Monday, July 05, 2010

Equity Strategy 2H 2010 & Asset Class Returns As At end-June 2010

Just passed the halfway mark. REITs finally took a hit, is this the beginning of the double dip. Do I believe in the double dip, yes of course. Only that the dip will be more restrained, not a significant or prolonged dip. Things move in cycles and like pendulums. Share prices are the same, they will sing to one side, over swing a bit and the correct. This is because the data are but collection of human behaviour, and masses will never react perfectly. They will chase a share price that is running until it overshoots, and attract sellers to come in. When the balance shifts to the other side, you will see it overshooting on the downside again.

June was another rough month for risky assets, although the losses were considerably deeper with U.S. stocks from a dollar-based return perspective. REITs also took a hit: for the first time since the opening months of 2009, real estate securities dropped by more than 5% for the second month running.

Bonds held up well in June. This is probably due to the threat of deflation taking a toll on investor sentiment, the safety of fixed-income (even at unusually low yields) attracted capital flows last month like moths to a flame.

US equity took the hardest hit in June. Was this an adjustment to the European crisis and the Euro crisis? Probably. Was it trying to discount a flattening of recovery, probably. Was it due to funds closing their books and squaring off positions and waiting for the right levels to reloan in 2H, absolutely.


But what we all should be focusing at is the YTD figures. Commodities are down by nearly 10% and foreign developed stocks have retreated by more than 13% in dollar terms—the steepest decline for the major asset classes on a year-to-date basis through June’s close. There has been some flight to reserve currency assets, but US equity did follow suit, much of its YTD losses came in the month of June alone.

So we are giving back all gains this year and more. Is this a risk aversion period? I think the sell in May rang true and it coincided with the Greek, Hungarian and Portuguese malaise, followed by the weakening Euro, which threatened demand for exports from the rest of the world.

China had to do a lot of braking in its domestic economy and the Shanghai index reflected that for the past 3 months. Now they have to contend with pressures to have a stronger yuan as well.

Some may cite the fact that many governments have piled on too much debt and that will come back to haunt us. Well yes, but not so soon. No one is going to put a gun to the US and ask them to lower their debts within the next couple of years. While the same seems to be happening in Europe, it is mainly a sovereign issue not a corporate issue.

We are actually still in the midst of a newly created liquidity bubble. Thanks to Bernanke and many of the other governments, we have printed and poured too much liquidity into the global financial system. We are also locked in with globally benign interest rates. Tell me what do the above ingredients make?

But why the recent pullback. Well, even when you are driving a Porsche, you are limited to how far and fast you can go if there is a traffic jam. Be sure, we have a highly powered underlying liquidity revving its engines. We just need the traffic to clear up a bit: Euro steadying a bit; unemployment growth flattening out but not down trending aggressively; corporates continuing to put out good quarterlies; etc.

I have changed my views on the Euro, I think it will stablise here 1.25-1.30 and not go any closer to 1.00 to the USD. Herein lies the key. The Euro crisis may have blighted our views too much. Look closer, most of Europe's top companies are benefiting strongly overall. We missed the picture that this is more a sovereign thing. Many of the companies are already getting an 18%-20% boost in receipts (added competitiveness) thanks to the weaker Euro - we all know that that is more than double the net margins of most companies.

European industrial production actually rose 0.8% in April much better than the average forecast of 0.5%. One of the better leading indicators of economic activity is cargo carriers, Fedex's recently reported that Europe is seeing solid activity, very much different from the picture the media would have us believe.

China may be the weak link in 2H. In addition to the yuan, the high interest rates, the yet to subside property bubble, we now have a snowballing labour issue. The Honda-Foxconn developments should ensure a cascading and rippling effect on all labour wage demands across China, watch it balloon in the coming weeks.

I think US equity and emerging markets equity will be quite positive for most of 2H2010. I see the Dow testing 11,500 and the FBMKLCI testing 1,450 before the year is over.

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