Schroders Says Buy European Equities

he European economy will continue to be sluggish in 2015 leading to the potential for political unrest, said the experts at Schroders, the giant British asset manager. However, European equities should do well in spite of this.

Meanwhile, Japan should see benefits from a weaker yen, but this will hurt other Asian economies.

The 200-year old firm, which manages $448 billion in 27 countries, presented its market view to the press last week in London.

Keith Wade, Schroder’s chief economist, said falling commodity prices will drive inflation lower, and the declining euro will stop deflationary pressure in the euro zone.

Wade is bearish on the Chinese economy, but he doesn’t expect a hard landing. Meanwhile, emerging markets continue to struggle because of the Chinese slowdown.

“A lot of headwinds are being lifted in Europe and that should help growth,” said European economist Azad Zangana, pointing to the weaker euro. Still, he remains cautious.

Rory Bateman, head of European and U.K. equities, agreed Europe’s economy will be sluggish, but that equities will do well. A weaker euro should help corporations deliver earnings growth between 3% and 5%. Falling oil prices will also help earnings. Bateman expects European financials to post double-digit earnings growth.

Still, with high unemployment across the continent, there is high potential for political unrest. Zangana doesn’t expect major upheavals, but still enough to worry investors.

Bob Jolly, head of global macro, said the high unemployment is increasing the popularity of extreme political parties, with potential flashpoints in Spain, Ireland, Germany and Greece.

Steven Cordell, who manages European equity funds, blamed the European recession Ukraine and Russia. He expects a slow protracted recovery. The German economy is suffering from sanctions against Russian companies and the downturn in China, two major export partners. Cordell agreed that the European banking system is now healthy. He said banks can access cheap capital at a 0.05% marginal lending rate from the European Central Bank.

While the credit market reflects the banks’ improved fundamentals, equities don’t. Cordell said 61% of European companies have better dividend yields than bond yields. This tells him the problem is in bond valuations, not equities. He said it’s a good time to buy European stocks because dividends are at their peak yield in excess of bond yields.

Exporting Inflation

As for Asia, emerging markets economist Craig Botham said while Japan’s policy of devaluing the yen makes Japan’s exports cheaper, Japan is exporting inflation to other parts of the region, like South Korea and China. Botham added that Asia is one of the best-placed regions to benefit from a U.S. recovery, when U.S. consumers buy more electronics and consumer durables.

James Gautrey, portfolio manager for global equities, said that by the end of next year the number of people accessing the Internet from mobile devices in India and China will exceed 1 billion. The way to make money is buy telecoms in India and Internet companies in China.

“I think Alibaba is very underrecognized,” said Gautrey. “Its take rate is 2.3% compared with the 12% done by Amazon.”

Originally published in Investor’s Business Daily.

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Roubini Says Commodity Super Cycle “Is Over,” but Optimistic on U.S.

For a man nicknamed “Dr. Doom,” economist Nouriel Roubini sounded almost giddy during a recent speech in which he said the reduced possibility of a euro zone breakup has lowered the risk in the global economy.

While the global economy is anemic and still fragile, he said over the next three years growth in the U.S. will be faster than Europe, Japan and China because “the fundamentals of the U.S. are much better in all technologies of the future.”

Roubini, a professor of economics at New York University’s Stern School of Business, received the Dr. Doom moniker after he accurately predicted the 2007 bust in the housing market and the ensuing fiscal crisis in 2008.

But as he stood before a crowd of more than 100 at last month’s Inside Commodities conference, the chairman of Roubini Global Economics said while the U.S. economy remains weak, especially the housing sector, it will get stronger, albeit slowly. Nor does he expect a crash in the bond market.

“How can we create inflation without wage inflation?” he asked the crowd.

He expects the Federal Reserve Bank to begin tapering its policy of quantitative easing and begin raising interest rates by early 2014, which will lead to a gradual strengthening of the dollar. Quantitative easing, or QE3, is the name given to the Fed’s $85 billion-a-month bond-buying program now in its third round. Roubini said by the end of 2017 U.S. interest rates will be as high as 4%.

Yet for the audience of commodity investors, Roubini’s comments were decidedly bad news. He said high interest rates and the stronger dollar will have an inverse relationship to commodity prices.

“The party as we know it is over. The commodity super cycle is over,” said Roubini. “When the dollar gets stronger, everything else being equal, commodity prices begin to fall.” In addition, a slow down in China’s growth will reduce demand for commodities.

