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Why I see positive growth surprises in 2013

My Outlook for 2013 is more positive than consensus: 

Many of us are very concerned about multiple risks, but remember …

a) We are still in the phase of aggressive monetary policy directly buying up assets

b) Substantial improvement has been achieved in some macroeconomic & policy areas even in Europe .. barely noticed.

Example: the sum of all global current account imbalances has corrected from almost 6% of GDP in 2007 to 3.9% in 2012.

Here my main deviations from Consensus in bullet points:
  1. Expect positive surprises to growth in 2013 – OECD, IMF and World Bank are guiding lower
  2. Expectations of Euro-Crisis or Breakdown: overdone in 2012, still overdone in 2013
  3. Fiscal overkill in OECD countries to ease in 2013 .. public discontent is rising
  4. Shift from bonds to equities likely as systemic concerns weighting on investors should barely materialize in 1H-2013. Key bond segments are overpriced
  5. Decline in cross-correlation among assets opens opportunity for active stock picking
    More long-term…
  6. A dysfunctional market economy with more government intervention and policy action: few investors have adjusted their investment process to cope with it. It’s not too late.

1) Expect positive surprises to growth in 2013

Over the past several weeks the IMF, World Bank and the OECD have all warned again of persistent risks and lowered their forecasts for global growth in 2013. The average estimate for 2013 of these three leading global agencies is approx. +3%. I disagree and think it is likely we’ll have clear positive surprises to growth.

+ China should lead the world with aggressive spending to boost urbanization and domestic consumption; it is likely to aggressively increase its budget deficit to achieve this. Expect China growth to confidently reach 8-9%.

+ Japan may stage a strong growth “boost. The bold policy to weaken the Yen with simultaneous fiscal spending entails risks, but should deliver both a monetary and fiscal shock to Japan. I believe this will fail to de-link the economy from a shrinking labor pool longterm, but it could substantially boost profits in 2013 and give G7 growth a growth boost.
+ India may deliver more benign but nevertheless positive contribution to growth. Deregulation and a pre-election boost to consumer spending should help the economy shift up gear in 2013.

+ USA and Europe should also deliver modest but positive surprises to global growth! Fiscal policy will be -simply put- less of drag on growth. => All in all, a more synchronized growth expansion is at hand, major currency shifts in 1H unlikely, except for the Yen, which I see still as the most vulnerable major currency (not the Euro!). Yes/USD to hit 120 before 2015.

2) Expectations of Euro-Crisis or Breakdown: overdone in 2012, still overdone in 2013

Although I opposed vehemently the launching of the “Euro”, I do not doubt it will survive. I always thought the Euro-introduction was premature, but there are many reasons why Europe will keep the Euro or some kind of unified currency. The continuing Euro crises are a “political process” in part to weaken dysfunctional national governments; and it’s bearing fruit for Brussels & Frankfurt: National governments have begun to hand over sovereign powers. 2013 may see more steps towards a unified fiscal policy. This will strengthen the Euro. The deterioration of Europe’s position in the global geopolitical landscape, leaves EU leaders little alternative, but to keep the Union and Euro as a means to keep influence on the global stage.

3) Fiscal overkill in OECD countries to ease in 2013
Governments will be able to back off from their excessive fiscal tightening. Nothing against fiscal discipline, but an overkill has self-enforcing deflationary effects on future tax revenues. Additionally while older generations deplete overextended funds, the younger generation foots most of the bill. Investors overlook the significant improvement of the current account imbalances in Europe’s periphery, also the fact that US municipalities will –after 4 negative years – add to hiring, spending and growth. They will mitigate any fiscal drag coming from a US federal fiscal tightening. Competitive improvements by the USA –so far underestimated- will also add to growth.

4) Shift from bonds to equities likely as systemic concerns weighting on investors should barely materialize in 1H-2013.Key bond segmentsare overpriced. Euro periphery and Japan could profit the most from a reduction of risk aversion.
As you can see in our “BCV Politique de Placement” the valuations in equity markets are not very demanding and downward revisions to EPS are already well underway (pp. 16, 17). Equity markets look fairly priced while bond markets look very stretched, especially sovereign. Additionally the reduced equity volatility and declining cross correlation between stocks should allow equity to attract cash and bond money.

Investors tend to discount all possible future risks with less regard for the likely timeline of policy and geopolitical processes – what policy makers see as necessary rhetoric, pressure or friction, investors read as “imminent breakdown”. Additionally too much risk has been priced on EU periphery assets, too little on German or US govt-backed assets. Barring any new surprise on the horizon, markets should normalize the pricing on both extremes over time; on bonds and stocks. I’d warn those wanting to bet on a Treasury bubble ending in collapse – you’d be betting against the P&L of the FED/ECB/BOJ, which would prefer an orderly normalization.

