)

2. Commodities and commodity producers

3. Technology (hard, soft, web)

4. Real assets

 

These classes and markets can all be defined as representing real change. Real development of markets, real output of products and real development of tangible technologies.

 

This is in contrast to the largely superficial credit driven prism of development and change from 2002 to 2007. This therefore represents a desire from the market to acquire real assets or have exposure to real development.

 

2011 Winners

 

Equities Winners:

 

EM, Mining, Metals, Energy, Tech, Security, Telecoms

 

EM economies should continue to post 5%+ growth rates in 2011 and will be the major source of global growth. As a result, the stock markets of EM will do well as investors continue to buy into the growth as part of a re-weighting of western portfolios.

 

Mining, metals and energy stocks will do well broadly as a category on the basis of continued and rising demand from the BRIC countries as well as growing EM for the underlying commodities these produce. Of course, sector will see individual winners and losers – note continued recovery in BP shares.

 

 

Technology and telecoms will do well as categories because there is real innovation that is rewriting many of the old rules of IT. We used to talk of 'old' economy and 'new' economy companies. Now, I believe we can talk of 'old' and 'new' tech companies. Old tech companies would be Dell, Microsoft, Cisco, AT&T whilst new tech companies would be twitter, RIM, Facebook, Apple.

 

Needless to say, I believe new tech companies can be defined as those who specialise in wireless, device based technologies that offer users the ability to connect to social networking sites as well as communicate on the move.  

 

The old tech companies are those who offer users mainly fixed location (pc based) IT services from software to hardware.

 

New tech company equities will do well at the expense of old tech in 2011. For instance, in 2010, shares in HMV fell by 70% as they failed to adapt their business model quickly enough to online based services.

 

Commodity Winners:

 

Cereals (wheat, soy) oil (crude) and metals (gold, silver) Iron ore, copper, bronze

 

Cereals will further rise in price in 2011 driven by supply shocks as well as rising demand from developing Asia. Similarly, China, India and Brazil are very thirsty with their annual demand for crude oil incasing faster than the possible rate of production. This will see further pressure on oil prices to above $100 per barrel and probably between $100-120.

 

Gold and silver will continue to do well as investors continue to price the risk of inflation after the large monetary expansion of the last few years. QE2 has helped drive gold higher and it will be the safe haven off choice during any market shocks during the year. Whilst the market may worry that gold has had a good rally over the past 18 months, investors will be tempted to also invest in silver.

 

Iron ore is necessary for steel production which will also have a good year in 2011 as the US economy has a stronger year than in 2010. Also, continued demand from developing EM markets will feed demand for this, copper and bronze.

 

Fixed Income Winners:

 

EM, Covered Bonds, E-bonds

 

Whilst EM credit has performed exceptionally over the past 18 months as an asset class (EMBIG index) investor appetite for exposure to the developing world will continue to grow in 2011.

Portfolio managers will continue to increase their investment allocation towards this asset class. The average US pension fund (the US has about 80% of the world's investable capital) has about .5% invested in EM. The potential for increase is huge.

 

Covered bonds will have a fantastic year and beyond as it will be the instrument of choice to commercial and investment banks which will continue to rebuild their balance sheets and de-lever. The debt security is popular with investors because it offers a rated position against real bank balance sheet assets, including in bankruptcy. This is opposed to securitisation, which is typically 'off balance sheet' and does not offer investors recourse to issuing bank assets.

 

The launch of 'e-bonds' by the EU via the European stability fund and other newly created institutions will be popular with global investors, especially sovereign wealth fund from the ME and Asia. The bonds offer a 100-200 basis point (1%-2%) spread to German bunds (German government issued bonds) and are guaranteed by the EU.

 

Currency Winners:

 

RMB, RUB, Euro, JPY

 

Alternative Winners:

 

Commercial real estate, data services, telecom hardware

 

2011 Losers

 

Equities: Consumer goods, Banks, Durable goods

Fixed Income: Gilts (US, UK, Eurozone)

Currencies: USD, GBP

 

Lets see in December how I did! 

Have a great year!

Malcolm