JOHANNESBURG – Not sure what to make of the markets next year?
Recently both Citadel and BoE Private Clients held separate sessions to answer this question.
They examined the effects of quantitative easing one and two on short-term capital flows, the gold-standard and rates. It’s hard to get economists or indeed investment strategists to provide firm predictions but for what it’s worth these guys made some big calls.
Much has been said about the state of the developed world and Sunday’s headlines confirming Ireland as the European Union’s (EU’s) second recipient of a bailout again focused the world’s attention on the vulnerabilities that exist within highly leveraged economies. But not everyone believe it’s the end of the world.
Dave Mohr, chief investment strategist of Citadel, and most recent winner of the Reuters Economist of the Year award, reckons “Europe’s problem countries are not as influential as people think – Ireland’s contribution to the EU is just over a percent, from a purchasing power parity point of view, so personally I don’t think the Irish can upset the apple cart.”
BoE Private Clients’ chief investment officer, Daryll Owen takes concurs on Europe. As a whole, “the euro area contributed only 15% towards the world’s output as a percentage of GDP in 2009, with emerging markets sitting at 47%, the US at 20% and the balance coming from other advanced economies. What we need to understand is that there’s a new normal growth in developed economies which continues to be slow, while that of emerging markets continues to propel us forward”.
When it comes to emerging markets, Mohr agrees albeit with a slight caveat, “right now inflation in both China and India is starting to become a problem, especially the Chinese markets which is showing signs of over- heating, however, “on balance I still think we’ll get reasonable growth in 2011, this year both the developed and emerging markets returned to positive growth with the latter, as usual delivering a superior growth performance.
Owen broadly agreed saying “the search for yield will definitely continue as a theme going forward, and emerging markets will by and large be the main beneficiary”.
Hot money is here to stay… at least for now
BoE’s big call as far as this journalist could gather is that the hot money or short-term capital inflows could stay longer than people think. “This is a longer-term play. My belief is that rates in the US will remain low for a protracted period and as long as that base scenario remains the same the search for yield will continue. Naturally there are risks to the hot money leaving (geo-political factors; the return of risk aversion) but if rates in the US only go up in two years time the US Federal Reserve will embark on a gradual increase and the differential will continue to make sense when compared to the return one gets in emerging markets,” said Owen.
The other factor to consider is South Africa’s position as the “gateway to Africa” we will always be an attractive place for both short and long-term capital, “our capital inflow story is not a short-term phenomenon, our markets are deeper, broader and a lot more liquid when compared to other countries on the continent.
“And if one looks at some of our retailers trading at a 20 PE (price:earnings ratio), as locals we feel they’re a bit rich but clearly overseas investors don’t think so, they’re in fact comparing our retailers to other emerging-market players and they’re finding value, this too should continue to attract some inflows”.
When will interest rate cycle change both here and in the US?
Mohr’s big call is on rates both here and in the US, “I don’t think it’s wise giving a precise time on when rates will go up especially in the US but locally we see the last rate cut in the first quarter of next year, with one bogeyman coming from food prices given they’re heavy weighting on the [consumer price] index, if we start to see prices going up that will be a big sign.”
The rates call locally depends on what happens internationally, “the Reserve Bank is influenced largely by what happens internationally, if you look at the Irish situation and the amount of anxiety it’s causing our [Reserve] Bank will have to respond, if the global picture looks stable and consumer spending together with some mild food inflation pick up we should see the cycle bottoming out towards end of first quarter,” says Mohr.
The US is a slightly different matter however says Mohr. He believes the Fed will not move on rates before 2012. “The Fed will play it safe they will keep rates low for as long as possible, however the closer we get to 3% growth in the US and [US Federal Reserve Chairman] Ben Bernanke scales back on some of the quantitative easing measures then and only then will we see the first signs of a change in monetary policy”.
The return of the gold standard
BoE points out why it simply wouldn’t happen. Monetary autonomy, as both Britain and the US have shown, is an incredibly valuable asset. Marginal European players, such as Ireland and Greece having given up there respective currencies lost the ability to revive their economy through devaluating their currencies. No longer could they print more and more money making their goods and services much cheaper, yes adding some inflation but also growing their economy through exports.
Britain who chose to stay out of the common monetary union has as a result retained its independence, as far as its monetary policy is concerned. So why on earth would governments give up their monetary authority, thus lose the right to print more money for gold? Had both Ireland and Greece not belonged to the EU perhaps they might not have been forced to go to Brussels and Washington carrying a begging bowl.
The good thing about predictions is that when you get them wrong people tend to forget. In this case should the above predictions fail to come true this journalist will no doubt go back to our economists and market strategist. Should they be proven right, no doubt I’ll be eating some humble pie.