27 February 2015

Macro Strategy Update

Clear Sky, Clear Mind

Executive Summary: The start of the year was bumpy but we were prepared to ride through it. Our risk matrix showed slight stress but was not enough to trigger us to reduce risky positions. The world continues to grow and should benefit from stabilization in Europe and Asia. The skies ahead are relatively clear, let’s cut through the noise, remain committed and make investment decisions which count.


January 2015 was a rather interesting month. Deflation fears, Eurozone (Greek) drama, ECB QE, tragic terrorist activity, $20 Oil forecasts, shock central bank policy, high yield bond sell-off made for some rather jumpy markets. Despite all that was happening, we were confident that we would sail through as we had our eye on our fundamental models and risk indicators which showed that although some stress was building, it had not triggered any red flags. With this clear-mindedness, we can avoid being swayed by headlines and stick to the task at hand.

Global Economics.
Latest PMI data shows that the world continues to grow and remain broad based with over 60% of countries reporting numbers in the expansionary zone (Fig 1). The recent data is also above the long term average and should result in better growth numbers than 2014.

Fig 1: Global Growth Will Likely Trend in the Modestly Expansionary Range

Of note, Europe looks much better after suffering from weak data points over the past few months. Flash estimates for Feb continue to show that the Eurozone is stabilising with service data recording strong uptrends (Fig 2). Business confidence has returned and despite the sabre rattling in Athens, investors have not reacted to this latest crisis with the same alarm like in 2011.

Fig 2: Eurozone PMI Data Stabilising and on an Uptrend

Emerging Asia also appears very promising, helped by low commodity prices and accommodative monetary policies. Asian countries’ fiscal balances are in much better shape compared to a few years ago, so the impending Fed tightening should impact currencies and bonds less than in 2013 (Fig 3). Companies will benefit from rising return on equity and positive re-rating and we expect the markets to reward them.

Fig 3: Asian Fiscal Stability in the Form of Current Account Surpluses

We have been positive on the US for some time. With data points at post-recessionary highs, it is no surprise that recent reports, especially corporate earnings, have been more subdued. With the US stock market valuations above long term averages, we should not be surprised if there are pullbacks this year. Despite this, we still expect the US to eke out a decent high single digit gain helped by fund flows, strong trends and continued scepticism that the market can continue rising (Fig 4). We would be wary if there is excessive optimism about the US, which we currently do not see just yet.

Fig 4: Recent BofA ML Fund Manager Survey Showing Reduced Positioning in US Market – Implying Continued Sceptism of Market Performance

We anticipated that recent spikes in US consumer confidence coupled with cheap oil would result in a discretionary spending boost. However we haven’t seen it flow through to retail sales just yet. We continue to remain optimistic that this will eventually happen as the environment is primed for it to take off, as there has been a significant improvement in real wage growth and employment data (Fig 5).

Fig 5: Wage Growth Has Been Picking Up, in Tandem with Companies Planning to Raise Wages

In the beginning of the year, we turned positive on Europe and remain so; equity risk premiums relative to bonds remain attractive, the weak Euro would boost corporate earnings, and asset reflation from the ECB’s QE program makes risk assets attractive. What we view most positively is the recent uptick in demand for loans in the Eurozone. Borrowing from corporates and households is the precursor to economic recovery and there are growing expectations that Europe could surprise in 2015 (Fig 6).

Fig 6: Latest ECB Bank Lending Survey Paints a More Upbeat Picture on Europe

Over the past few weeks, local media, brokerages and even a well-known investment bank published feng shui related investing advice. A short summary is shown in the table below (Fig 7). Following it would likely be bad; both for your mental health and performance. We prefer to stick to the fundamentals.

Fig 7: Follow Astrology at Your Own Peril; Stick to Fundamentals!

Looking at long run valuation averages, Asian markets still trade below their mean (Fig 8). We feel that the market is discounting the potential of Asia, after suffering in a sideways trending market for the past 5 years. Couple this to the consumption boost from lower import and commodity prices, steady growth, and stable governments, the environment is ripe for Asia to outperform once again.

Fig 8: Valuation of Asia is Still Below Average and Deserves a Positive Re-Rating

Our risk matrix highlights reduced risk in the market despite all that has been happening in the world recently. Global data still shows growth in the majority of the world, and it has been helped by the stabilisation of Europe. The US continues to be a bright spot, and Asia is also expected to do well this year. We see relatively clear skies ahead and should continue to stay invested if we are in it for the long run.

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