Salient to Investors:
Alexander Friedman at UBS says:
- What Fed has done is not unexpected and the market reacted because it was ahead of itself. All the Fed was saying was that the US is doing OK, that the data is trending as it should, and that it has confidence that in the future it will be able to unwind QE, which is a positive.
- Some investors were caught overleveraged in fixed income so there is unwinding of the carry trade. In countries like Australia, India and some emerging markets, a lot of investors hold bonds in local currencies which is a risk so expect significant volatility on the emerging market side.
- China less a risk than perceived because it is just trying to re-balance and is willing to sacrifice some short-term growth to get control over the credit situation and avoid bubbles.
- Biggest risk to investors is in misinterpreting the Fed, which creates a buying opportunity.
- Last week the market saw much of the repricing of the tapering risk and so we won’t see a repeat in September. Assuming we see the positive economic data for the next few months which is necessary for the Fed to begin tapering then the market will focus away from life support and more on underlying growth.
- Buy where underlying monetary policy will match the underlying requirement and where there is economic growth: meaning US equities, US high yield equities which are oversold and now offer 6 to 8 percent returns over the remainder of 2103.
- Wary of gold, which was an emotional trade against currency debasement and so has room to decline further.
- Wary of emerging markets, including Australia, neutral on Europe.
- Not yet seen bond money switching to equities as most of the money into equities has come from cash and money markets. We will see a shift from bonds to equities for many reasons, not least the immutable force of demographics such as the elderly selling fixed income savings over time and there is no yield in them.
- US high yields with equity characteristics are attractive.
- Expect tapering around December although market is pricing in September. When it happens, US economic data will be trending positively and rising rates will accelerate the housing recovery story as it will cause fence sitters to buy to avoid the mortgage rates increases. Tapering of $10 billion a month is priced into the market and do not expect to see rates rising until 2015.
- US financials and insurance companies are a bet that rising interest rates will help their profitability.
- The Russell 2000 stocks are more attractive because they have more cyclical exposure and exposure to the recovering US story as opposed to the global story where there is still sub-trend growth. With dividends and share buybacks, stocks offer a 4.5%- 5% yield in 2013 which is attractive.
- Long the dollar against many alternative currencies because of recovering economy and the Fed slowly winding down QE.
- Less optimistic about Eurozone, and short Australia.
- China rebalancing a good thing as banks have been lending too aggressively and China wants to avoid a credit bubble since shadow banking is such a huge proportion of their credit market. Clamping down on lending means it will be more expensive for companies to borrow so GDP will suffer a little bit. China growth could slow to as low as 7 % causing more volatility short-term but OK over the longer term. Less concerned about China, which has great foreign reserves and is less reliant on foreigners owning local bonds with risk of money exit, unlike Australia, South Africa and India
- The emerging market is a decent to good place to have a strategic allocation and you want exposure there for the longer term but short-term there is a lot of volatility. Most worried about countries who have financed deficits with foreign money so when that money leaves they end up in a scary spiral. Countries like South Africa, India, Brazil.
- Before the end of the year expect to see re-escalations of crises in the Eurozone for many reasons. The Eurozone periphery is like the emerging market with the same concerns including the unwinding of leveraged positions and volatility. After the German election we won’t see a path to true fiscal integration and banking union but instead a recognition that France is very weak, Germany won’t act alone, and that France and Germany are not acting together. Europe needs true labor reform in countries that are not competitive and that is very difficult
- France is a concern because it has poor underlying economics and Hollande is weak politically.
- Biggest concern is Spain, which is too big and quite vulnerable and will enter a program with the troika that will be put off politically until the last-minute after volatility spikes over the next 4 to 6 months.
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