Business Times Singapore Investment
Roundtable
Equities: What's on the horizon
William R. Thomson
Aug 21, 2009
OVERVIEW
STOCK prices around the world recently hit their highest levels
for this year, buoyed by a wave of optimism about prospects for
a global economic recovery - only to fall back to a three-month
low this week on fresh doubts about the sustainability of that
recovery. So, is it 'for real' or is it destined to run out of
steam? The Business Times empanelled a team of key experts to
answer this critical question, and to tell us whether the world
faces a threat of inflation, deflation or stagflation in the
coming months. There were mixed views on the prospects for equity
markets, but interestingly, everyone on the panel was bullish
about gold.
Panellists
Mark Mobius, executive chairman, Templeton Asset
Management
Eisuke Sakakibara, former vice finance minister for
international affairs, Japan, and now Professor at Waseda University,
Tokyo
Jesper Koll, president and CEO, Tantallon Research,
Japan
The Hon Robert Lloyd-George, chairman of Lloyd George Management,
Hong Kong
Ernest Kepper, former senior official of the International
Finance Corporation (IFC) and Wall Street investment banker who
now heads an Asian financial consultancy
William Thomson, chairman, Private Capital Ltd, Hong
Kong and senior adviser to Axiom Funds, London and formerly a
Vice President of the Asian Development Bank
Christopher Wood, managing director and equity strategist,
CLSA Asia-Pacific Markets, Hong Kong
Moderator: Anthony Rowley, Tokyo correspondent,
The Business Times
Anthony Rowley: Let me start by asking: is the apparent
recovery in the global economy for real, or a 'phony' one? And,
are stock markets justified in behaving the way they have been
doing lately?
Eisuke Sakakibara: I don't understand why equity prices
are so high - in Japan the US and elsewhere. In China's case,
there is obviously a very major bubble in the equity market.
Also, I don't see any reason why the US Dow Average should be
more than 9,000 (as it is now)or why the Japanese Nikkei average
is more than 10,000. I just cannot understand it.
Ernest Kepper: This is a phony recovery. A turn-up in
the economy is not the same as the economy recovering all lost
ground. To keep rising in the future, markets need a sign of
real economic recovery, and that requires a surge in consumer
spending, business investment and home buying, combined with
a reduction in government spending.
I fully expect to see the markets rise for a while longer, even
as high as Dow 10,000 or S&P 1,100. After that, I think that
we are going to see another leg down when the current rally ends,
just as the powerful rally following the initial crash in 1929,
ended up dealing out severe losses to those who held onto their
shares.
William Thomson: In the wake of Lehman's failure the global
financial system was staring into the abyss of a systemic meltdown.
Governments then junked their economic philosophies and threw
fiscal and monetary assistance at the problems on an unimaginable
scale, just to keep things afloat. It has worked to the extent
the system limps on and there has been a rally in the markets.
But there has been no recovery in the real economy yet in the
West. The pace of decline has slowed and the second half of 2009
could be modestly positive. But modest is the operative word
since unemployment is likely to continue to grow well into 2010,
reaching double digits even on the official count.
With housing foreclosures likely to keep climbing in the wake
of extended unemployment, the consumer is likely to keep his
wallet shut and try and repair his balance sheet. Modest economic
recovery should continue as long as neither fiscal or monetary
conditions become restrictive too quickly. But markets need a
period of consolidation whilst they assess future prospects,
so a broad trading range may be possible for the rest of the
year. Dips can bought and rallies sold.
Anthony: Are any of you gentlemen more optimistic about the
global outlook?
Robert Lloyd-George: This is not a 'phony' recovery. It
may be slower and weaker than usual because of the debt super-cycle.
But it is a real recovery - in trade, auto sales, consumer spending,
corporate capital spending and so on.
We are 'climbing a wall of worry' because many economists (and
hedge fund managers) do not believe in the recovery and still
have 50 per cent cash, awaiting a correction, which may never
come. Earnings, and GDP, figures will slowly improve and equity
markets will strengthen well into spring of 2010.
Mark Mobius: The financial crisis was real in the banking
system but not in the industrial economy. It impacted the economy
because the banking system froze. However, markets are leading
indicators and they are telling us the recovery is on the way
now.
Jesper: I agree. There is nothing 'phony' about the recovery;
globally, the policy response was swift and massive and very
correct. Since the start of 2009, slowly but surely, global money
and credit have started to flow again.
Markets have, of course, been pulled by the massive liquidity
creation; the tell-tale sign was the US banks raising massive
amounts of private capital this spring without much problem;
and beyond financial companies, corporations in general have
been very fast in cutting costs and slashing inventories. Many
CEOs used the crisis as an opportunity to do all the harsh and
hard things they had been wanting to do for years, but could
not ; corporations are now mean and lean. Corporate profits for
many companies are poised to explode in the coming two years;
global stock markets are - right now - transitioning from a 'liquidity
market' to an 'earnings market' ; in this phase, stock selection
will become increasingly important.
