So, is the rebound potential forecast for 2013 actually under way? What is the best asset class to play? Are valuations expensive in a climate in which economic growth and political uncertainty are still subject to risk?
Continuation of the current context – favourable to risk assets – to extend into the first half of the year
Growth momentum should continue to improve in 2013. The Dexia AM scenario is based on around 2% US growth, enhanced growth in the emerging countries and a stabilising European situation that should hit a trough this year. “Fourth-quarter figures are reassuring in advance of the Chinese cyclical rebound, while the partial resolution of the American fiscal cliff offers a little more visibility on US growth. Europe, in fact, is the geographical zone about which investors are most sceptical”, says Koen Maes, Head of Asset Allocation at Dexia AM. “Nonetheless, we shall take into account fewer fiscal restrictions than in 2012, the positive effects of the improving financial conditions and a more buoyant international context before forecasting any sequential improvement of European economic figures in 2013.”
This global context, still depressed but more dynamically driven, is coupled with the anticipation that inflation will be kept under control and that the central banks will offer concurrent, unwavering support. The Fed will continue to expand its balance sheet in H1 2013 while the ECB will intervene as and when necessary. Japan, the biggest surprise of late 2012, should offer, through its more aggressive reflation policy, additional support to liquidity.
Finally, the reduction in political risk will help compress the risk premium: there should be greater visibility in the US, China and Japan than in 2012 following some key events in Q1 2013 (renegotiation of the American debt ceiling by the end of February, appointment of new governors for the Bank of Japan in late March/early April). In Europe, ECB strategy has given policymakers some breathing space and, with the German elections scheduled for this autumn, we really can look forward to less political divisiveness.
The search for returns and growth should remain core themes in 2013 and benefit equities more than bonds.
Normalisation of the context should result in slightly more diversified performances with greater focus on valuation.
2012 – quite a positive year for bonds, with a tightening of spreads – will be difficult to repeat in 2013. Even if the absence of a strong economic recovery and central bank support prevent us from forecasting a strong bond correction, credit will provide investors with, mainly, carry return. “We are more positive on segments like financials, high-yield credit and emerging debt, in which spreads could continue to decrease, but to a lesser extent than last year”, says Nadège Dufossé, Asset
Allocation strategist. “However, along with this fixed-income positioning, we are globally prioritising equities.”
The valuation gap is reflected in the record high differential between dividend yield and bond yield (sovereign and credit), which is as big as it was in early 2012 taking into account the performance of the respective asset classes in 2012. Similarly, there is still quite a wide gap between credit yield and corporate cash flow yield that is encouraging for equity investment. The rotation among asset classes in favour of equities is a key element in the Dexia Asset Management scenario. Its success will depend on investors’ confidence in an improving economic situation this year and next, and in the absence of major political risk. In 2012, investment flows were still bond-friendly, with, at year-end, the emergence of positive equity flows, which bode well for the future.
Nadège Dufossé: “As far as equity is concerned, we are, nonetheless, focusing on geographical zones with the most attractive valuation and recovery prospects. We are positive on the Euro zone and the emerging countries.” The Euro zone is benefiting from a lower relative valuation and weak investor positioning. Returns should be boosted by an improving economic rhythm after sinking to a low in 2013. Dexia AM is prioritising peripheral countries like Italy and Spain, which have a greater recovery potential, while remaining selective on stock picking. The Asset Allocation team is equally positive on the emerging markets, where the cyclical rebound is not fully valued. In addition, the exposure to Japan has been increased to neutral. Indeed, the change of government should lead to stimulus package and a more aggressive reflation policy following the change of leadership at the central bank. Any continuing depreciation of the yen could prove beneficial to equity valuation. It will, however, be important to measure more accurately the impact of the economic policy changes on the country’s fundamentals before turning more positive on this region.
Nadège Dufossé, again: “Our focus is still very much on cashflow-growth themes.” Such growth could be based on strong corporate franchise offering good visibility, or on cyclical corporate recovery, which should be taken into account in the valuation.
With respect to the commodities asset class, Dexia AM is slightly less positive. In fact, even if the pace of demand improves in 2013, global growth will not be of such a level as to provoke a risk of overheating. The market will remain supply-driven: apart from certain base metals like copper, where there is a tighter supply-demand balance, the offer should be enough to cover the increased demand in 2013.
The risks and chances of a change in scenario in 2013 are high
With respect to the possible risks to the scenario, Koen Maes says: “We foresee a double risk: insufficient growth or premature recovery.”
Insufficient growth would see us re-living a scenario like that of previous years: short mini-cycle with improving end-of-year/start-of-year economic expectations, followed by disappointing figures as of the second quarter. External shocks have been the main source of this recurring trend over the last two years. That said, with the support policies implemented by the central banks, European political developments would appear, to Dexia AM, less of a risk in 2013. On the other hand, the risk of disappointment in the US economy following fiscal tightening could materialise later in the year. Finally, with respect to commodities, Dexia AM foresees no degree of overheating capable of destabilising the economic growth.
To the contrary. Koen Maes would remind us that “Premature expectations of a Fed exit from quantitative easing on the basis of improved economic figures could propulse us earlier than expected into a second phase of the cycle. The fundamentals do not appear sufficiently consolidated to support a premature exit strategy.” True: the US economy will be impacted by fiscal tightening whereas the job market has not yet recovered to the extent that it can support consumption. Nor is the European problem on the verge of being solved. Even if the ECB has responded to the liquidity stress and reduced the perception of extreme risk, there still remains the question of peripheral-country solvency. And, even though the implementation of solutions such as the ERF could be a long-term means of dealing with the topic, no immediate decision will be taken on this. The necessary development of European integration to sustainably stabilise the zone will be a slow, step-by-step process.
To sum up, Dexia AM’s current stance is thus positive on equities, in particular Euro-zone and Emerging Market stocks. In the bond bucket, we will focus on high-yield credit and emerging debt. The last word goes to Nadège Dufossé : “Our exposure will be adapted naturally to changes in our forecasts over 2013”.
Source:Dexia AM
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