WEEKLY OUTLOOK (06/09 TO 10/09/2010)
Fundamental Highlights
Critical data releases almost solely surprised on the strong side, with the Chinese and US purchasing manager indices rising and the US labor market report clearly beating expectations. The FOMC Minutes sent a message of cautiousness on the recovery this year, but remained confident on recovery next year. The ECB’s press conference signaled no change in its stance. In line with market expectations, it revised up growth forecasts for 2010, (from 1.0% to 1.6%) and for 2011 (although more modestly: from 1.2% to 1.4%). It also raised the 2010 CPI forecasts from 1.5% to 1.6% and the 2011 from 1.6% to 1.7%, adding that risks to these forecasts were slightly tilted to the upside. On the liquidity front, the ECB decided to conduct its main refinancing operations (MROs) and the 3M LTRO as fixed-rate tender procedures with full allotment for as long as necessary, and at least until the end of this year’s twelfth maintenance period on 18 January 2011. The fixed rate in these special-term refinancing operations will be the same as the MRO rate prevailing at the time. The decision to extend the variable rate to the 3M LTRO indicates that the liquidity operations are progressively being scaled back, albeit at a very slow pace. This week, the data calendar will be rather light. In the eurozone, all the main releases will be in Germany, where we will get important indications on industrial activity at the beginning of 3Q. After a very strong June, we expect a moderate technical correction in July factory orders, while IP will probably post another solid gain. Importantly, in the EMU, the EcoFin meeting is scheduled for Tuesday, at which time the finance ministers should approve the second tranche of the EUR 110bn package to Greece. The tranche amounts to EUR 9bn, of which EUR 6.5bn will come from the euro zone, while EUR 2.5bn will come from the IMF. Having said this, sovereign bond yields in the euro zone still show ongoing strain (see chart).
Events/Stories
Equities: How is the underlying strength of the economy developing? This remains the key question going forward for the equity market outlook. Last week delivered diverse economic data. This week, only few data releases are scheduled. The current environment is characterized by strongly diverting opinions regarding the economic outlook and judgment of available promising policy options should measures to counter an economic downturn be necessary. The division can be seen among academic economists, within the governing council of central banks and among investors. Against this backdrop, surprising economic data can exert a higher impact on share prices as investors adjust their investment stance, hence creating volatility. This uncomfortable situation should continue for the time being. Our view is that, on balance, further economic headwind is still the most likely scenario. European political events will attract more attention from this week on as political activity moves into full swing after the summer break. One special point of interest will be the political developments in Italy regarding the stability of the government. During the EMU turmoil in 1H10, Italy acted as a zone of stability within instable southern Europe. Should the political landscape now become more complicated at a time when in all countries the 2011 budget needs to be approved by parliaments as well as reforms need to be implemented, then this could add to uncertainty that equity investors do not like. Read More...
FI: After 10Y Bunds reached a yield level of 2.087% on Tuesday, a substantial countertrend move emerged on the back of the positive data surprises and the ECB's press conference. With the cooling of 3D (double-dip/deflation) discussion, it finally closed the week at 2.361% for a swing of almost 30bp, a magnitude not seen since May. Naturally, periphery spreads have benefited from the improvement in market sentiment, recovering from the record-wide levels of last week. Given the almost empty data calendar this week, the current countertrend move should continue. However, we do not think that the easing in risk aversion observed last week will mark a long lasting change. The environment remains extremely challenging on both sides of the Atlantic: in the US, macroeconomic data are likely to keep showing a slowdown in the growth momentum, while in the EMU, the fragility of the financial sector, the uncertainty of the US growth prospects and divergences in growth performance between core and periphery remain a threat to the recovery.Read More...
FX: Last week again showed that the USD is only the number three safe-haven unit behind the CHF and JPY. Thus, EUR-USD is more exposed to positive data surprises (coming from both inside and outside the US), than EUR-JPY and EUR-CHF, while negative data, primarily from the US, have a weaker effect to the downside. As stock markets and their interaction with bond markets will determine FX markets, we expect swings both ways for the EUR-USD between 1.2930 and 1.2660. The sigh of relief in Tokyo about the return of investor risk appetite must have been enormous, as MoF/BoJ have so far refrained from physically intervening in FX markets. Indeed, we believe that if the global risk picture worsens again, triggered by weaker US data, JPY bulls will return more strongly to challenge the Japanese authorities. To avoid a credibility loss, MoF/BoJ will not be able to afford to stay on the sidelines forever, although unilateral interventions are unlikely as they have a long-lasting effect. Otherwise, USD-JPY could rapidly slump towards 80 within a few days, which could be accompanied by a EUR-JPY move to just above 101. EUR-CHF hit new all-time lows below 1.29 with the persisting inaction of the SNB. Further swings between risk aversion and risk appetite may allow EUR-CHF temporary relief, but any bounce should be viewed just as a new opportunity to return short. More silence from the SNB should come as no surprise, making a 1.27 target for EUR-CHF and a drop maybe even below parity for USD-CHF is feasible. Read More...