The economist said energy prices will gradually lower over time, with oil hitting $90 a barrel, and precious metals will fall too. He predicted the price of gold could fall to $1,000 an ounce by 2015. Rising interest rates and lowered global risk are big reasons for the drop in gold. He also thinks European countries may sell some of their gold stocks to reduce their public debt.

Even though the risk of the European Union splitting has declines, he pointed out that many of fundamental problems there are not resolved. Some countries remain in economic crisis, potential growth is low and the recovery will be “extremely anemic,” between 0% and 1%, which is lethal for the unemployed.

He said the loss of competitiveness in the Euro zone hasn’t been resolved and a fiscal drag remains. The recovery in the Euro zone “will be fragile and always be behind the curve.”

Another big unknown is whether China will have a soft or hard landing. Roubini said China’s growth is unsustainable and its leaders know it. He said the bubble from too much development, housing and investment will fall, along with consumption, and that will bring down growth. He said China’s growth rate at the end of this year will be 7%, sliding to 6% next year and less than 6% in 2015. While not a true hard landing, it will be worse than people expect.

The slowdown in China will cause a drop in demand for commodities which will hurt many emerging market economies. Countries with weakening fundamentals include Indonesia, India, Hungary and Ukraine.

While the prices for all commodities won’t fall for the same reasons, he says geopolitical factors, such as the lowering of tensions with Syria and Iran as reasons for the price of oil to fall. In addition, the balance of supply and demand, will be evened out and prices will decline with new discoveries of oil, as well as the rise of other forms of energy, such as shale. In addition, “the green economy will raise new energy and reduce demand for old energy.”

He recommended that investors be underweight in bonds and overweight in U.S. equities as the economic recovery become more robust and moves into cyclical stocks. He also believes Japan’s economy will succeed under Prime Minister Abe. He said investors should be overweight in advanced economies compared to emerging markets, and that the U.S. and Japan will do better than Europe and United Kingdom.

ING Likes Value Stocks, Emerging Markets and Europe in 2013

Just like the Christmas season, forecast season rolls around this time of year with investment advisors predicting what the new year holds and where we should all be putting our investment dollars. Ahead of us looms the fiscal cliff, a combination of tax increases and large government spending cuts that could chop as much as 4% out of the gross domestic product. Should the fiscal cliff go into effect it could put the current tepid economic recovery into jeopardy.

In a press briefing at ING’s offices Tuesday, Paul Zemsky, ING Investment Management’s chief investment officer of multi-asset strategies, said he expects the fiscal cliff to be resolved by the end of this year, with a negative impact of just 1% to 1.5% to GDP. He expects to see an end to the payroll tax holiday and the Bush tax cuts for the highest-income brackets. He also expects capital gains taxes to rise to 20% and dividend taxes to revert back to taxpayers’ regular rate from 15% now. Should the Congress wait until after the new year, Zemsky expects to see a major sell off in the equity markets. “It could be as much as a 10% drop, but we would expect this to be a V-shape bounce because the government would have to fix the problem. We would consider this a buying opportunity should it happen.”

Stocks remain cheap relative to bonds, said Zemsky, and both U.S. and global equities are attractive investments right now with price-to-earnings ratios around 15. Zemsky said the housing market has bottomed and is poised to rise, however investors have not yet realized this. As housing prices bottom, this makes collateral stronger, said Zemsky, adding now is the time to increase investments in U.S. financial stocks.

Overall, ING expects 2013 will bring modest growth in the U.S., continued growth in emerging markets and the end of the European recession. Zemsky’s overall forecast predicts U.S. GDP to see 2% to 3% growth next year, which will lead to 5% to 7% earnings growth in the S&P 500. He expects the S&P 500 to grow 8% to 10% next year with a year-end target price between 1550 and 1600. U.S. value stocks and emerging market equities look especially attractive in 2013.

The most popular ETFs tracking these areas of the market are the SPDR S&P 500 (SPY), the Financial Select Sector SPDR (XLF) and the Vanguard MSCI Emerging Markets ETF (VWO). Click here for a list of ETFs that track U.S. value stocks.

Zemsky added that it might be time to begin overweighting European equities. He said people are too negative on Europe. While there is still risk in there, he said the Euro Zone is beginning to stabilize and this could lead to higher equity prices. Click here for a list of ETFs that track European stocks.

