12 Dec 2012

Macro Strategy Update

Ending The Year On A Positive Note

Our bullish stance has been validated with markets posting a V-shaped recovery since the mid-November sell-off. This occurred despite no progress on the fiscal cliff, which the media continues to belabour. We continue to point readers to what really matters - improving economic fundamentals and positive signals from the market. Our last update for 2012 remains positive and offers hope for the new year.

If investors were to focus solely rely on the outcome of the fiscal cliff negotiations to make investment decisions, it would be a roller coaster ride. There is no firm progress on how a deal will be reached as both sides continue to publicly defend their pet priorities - entitlements for the Democrats, and taxes for the Republicans. Yet, our view remains unchanged. It is to everyone's benefit that the current Congress does not allow the fiscal cliff to occur. The automatic spending cuts and tax increases enacted in 2011 was designed to get an agreement going. Hence we should not be surprised when we read of compromise, even on once non-negotiable issues1.

So instead of focusing on the fiscal cliff, we turn to the real economy. The bears may point to slowing US industrial production, which is beginning to slow (Figure1). However, this has been signaled by markets even before the deceleration started. Industrial stocks have been weak and underperforming since the beginning of 2012 (Figure 2). More important is that they have begun to outperform since October, signaling a recovery in US industrial production in the months ahead.

Figure 1: US industrial production index rolling over.

Image courtesy of Stockcharts.com

Figure 2: Industrial stocks performance relative to S&P500.

Retail sales, a key indicator of US consumption, remains healthy (Figure 3). Going into the holiday season, sales have been rising. Importantly, big ticket items have also been rising. Auto sales are up2 and so are sales of white goods3. An improving job and housing market are reasons why retailers are merrier this time round. Markets continue to signal an ongoing improvement in US consumer spending with consumer discretionary stocks rising both on a absolute and relative basis (Figure 4).

Figure 3: US retail sales

Image courtesy of Stockcharts.com

Figure 4: Consumer discretionary stocks outperforming

We also notice an ongoing improvement in the financial sector. Thanks to low interest rates, credit growth has increased (Figure 5). Banks have been making more loans as businesses and consumers spend more. Credit creation is a sign of business activity as it moves money from savers to borrowers who consume and invest.

Figure 5: US credit growth

It is also worth noting that globally, financials are outperforming (Figure 6). A healthy financial sector is crucial, as credit is the blood that flows through the economy. With the market signaling a better outlook for global financial stocks, the risk of a global recession is falling.

Image courtesy of Stockcharts.com

Figure 6: Global financials outperforming global equities since 2012.

In Europe and China, the positive signs continue to appear. Germany's ifo survey surprised on the upside, confounding expectations of a decline4. A sustained improvement will help douse fears that the recession in Europe will deepen. Fortunately, when we see how European equities have been performing, there is hope that stability is returning to the European economy, thanks to the ECB's plan to intervene in bond markets.

Image courtesy of Stockcharts.com

Figure 7: European equities rising

As for China, the latest data release confirms a recovery from a growth slowdown. Industrial output and retail sales growth accelerated while fixed asset investment showed no signs of slowing5. With inflation steady, there is scope for more stimulus given that exports growth remains tepid. Slowly but surely, Chinese equities, commodities and the Australian dollar are beginning to indicate a rebound in demand from China. Hence it does appear that the pieces are falling in place for global growth to rebound.

As mentioned in the last update, earnings continue to be the driver of stock prices. With global growth recovering, the odds are rising that fourth quarter earnings could be better than expected. We suspect CEOs of multinational companies will begin to sound less bearish, especially with China's improvement and Europe's stability. Admitedly they will warn on the fiscal cliff and its impact on future plans, but should a deal gets done in Washington and global demand continues to improve, we could see a surge in corporate investment in the first half of 2013. This would sustain economic activity and arrest the slowdown in earnings.


As we end the year, it is a fact that on a macro level, things are improving. While it is not clear skies ahead, we see signs that stability is returning to Europe, China's slowdown is ending and the US continues to confound skeptics. Markets continue to signal to us that the investment outlook is going to get better as we head into 2013. Our bullish view remains unchanged as we count down to the new year.

Portfolio Positions

No change.

1. Democrats Hint at Entitlement Program Cuts in U.S. Budget. 7 December 2012. Bloomberg News.
2. Auto sales race to five-year high for November. 3 December 2012. Fox Business.
3. Whirlpool CEO: Housing Rebound, Pent-Up Demand to Lift Sales. 7 December 2012. CNBC.
4. German business climate up as global outlook brightens. 23 November 2012. Deutsche Welle.
5. China's Factory Output Tops Forecasts as Rebound Picks Up. 9 December 2012. Bloomberg News.

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