Credits: Investors had low expectations for last week's numbers and when these were not as bad as previously feared, markets rallied. Non-farm payrolls gave another boost and the erratic swings in spread movements triggered by macro data illustrate the high uncertainty regarding the direction of economic growth. As this week's data calendar is light, spreads should hover at the lower end of the established trading range (iTraxx Main: 95bp-120bp; Crossover: 450bp–600bp) as direction of spreads will remain set by the macro universe unless the picture becomes clear, and volatility should be elevated. Read More...
Emerging Markets/EEMEA: We expect the PLN and the CZK to remain relatively stable during the week, while we note that risk-reward is increasing on EUR/HUF shorts. On the RUB, we expect slight downside momentum for the ruble as, according to CBR data, Russian banks and companies have to redeem about USD 40bn by the end of the year. Credit: In the credit universe, we note that Hungary is cheap versus local rates and we would play the spread. In the local rates universe, we remain payers of 1Y RUB and 5Y HUF vs. receiving 2Y PLN. Political landscape: Politics is again center stage in some countries: in Romania, the government has started a major reshuffle in response to strong political pressure over the government’s unpopular austerity measures. So far, there are six ministers who will be released from their functions (economy, finance, labor, agriculture, communication, transport). Although the government reshuffling might bring increased uncertainty (higher CDS and weaker RON), we do not expect the measures to have a negative impact on the deficit (with the IMF on the ground). Although there is quite high pressure on the government both from the opposition and population (due to the implemented harsh austerity measures), a return to normality is likely for the upcoming period. In Turkey, on Sunday September 12, the referendum on the constitutional package will be held.
EM Equities: Sentiment took a substantial turn to the positive last week, on better US and Chinese economic data, particularly for the US labor market, and markets globally rallied strongly from mid-week. And though doubts certainly remain about the health of the US economy, investor attitudes seem to have shifted, making higher-beta investments more in demand. This is good news for Emerging Europe, which should benefit substantially if this new shift is sustained – particularly as it is being complements by new strength in oil and industrial commodities and by a drop in the VIX index and other risk spreads. There is some risk of profit-taking early in the week, however, given that many markets have seen bounces near 5% in just three days. But with a lighter flow of macro news in the week ahead, the positive underlying tone should limit the pull-back.
Commodities: This week will be rather calm for commodities. Major news for the commodities market is not expected before Friday, when the IEA publishes its monthly oil market report and China updates its economic data for August. We expect no major change in the IEA scenario for the oil market. Demand estimates should remain stable. The precious metal sector will continue to profit from the Fed decision to monetise US government debt. Read More...
3-6 MONTH TREND
Equities: The reward/risk trade-off for equity investments is deteriorating for cyclical reasons (i.e. short term negative effect of fiscal consolidation in Europe, doubts about the sustainability of the US recovery, slowing growth dynamic in China). For the Euro STOXX 50 a multi-month sideways movement is the best-case scenario. The general loss in growth momentum is shown by a broad set of economic indicators. A further weakening – especially in the US – might lead investors to focus on a new topic: What possibilities do governments and central banks have if the growth dynamic were to slow more strongly? Low key interest rates and high government deficits limit the scope for action. Faced with this dilemma, there is a distinct possibility that in the current cycle equity investors might react more cautiously with investments on signs of a slowdown – and also be more reluctant to increase the equity ratio on signs of a possible economic improvement. Read More...
Fixed Income/Government Bonds: With the ECB staying on hold until 4Q11 and double-dip recession & deflation fears the dominant topic, a U-turn towards a pronounced increase in yields is unlikely. EUR money market rates will most probably continue to creep higher, albeit at a slower pace, as the ECB extended its full allocation strategy into 1Q11. Given this bond-friendly environment, 10Y Bund yields are unlikely to show a severe increase until the end of the year. Read More...