Anthony: What is driving recovery in the markets - emerging
markets especially?
Mark: In a word, money is what is driving the recovery.
The money supply in most countries is rising at a very rapid
pace. This money is finding its way into the economic system
and is driving prices and economic activity. Added to this are
the US$600 trillion in financial derivatives which amplifies
money supply.
Jesper: In a word - growth. There is no question that
the structural growth potential of 'Chindonesia' - China, India
and Indonesia - is easily about two times, if not three times
higher than that of the US, Europe or Japan. Even so, it will
be interesting to see how long emerging markets sustain their
growth premium. Valuations are now very stretched and if the
US and Japanese recovery continues to gain visibility, these
two markets could well start to outperform the emerging world
for a couple of quarters.
Robert: Emerging Markets - Brazil, India and China anyhow
- have clearly risen faster and stronger from the crisis, for
good fundamental reasons - young consumers in hundreds of millions,
and governments following ambitious infrastructure plans (in
turn), driving demand for commodities.
Christopher Wood: Recovery is partly driven by the hope
of a US restocking cycle and partly by the fact that Asia and
emerging markets in general are becoming more domestic-demand
driven.
William: We are in the midst of a historic shifting of
economic power globally from a worn-out, complacent, over-leveraged,
demographically challenged and decrepit West to a youthful, striving,
high savings and increasingly well educated and confident Asia
eager to take its place at the top table internationally.
Emerging markets cannot decouple completely in a globally integrated
world but they do have greater flexibility to develop their own
internal markets - as we have seen with the Chinese stimulus
programme. This growth of emerging markets at the expense of
the West is the story of the next 50 years.
Anthony: Let's focus on China especially for a moment
since that is where most of the action continues to be. How do
you see prospects in the China market?
Mark: Excellent. Chinese stocks have already gone up a lot
and they will correct downwards but that will be temporary.
Robert: I remain bullish on China. Their macro-economic
planning and management during the crisis continues to defy the
Western pundits. They have plenty of cash (US$2 trillion reserves)
and plenty of confidence. The younger generation will consume
and borrow more. Economic relations with Taiwan improve. Overseas
trade will recover. The renminbi is internationalising.
Jesper: China is one of the countries most exposed to
rising cost pressures. Profit margins are already very thin,
competition keeps intensifying across most sectors, and skilled
labour is scarce. The key to success in the Chinese equity market
will be an intense focus on stock selection - the gap between
winners and losers is poised to widen sharply.
We will see the rise of true multinationals from China, true
global players who do not just manufacture, but actually control
the distribution channels and branding across the globe. These
will be the real winners emerging from China over the next couple
of years.
Ernest: China took aggressive measures to increase bank lending
which in turn supported a strengthening of the stock market and
is producing what looks like the start of a bubble, which the
authorities are now trying to contain.
The Chinese government's stepping up bank lending was necessary
but it's time for the excessive lending to be scaled back now.
China's stimulus adds its own risk, including those of asset
bubbles, overcapacity and non-performing loans.
Christopher: It is possible that the Chinese economy will
grow by around 9 per cent in the second half of this year, after
7.1 per cent (year on year) growth in the first half of the year,
due to surging public-sector and private-sector fixed-asset investment
and resilient consumption. This assumes no real recovery in the
West and a negative contribution to growth in terms of net exports.
I am still overweight on China equities.
Eisuke: China will continue to grow at a fairly high rate
of 7 or 8 per cent for some years to come and next year I think
that China will be number two in terms of GDP.
That is only natural (because) China is a big country with a
big population. China will need to emerge as a major economic
power in the world.
William: The Chinese stimulus programme has been successful
but the question is whether it is sustainable. It has involved
a rapid expansion of bank balance sheets that could result in
substantial losses a few years from now. As long as China's export
markets stabilise then China's growth rate can be maintained
at levels well above the West's rates. China recognises the old
reliance on exports must change and it will. The real question
is how fast that transformation can occur. Chinese equities have
had a great run and are overdue for a breather but they have
a core position in any long-term growth portfolio.
Anthony: Let's turn to wider issues. Is the world facing
a risk of inflation as a consequence of all the liquidity that
has been injected into economies, or deflation because of the
global recession?
Eisuke: The global inflation threat is almost zero but
there are some asset bubbles. If you think in terms of prices
of goods, inflation fear is groundless but in terms of the prices
of assets, there is a danger of bubbles in China, and even in
Japan and the US. I don't think there will be hyper-inflation.
Robert: I expect inflation to rise within 12 months. Deflation
is politically unacceptable in Western democracies and monetising
debt is the only way out. This is very bearish for government
bonds but mildly bullish for equities, property, and commodities,
provided that inflation remains below 10 per cent.