As for the bond market, Christine Hurtsellers, ING’s chief investment officer of fixed income and proprietary investments, said the U.S. market is not pricing in any changes in policy from the U.S. Federal Reserve Bank. She says it’s time to underweight U.S. Treasury bonds and high quality investment grade U.S. credit. She recommends moving into emerging market debt, especially high-grade sovereign debt. The PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) covers this market.

Fund Manager Sees Little to Fear from Greece and China

I spoke with Christopher Baggini , the senior portfolio manager for the long/short Turner Titan Fund yesterday. He sees the U.S. market moving higher and likes the technology, industrial and health care sectors. However, he’s down on utilities, telecom and basic materials.

As for his view on the macro environment, he says last year’s fears that China will soon be experiencing a hard landing have diminished. He says the sales comparisons for Chinese New Year are up 15% year over year.

While the problems in Europe are already dragging down the U.S. economy, he thinks there is a low probability that a full-fledged Greek default will affect the market. Most of that is already priced into the market and he says that “Greece’s impact is minor to the overall scheme.”

Italy is a bigger problem, says Baggini, but so far it’s not an issue and neither are France or Germany. While Spain has been an issue for a long time, with little money and a high cost of labor, he doesn’t expect it to have an impact in the near term.

Reuters: Germany, U.K. ETFs Best Way to Play Europe

With the recent agreement to save the Eurozone, European leaders seem to be ignoring one of the major problems, which is that Europe’s “economies are growing too slowly,” says Reuters.

The strict budget guidelines outlined in the agreement may actually exacerbate this problem Add cost-cutting austerity measures and huge debt burdens to slow growth and the recession that’s already engulfing Spain, Portugal and Greece will soon move into France and Germany over the next six months, according to Standard & Poor’s.

The United Kingdom also offers opportunities because it doesn’t use the euro, but rather the pound sterling. Because the UK has control over its currency, it can take measures to offset the slowing growth. The iShares MSCI United Kingdom Index Fund (EWU) holds 106 stocks, and provides a decent proxy for the British stock benchmark, the FTSE 100, which is currently not tracked by a U.S. ETF.

Because of recession fears and as a proxy for their European-wide market viewpoints, investors have been selling German stocks. The sell-off has left the German market trading at nine times forward earnings vs. the S&P 500’s forward multiple of about 12. Reuters says a good way to play the European crisis is to buy German stocks because of low valutions and because any drop-off in German exports to Europe may be picked up by the U.S. and China. I doubt the U.S. and China can make up for Europe’s weakness. But a good way to play it is to buy the iShares MSCI Germany Index Fund (EWG), which holds Germany’s 50 largest companies. It’s down 17% this year and yields 3.3%.

If you believe the euro will continue to fall as the debt crisis continues, Reuters says pick up the PowerShares DB US Dollar Index Bullish (UUP). By tracking the performance of the dollar against the euro and five other currencies it provides a hedge to U.S. investors holding European stocks.

CNBC Says It Might Be Time for Index Funds

With just one in four fund managers beating their benchmarks this year, CNBC.com says it might be time for investors to ditch actively-managed mutual funds and just buy index funds. While CNBC didn’t say buy ETFs, anyone worth their salt knows the cheapest, most tax-efficient, most flexible index funds come in the form of ETFs.

CNBC.com reports that “only 23% of large-cap managers beat the S&P 500 and 27% outdid the Russell 1000, according to Bank of America Merrill Lynch.” While the fund managers interviewed for the piece make it seem like this was an unusual year, the actual numbers aren’t that shocking. Scads of research show that the indexes annually beat 70% to 80% of all active funds.

Since 2008, many investors have been wondering what they are getting for the high fees they pay to active mutual fund managers, especially in a down market. While it may be difficult to beat the index on the upside, if active managers can’t protect your assets on the downside, what’s the point of going active?

And it doesn’t look like things are getting better anytime soon. Philippe Gijsels, the head of research at BNP Paribas Fortis, thinks that not only won’t we see a Santa Claus rally, but in fact, the September/October rally was just a respite from an end-of-year decline and long-term move to the downside. Gijsels says the longer the European Central Bank fails to find a solution the worse it will get for the equity markets here and abroad. If this French banker doesn’t believe a solution is near, it’s time to worry.

In another corner of Bank of America Merrill Lynch, technical research analyst Mary Ann Bartels says the sell-off will continue and may not hit a bottom until the first quarter of 2012. She predicts the S&P 500 could test the October low of 1074, a 14% drop from today’s close of 1244.

