GEM EQUITY STRATEGY: TAKING SOME PROFIT - JONATHAN GARNER
In the global emerging markets strategy team we recommend taking some profits following exhilarating performance by MSCI EM over the last five weeks. We are reducing our equities overweight by 2% — going from 6% over benchmark to 4% over benchmark. We are raising our recommended cash weighting back to a level of 4% (just below our neutral level of 5%).
We think MSCI EM is starting to look technically overbought: It has risen by 23% since mid-August and is at a new all-time high. It is trading at an unusual distance of 19% above its 200-day moving average.
The fact that consensus has moved so quickly towards our core bull thesis of EM decoupling worries us. EM valuations are starting to become a concern, although earnings growth expectations remain firm. The MSCI EM trailing P/E (18.5 times) is now 12% above is 15-year average and at a 10% premium to MSCI World. Trailing price/book has also reached 3.0 times — it has been higher only three other times in the past 15 years. But the earnings cycle in EM remains strong, and some forward-looking valuation metrics are still below previous peaks.
Finally, we are also concerned that China A and H share valuations are at previous peak levels. Given that MSCI China is now the largest market in the MSCI EM index, we think any sharp sell-off in Chinese equities could cause investors to question growth momentum of the asset class as a whole, especially as China’s growth underpins our thesis of strong decoupling and commodity prices. But there are good reasons to think any impact would be temporary. We remind investors that not all equity bull markets end in bubbles and not all bubbles end in recessions. China’s bull market has deep underpinnings. Impact on economic growth in China from a fall in share prices could be less pronounced than anticipated.
Our core long-term bull thesis tells us to remain overweight EM equities. We have made two changes in our focus list: Adding Lonmin (£36.49) and MMK ($15.15) and removing Corporacion GEO (M$47.81) and Samsung (W573,000).
US ECONOMICS: CAPEX RECESSION AHEAD? - RICHARD BERNER
Coming weakness in US capital spending, and thus at some US capital goods producers, likely will reflect slower growth and tighter financial conditions. Despite those headwinds, strong global demand and a weaker dollar will continue to support the top and bottom line for many high- and low-tech companies.
Discipline should pay off in 2009. US capital spending discipline has limited the growth in and sustained “pent-up” demand for US business investment in this expansion. The resulting lack of excess will limit the near-term downside risks and help avert a capex recession. And that discipline should pay off in 2009, when we expect the housing recession to end and the economy to re-accelerate.
Weakness in capital spending will intensify recession fears. But it may also revive the debate over US productivity, potential output, and inflation risks, making a sluggish US economy appear more stagflationary. That may be a recipe for a bearishly steeper yield curve and a challenge to risky assets. Nonetheless, these developments continue to favor outperformance at capital goods producers with high global exposure.
Even a mild capex downturn could knock half a percentage point off an already-weak US growth prognosis. Investors may also worry that capital discipline has swung too far towards corporate anorexia, making the domestic portion of US businesses less attractive than their global peers. Relative to our anemic baseline forecasts, however, strong gains in US exports create upside risks to the US outlook.
ASIA-PACIFIC EQUITY STRATEGY: IMPLICATIONS OF A MORE AGGRESSIVE FED - MALCOLM WOOD
An aggressive US Fed has five implications for Asia-Pacific equities: 1) liquidity conditions will become more positive; 2) the PBoC becomes key in containing regional overheating pressures — so far, it appears to be succeeding; 3) downside risks to US growth are more moderate, but we only foresee a U-shaped recovery; 4) Asia-Pacific currency appreciation is likely to accelerate; and 5) risk appetite is likely to rise. We conclude: Stay invested; stay domestic; focus on financials, property and consumer; and avoid exporters.
US liquidity fuel on Asian liquidity bonfire: The Fed is likely to become moderately accommodative. This will add to Asian liquidity conditions, which are already very positive.
The PBoC will be key to containing overheating pressures: Excluding food, inflation appears contained in China. Five rate rises and seven reserve requirement increases should help contain inflation expectations.
US growth – less downside risk, but U-shaped recovery: A pre-emptive Fed should reduce recession risks. But monetary policy is unlikely to induce a powerful recovery. We see a U-shaped US recovery.
Asian currency appreciation to accelerate: Cost of carry for Asian currencies should fall. Together with strong fundamentals, we see a stronger, 7–10% upside.
Rising global risk appetite: Risk appetite is only back to average levels. We see more upside.
