End Of The Year Update
2009 end of the year update
2009 has been a year of recovery, first in share markets & then in global economic activity. Patient investors have seen some recovery in their wealth after the losses of 2008.
The perception of risk is still out of balance. While government bonds are expensive and there is still a lot of money in cash, equities and corporate bonds are no longer cheap.
Outlook for 2010
2010 is likely to see the economic recovery continue and become self-sustaining. Interest rates likely to be kept low by the US and the Europe.
A ‘U’-shaped recovery is most likely, which in some ways is the best outcome for investors. A ‘U’-shaped recovery presents investors a chance to enter the market when asset prices remain low. Global GDP growth in 2010 is at 3.6%-3.8% according to consensus.
Share markets are likely to rise further thanks to the combination of improving economic and profit growth, low inflation and still low interest rates at time when there is still plenty of cash on the sideline.
However, with uncertainties about the strength of the recovery and key central banks moving towards rising interest rates in the year ahead, share markets will be more volatile and gains more constrained than has been the case since March. A well-diversified portfolio should help to smooth performance.
USA
US economy remains fragile
As problems of commercial and residential mortgages are only due to bottom out late 2010, pressures of bank foreclosures will intensify. The US economy has emerged from its 2008 free-fall. Recent profits announcements have been good, and productivity gains high; but these mostly reflect job lay-offs and cost-cutting, not the solid rise in underlying sales that explains much of the improvement in Asian corporate profits. Furthermore, US equities are priced as though there really is a strong economic recovery underway.
Weakening US dollar
The weaker USD is inevitable, and is also a positive thing. In general, the US is adjusting from a leveraged, consumption-led economy, to one that is less consumption-driven, to one that relies more on export growth. In the past 6-9 months, Asian central banks have been pegging against the fall in the USD, causing asset prices to inflate. Central banks in this part of the world would inevitably be forced to appreciate their currencies against the USD to tackle inflation caused by excess USD.
Premature / overdue tightening the main risks
As we know it, the US interest rates will have to rise at a point in time to reverse excess liquidity that is driving inflation and asset bubbles. Withdrawal of key central banks stimuli is expected next year too. There lies the difficult balance a premature action in rates will hurt the economic recovery and an overdue action will breed excessive risks in the market.
Asian and emerging markets
Likely to remain out performers
Despite the strong performance of Asia and emerging markets this year, we believe that the rally has further to go. Most major Asian and emerging market economies will likely outpace economic growth in developed countries and become drivers of the world economy.
Furthermore, economic fundamentals are much stronger in the Asia and emerging world. The prospects for earnings growth are very strong and emerging markets are trading at a discount to developed markets. Low government debt levels as compared to developed world. Domestic and Asian demand increasingly important in driving Asian and emerging market growth. These advantages add up to a very positive outlook for these markets next year. Asian equities expected to rise about 25% in 2010. Market consensus for China and India GDP growth is 8.5% and 6.1% respectively.
Risks
Generally, the biggest risk for Asia markets would be what will happen to export growth past the initial recovery phase in the global economy, where we’ve seen a rebound in exports on the back of inventory restocking? Is there enough of an internal activity within this region to sustain growth? How strong would Asia’s upward growth trend be, in a world where exports will take quite a while to get back to where it used to be up till 2007?
The other risk would be if Asian central banks continue to peg their currencies to the weakening USD, that is going to create inflation. Effectively, the central banks are importing US monetary policy, and US monetary policy is going to remain easy for a long time. And Asia does not need this much money in the system, given how the inflation rates went up in 2008. Asia could be one region that will probably face inflation problems by the end of next year. Already, India is facing inflation problems and we can expect a mild short-term correction in markets like China.
Certain countries with high debt will be under pressure from sell off by investors. As can be seen by Dubai World’s, a Dubai-owned property developer, late November announcement that it could not meet a forthcoming debt repayment. Shares in Dubai & Abu Dhabi tumbled, putting in question “implied sovereign guarantees”. Shares subsequently recovered on Abu Dhabi’s bail out which covers Dubai until Apr-2010. Greece’s sovereign debt level has caused downgrades from rating agencies.
Opportunities
For a core portfolio, a mix of Asian equities with diversification in corporate and, to a lesser extent, government bonds will provide stability to achieving investment objective. Emerging markets offer greater returns but at the same time volatility and should be kept to manageable portion.
In 2010, short-term advantage can be found in Asian financials, commodities and AUD. Singapore market is looking attractive on valuation basis and as the world economy stabilize, STI is likely to reach previous high of 3700 points in early 2011 from the current 2800 points.
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