5) Decline in cross-correlation among assets opens rare opportunity for active stock picking: The sharp rise in long-term asset cross correlations (footnote 1) in the past ten years resembled a phenomenon that happened at the turn of the 20th century, a time of unprecedented globalization. Both events, though 100 years apart, bear similarities. Sharp increase in mobility and globalization increased correlations, but not forever – globalization increases competition and friction. The sharp increase of asset correlations made diversification in portfolios somehow futile. Nevertheless cross correlations are coming off lately, which may give stock pickers a window of opportunity vs Risk-on/Risk-off managers. As nations run out of fiscal & monetary ammunition (so the consensus view) and corporates keep prioritizing shareholders over other stakeholders (lack of income growth in developed nations), unilateral policies to manage Terms-of-Trade to support exports and growth may lead to international frictions – eventually affecting correlations. Despite recent negative experience on diversification, a healthy degree of it should prove helpful in years to come. Correlations are not the only driver of the diversification benefits (footnote 2). The change or difference in volatility plays a role too. Thus even if two assets highly correlate, the larger volatiliy in one of them, can lead to higher return gaps. Those gaps can override correlation effects and deliver positive diversification “total effects”. One more reason for an active Asset Allocation. Given the recent simultaneous decline in equity volatilities and cross correlations an interesting window of opportunity has opened. Especially if investors take advantage of both correlation and volatility.

I am not denying systemic risks; they persist in the background .. and shall visit us later

6) A dysfunctional market economy with more government intervention and policy action to come. If investors would give up their apathy towards political processes and rather follow them, they would need to “react” less. Not everything we deemed as an external shock in recent years was totally unpredictable; and more shocks and policy interventions are under way. The distrust of the masses towards “the capitalistic market economy” has reached a so-called tipping point. In my view we’ve already passed the point of no-return, thus governments will reign more and more into markets. The whole economic stabilization and market recovery we’ve experienced over the past 5 years has been orchestrated by political and monetary policy makers, NOT markets. We went from collective greed to collective panic – collective in the sense that deviation from “the market consensus” was barely desired or dared. Another reason why policy will get tougher: Over the past 30 years corporate profits are sky-rocketing while salaries of workers are going downhill. Stagnant incomes mean stagnant demand. A vicious cycle leading to ever more government subsidies to support income, and larger budget deficits. Our inability to correct market excesses (by many culprits: govt’s, lobby-groups, shareholders etc) has led to widespread distrust of the market economy, resulting in a policy-driven economy. Whether we like it or not, Western nations are increasingly handling their economies in a way China has mastered. Western Capitalism as we knew it is living on borrowed time. More worrisome is rather that many market participants interpret price signals and yield curves the “old way”, forgetting central bankers help fix them for us now. Hedge funds are up and coming – the biggest Hedge Fund is now the Fed – they have unlimited leverage and can print money legally. I thank God for hedge funds, they are a bold few challenging consensus! Others follow passively “the market” and the ever more inefficient market-cap weighted benchmarks – and their deteriorating risk/return profiles. No wonder naïve equal-weighted portfolios beat most of them.
There are strong headwinds for corporations and profits ahead: as G7 governments step up intervention and get bolder, the middle class continues to bleed and a jobless (young) generation feels their fiscal thrift. But corporations and older generations (>50) are next. Imagine: If the USA would end special entitlements to corporations (“legalized tax evasion?”) the US deficit would be on a sustainable path. The US middle class has no such gigantic entitlements. The reduced equity profits will be a tax on shareholders and older generations, but they will reflect a shift of economic rent towards governments and possibly labor. As for me, I’m friend of a flat tax for everybody!.

Bright spots! Markets believe that most of the fiscal & monetary ammunition has been spent. I strongly disagree, the monetary policy of central banks can still get more aggressive. Why not buying more govt debt and cancel it out? Would investors rebel? Not in a big crisis (interests aligned). And once world population peaks at 11 billion, things can start improving again: more GDP per capita (no more growth hysteria), less pollution, more quality of life (footnote 3).

Finally, keep gold not only as inflation-, but rather system-hedge: as unilateral currency devaluations led to the Euro, it is likely that the dramatic de-basing (devaluation of inherent value) of our paper-moneys since 1974 and devaluation-competition will ultimately lead to a crisis of confidence and subsequently a global currency reform. END.

Christian Takushi MA UZH

Disclaimer: All opinions expressed reflect the personal macroeconomic & geopolitical research of Ch Takushi (C 2013) at its latest stage. This personal opinion should in no way be construed as a buy or sell recommendation for any asset mentioned here.

Footnotes:

1)     YALE University. ICF Working Paper, Long term Global market correlations. By William Goetzmann, LingFeng Li, Geert Rouwenhorst. October 2004.

2)     Correlation, Return Gaps, the Benefits of Diversification, by Meir Statman, Jonathan Scheid. Nov. 2007.

3)     Financial Analysts Journal, Fewer, Richer, Greener – The End of Population Explotion and the Future for Investors, Laurence B. Siegel, Volume 68, number 6.

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