William: We have been printing money like never before:
the Fed's monetary base more than doubled in three months in
late 2008. However, this has been going to fill up the black
holes in balance sheets created by the credit implosion and velocity
has dropped sharply. As a consequence it has yet to create inflation.
As things stand, we still need more quantitative easing and ultimately
we need some inflation to reduce the real burden of our excessive
debts. Renewed inflation would most likely come from currency
depreciation especially the dollar which looks very weak at present
and headed further south, possibly disastrously. I believe US
government bonds are unattractive under such circumstances, selected
equities are relatively more attractive, especially emerging
markets on pull backs, as well as some commodities, including
gold, silver and oil. Income producing property should also be
attractive after the falls of the last two years.
Christopher: The risk in America and the West remains
deflation. There remains almost zero evidence of re-leveraging
in America.
Mark: Inflation is good for equities but not for bonds
because bond rates must go up. Depending on how fast the money
supply brakes are applied then the impact on equities could be
positive or negative.
Anthony: While we're talking about inflation, the gold price
continues its upward climb. Where is it headed and why?
Mark: Gold has probably already discounted a lot of inflation
expectations but when hyperinflation hits then gold could move
much higher.
Robert: Gold is going to a minimum of US$2,000 an ounce
by 2011, in my view, for all the reasons above. World money supply
has doubled in the last two years. No new gold supply, plus dwindling
faith in 'fiat' currencies all around the world. Neither the
dollar, nor the yen, nor the Euro will fill the bill.
Christopher: I maintain a long-term bullish view on gold
bullion, with my long-term target price set at US$3,360 an ounce.
William: Gold has been tracing out a huge consolidation pattern
since it first crossed the US$1,000 mark in March 2008. The demand
for physical gold has been huge during this period of financial
crisis as gold performs its familiar role of asset of last resort
as governments around the world have engaged in unprecedented
levels of quantitative easing. I am looking for a significant
breakout to higher prices in the coming months: US$1,200 by the
end of the year is not impossible with higher prices next year.
Jesper: Gold is the best hedge we have to the principal
risk, which is inflation; so I like gold and also inflation linked
bonds as a hedge.
Ernest: Psychology is the driving force behind the price
of gold. Unless you have a clear idea who is going to come and
rescue your portfolio of paper investments, owning gold and silver
is important. Gold is still the only asset class which has risen
in price every year since 2001. In fact, it is a bargain for
gold to be selling for less than US$1,000 per ounce!
Anthony: In conclusion, what could go wrong to derail the
present recovery?
Mark: Money supply has had fed the markets. Excess money
supply begets inflation and that is what could go wrong but that
is something we don't have to worry about for probably another
year.
Robert: The only real problem I see is the high level
of European government debt, which should not affect Asian markets.
Christopher: What can go wrong, and will go wrong, is
that Western growth will remain anaemic in 2010 as a result of
continuing de-leveraging.
Jesper: The biggest threat is inflation; if we get a new
round of cost-push inflation we would be forced to call for a
negative earnings cycle coming as soon as 2011. Another big threat
is protectionism. Personally, I am hopeful this threat is low;
I am very encouraged by the well coordinated response we have
had to the global financial crisis, which suggests that global
policy makers actually act rationally.
William: Many problems have been swept under the carpet
and so a sustainable recovery to former growth rates does not
seem to be on the cards for the US, the EU and Japan. The de-leveraging
process still has a way to go and consumers, especially, have
to continue to rebuild their balance sheets. Governments will
have to restrain their expenditures and increase taxes, which
will be neither easy nor popular.
Central banks also have to walk a fine line between taking away
the punchbowl of quantitative easing and creating the fuel for
future large scale inflation.
Ernest: There are two major things that could go wrong -
the commercial property mortgage market and stimulus spending
which could cause a bubble. Years of loose monetary policy has
fuelled a dangerous credit bubble, leaving the global economy
more vulnerable to another 1930s-style slump than generally understood.
Throwing billions of stimulus dollars at the banks is unlikely
to produce a healthy economy because households are broke. At
best, it may only lead to a temporary pickup in growth. Stimulus
packages around the world are ultimately going to cause more
damage than they prevent. These packages have simply delayed
the coming downturn, and by adding significant numbers to the
massive debt bubbles of the world's nations, will ultimately
make the downturn worse than had governments not injected massive
amounts of money into the economy.
When the (current) debt bubble bursts, the world will enter a
serious downturn. The bailout is much bigger than the dot-com
and real estate bubbles which hit speculators, investors and
financiers the hardest. When the 'Bailout Bubble' explodes, the
system goes with it because neither the US President nor the
Federal Reserve will have the fiscal fixes or monetary policies
available to inflate another bubble.
Copyright
© 2009 Singapore Press Holdings Ltd. All rights reserved.
Aug 21, 2009
William R. Thomson
email: wrthomson@btconnect.com
321gold Ltd
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