Europe Must Act Now to Avoid a Default, Buiter Says

Willem Buiter, chief economist at Citigroup Inc., discusses Europe’s sovereign-debt crisis, the exposure of banks to the region and the role of the European Central Bank in resolution of the crisis. He speaks with Tom Keene on Bloomberg Television’s

Buiter says what everyone inherently knows, but can’t say outloud, that “time is running out… I think we have maybe a few months — it could be weeks, it could be days — before there is a material risk of a fundamentally unnecessary default by a country like Spain or Italy which would be a financial catastrophe dragging the European banking system and North America with it. So they have to act now.”

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The Real Issue Behind The Euro Crisis

The European Central Bank’s unbending stance now threatens the survival of the euro and the broader integration of Europe itself, say European politicians and analysts. Forgetting for a minute whether the ECB has the will to intervene and print money like the U.S. Federal Reserve, the big question is whether it has the legal authority. According to its charter, the ECB’s role is to maintain price stability and maintain the euro’s value by preventing inflation. It is “specifically prohibited form financing the governments of euro area members,” says the New York Times. Still, because it can print money, its ability to buy the bonds of member nations is theoretically unlimited.

While becoming the lender of last resort would be against European law, many believe the ECB won’t let the euro collapse to defend that principle. Many European, and U.S., leaders says the ECB is the only institution that can prevent the collapse of the European economy and with it the common currency. But the Wall Street Journal says by transcending its mandate it would assume as new role as the most potent institution in Europe. The WSJ then gives a nice summary of how the ECB got into this predicatment.

 

 

ING Offers Positive Outlook for 2012

Europe, Shmeurope. If you looking for good news, ING has it.

“Don’t listen to noise coming out of Europe,” said Douglas Cote, chief market strategist of ING, at a press conference Wednesday where the firm offered its outlook for the new year. “The [European Central Bank] will be forced to jump in. I expect an end-of-year rally.”

Paul Zemsky, ING’s chief investment officer of Multi Asset Strategies, says while Europe may suffer a mild recession in 2012, the U.S. will experience tepid growth between 2% and 2.5% With housing weak and the Federal Reserve not raising interest rates until 2013, he says inflation won’t be a problem, staying around 2%. However, he says this growth won’t be enough to bring down the unemployment and if per-capital income remains stagnant, this could cause some social unrest. And while the housing sector has bottomed out, he says it may take another year before the market begins to see a sustained recovery. The main risk to the U.S. economy is the contagion of a European slowdown.

Still companies continue to post record profits, keeping expenses low by not hiring new workers. Zemsky expects the S&P 500 to surge 9% by the year’s end to 1325, and again to 1450 by the end of 2012. “Unless,” he adds, “ Europe blows up.”

You can track the benchmark with the largest ETF in the world, the SPDR S&P 500 (SPY).

“How can you not be in the market with earnings hitting record highs?” asked Cotes, suggesting market fundamentals will continue to be strong in the face of rising global risk. In addition to rising corporate profits, he sees U.S. manufacturing expanding and retail sales at their highest levels after seven consecutive monthly increases. “As far as eye can see we see positive quarters.”

Mid-capitalization stocks are the “sweet spot of the economy,” he says, because they have the financial wherewithal of large-caps and the growth of small-caps.” He also like emerging market stocks and global real estate investment trusts.

For mid-cap stocks take a look at SPDR S&P MidCap 400 ETF (MDY).

As for those global risks, Cote says Europe’s “bank recapitalization plan is an effective fence around the crisis.” In addition, if China begins to experience a slowdown, South Korea and Turkey will pick up the slack.

Really?

The Institute of International Finance said the recapitalization plan has “serious problems” that will hurt economic growth.

Meanwhile, China is one of South Korea’s major trading partners. If China stops buying South Korea is going to have to find a lot of other clients just to break even.

Christine Hurt sellers, ING’s fixed income chief, continued the trend of discounting Europe, “there are a lot of good opportunities, unless you think there will be a massive global recession.” U.S. companies are well prepared for any credit crunch because they have nearly $1.5 trillion in cash on their balance sheets.

She likes high-yield bonds, because spreads are wide, but not consumer cyclicals. She also recommends buying sovereign debt in emerging markets. With emerging markets seeing inflation declining and credit quality increasing people should “take advantage of the shift in liquidity out of Europe.”