FX: Fears that US economic growth may prove more sluggish than expected, while the eurozone may show a better performance, have clearly been behind the EUR-USD rally between July and early August, but its impact has already given way to resurfacing risk aversion and resuming EU sovereign debt fears. This may adversely affect the rebound above 1.28 and pave the way for a EUR-USD correction back towards 1.26-1.24. The worsening global scenario also boosted demand for safe-haven units and primarily the yen. With the 85 base already passed, USD-JPY may rapidly drop towards 80, if the feared BoJ intervention fails to materialize soon. In any case, the margin for a much weaker yen on a 12M horizon has clearly diminished. The Swiss franc has also been boosted by increased demand for safe-haven assets and renewed deficit worries across the eurozone. We confirm our 1.29-1.27 target for EUR-CHF and any possible stabilization that may occur next year - provided the global picture steadies - is unlikely to exceed the 1.33-1.35 area. Cable may still suffer from the worsening global picture and a potentially more dovish BoE on the monetary front and a drop below 1.52-1.50 has become a feasible scenario if risk aversion persists. Read More...
Credits: A double-dip recession is not our base-case scenario; we rather expect the discussion about it to flare up and die down from time to time as the structural problems are being tackled. Hence, credit spreads should remain range-bound within the limits set after the sovereign debt crisis emerged. As we are nearing the 100bp threshold last broken in the first days of August, valuations appear stretched given expected volatility and resurfacing macro concerns. The current series of upside surprises won't continue forever as previous - albeit now pushed aside - economic indicators painted a high risk picture for the crucial US housing market, and part of the rundown in spreads is driven by yield hunting, which amplifies spread movements. In addition, there are few catalysts for tighter spreads, as the moderation in the recovery limits further earnings improvement through growth. It rather entails the risk of re-leveraging to boost EPS to satisfy equity investors. Read More...
Emerging Markets/EEMEA: On a longer-term perspective, prospects of new quantitative easing in the US might prove supportive for EM currencies, but the key question remains how sustainable the rally is and whether local central banks will tolerate such an appreciation. Meanwhile, we look for some economic slowdown across the region, which will likely put a halt to hawkish speculation. Overall, we maintain our neutral currency outlook (big current account improvement vs. competitiveness worries at central banks), while we continue to favor the short to mid-term section of several local currency bond markets. As G3 yields reached new lows, we believe that this will continue to create a relatively favorable trading environment for local currency bonds
EM Equities: EME equities participated in the cathartic global bounce in recent equity trading, on signs of some easing in the poor US data in the housing and labor markets. We recently noted that an autumn rally would rest on three fundamental pillars: (1) Signs of some easing in US housing and jobs markets – data are now in the right direction, tentatively; (2) Sustained strength in the Chinese economy – data also support this view; and (3) Momentum in the German recovery staying strong – also supported by recent data. This is the pro-cyclical foundation. We do have to recognize the threat from fiscal cutbacks, however, so the next few weeks will be important in gauging how well the consumer is holding up as further fiscal austerity takes hold. Overall, we continue to see Emerging European markets as moderately attractive on a medium-term perspective, and believe they can outperform on a 3-6 month perspective. On market dips we would be buyers, adding to the better-quality pro-cyclical names, including Materials stocks and leveraged but otherwise sound companies. In addition, a better macro trend tilts the risks to consensus EPS estimates slightly to the positive side. Within EME, we continue to believe that moderate OW positions in Russia and Kazakhstan are justified on a 3-6 month view, and we fund this with modest UW positions in CE-3. Russia’s valuation is attractive vs. GEM at near 8x 2010E P/E. In terms of sectors, we stay Neutral in Financials and OW in (Russian) Utilities, staying modestly UW parts of the Energy sector. We remain OW Materials (Russian/CIS mining and fertilizer stocks). We would selectively add Industrial and Consumer Discretionary stocks (OW). Read More...
Commodities: The International Energy Agency forecasts global oil demand to grow by 1.3 mnb/d in 2011 to a new record level of 87.9 mb/d. 2011 non-OPEC supply is forecast to grow to 52.9 mb/d, but most will be the rather expensive alternatives like biofuel, oil from tar sands and natural gas liquids. However, the upward potential is limited due to OPEC's high spare capacity of 5.9 mb/d. On the other hand, if decline rates in mature fields accelerate and OPEC hesitates to increase oil production in the second half of the year, we expect the supply-demand balance for crude oil to considerably tighten in 2011. We expect the oil price to move sideways for the next 3-6 months around USD 75 per barrel. Falling ore grades will keep the copper market in supply deficit in 2010 and 2011 despite slightly lower demand. We expect a gold price of USD 1,350 per troy ounce towards the end of the year. Investor demand is high due to fears of a possible sovereign default and inflation fears. Asian customers have obviously gotten used to the high gold price, with jewelry demand increasing. Mine supply is weak due to falling ore grades. Read More...