She expects the ECB to come save the euro zone, but if you wait until the ECB acts, it will be too late. Because there is very little liquidity in the credit markets, she says you need to buy bonds you are willing to hold for a long time.

I wasn’t very satisfied with their optimistic answers about Europe’s problems. Even though the ECB is the chief monetary authority for counties that use the euro, European Union treaties forbid it from being the lender of last resort for member countries. And as Roubini said last week, that’s not going to change.

Hurtsellers said Italy’s high bond yields are worrisome and if Italy doesn’t get enough tie to restructure, the whole thing could balloon out of control. If that happens, “market’s can create their own chaos and we’ll see more pressure on Germany.”

Zemsky added that while the ECB has remained out of the picture in terms of directly financing governments, if the European banking system seizes up, the ECB would supply quantitative easing. Why did he think that? “Because in 2008, the Fed stepped in to where we never would have expected it before, but they did it to save the world.” True, but the Fed had the power to do that and the ECB doesn’t.

“The ECB will stand behind a bank if they have enough collateral. If that doesn’t happen,” said Zemsky, “that’s the worst case scenario and will lead to a much worse recession of possibly negative 4% gdp growth in Europe.”

That should put our minds to ease.

It’s Not the Heat; It’s the Liquidity

It’s not the heat, it’s the liquidity, says Nouriel Roubini on why Italy’s days in the eurozone are numbered.

Even as stocks and Italian bonds posted a recovery after Wednesday’s surge in Italian yields, Roubini, better known as Dr. Doom, said in the Financial Times, the only way to avert “the upcoming disaster is “if the ECB became an unlimited lender of last resort and cut policy rates to zero”, combined with the euro’s value falling to even with the dollar, “fiscal stimulus in Germany” and the deflation in the eurozone’s. Since the ECB can’t do that without rewriting the eurozone treaties, it doesn’t really matter that the other four are basically impossible as well. More to the point, even if Italy isn’t insolvent, the lack of liquidity in its system could be just as fatal.

Meanwhile, an extremely cute economist named Megan Greene agrees with Roubini. Greene has been waiting for the eurozone to go “into full meltdown mode” for months. She says “the only possible way Italy could regain market confidence at this point is if it swiftly implemented a package of austerity and structural reforms under a government with cross-party consensus and a strong, respectable leader, and this package immediately yielded results. This is nearly impossible.” Of course, being cute has nothing to do with it. She writes a blog called Euro area debt crisis. I’m going to assume that if your blog title is that specific, you’ve got a pretty good read on the situation. My favorite tab on the blog is “Beyond the Pigs.” It lends itself to so many interpretations.

Roubini says Italy, and the next bailout in line, Spain, are “too-big-to-fail but also too-big-to-save,” and will need a restructuring of 1.9 trillion euros of public debt. However, the European financial stability facility has already committed half of its resources to Greece, Ireland and Portugal, leaving just 200 billion euros for Italy and Spain. Efforts to leverage that 200 billion euros to 2 trillion, “is a turkey that will not fly, because the original EFSF was already a giant collateralized debt obligation, where a bunch of dodgy, sub-triple-A sovereigns try to achieve, by miracle, a triple-A rating via bilateral guarantees.” He calls it another “a giant sub-prime CDO scam.”

Still Wall Street isn’t going down easy. After Italy passed an austerity measure, the S&P 500 jumped 2% to 1264 and the Dow Jones Industrial Average climbed 2.2% to 12158. The yield on Italy’s benchmark bonds fell to 5.69%.

The rebound was so strong that some of the ETFs that tumbled on Wednesday are now trading above Tuesday’s close. These include the PowerShares DB Italian Treasury Bond Futures ETN (ITLY) up 3% to $18.25 and the PowerShares DB 3x Italian Treasury Bond Futures ETN (ITLT) up 10% to $14.29. These ETNs measure the performance of a long position in Euro-BTP futures, whose underlying assets are Italian government debt with an original term of no longer than 16 years. The ITLT ETN provides leveraged exposure three times greater than the unleveraged bonds.

Meanwhile, while not above the Nov. 8, close, these still made a nice recovery. The iShares MSCI Italy Index Fund (EWI), which tracks about 85% of the Italian equity market, gained 4% to $13.24 and the CurrencyShares Euro Trust (FXE), which offers U.S. investors a way to bet on the euro without trading on the foreign exchange markets, climbed back to $137.