Forget Cyprus: Low Competitivness and High Unemployment Are the Real Drag

Lots of media space is given to the crisis in Cyprus. The real problem however, is the low competitiveness of Southern Europe. The chart below taken from the FT, displays the low unit labor costs of Germany against the rest of Europe.

Meditereanan countries used to devalue their currency once a while in order to regain competitiveness. After the joining the European Currency Union they no longer have this economic policy option. The result is rising labour costs, lower competitiveness and higher unemployment rates (see chart below):

Looking at the chart above, I do not see any solution of the Euro crisis any time soon!

BCA roundtable, 21st of March 2013: US Investment Strategy

I attended this morning a presentation of BCA about the US macro environment. That's what Mark McClellan had to say:

US growth should accelerate Q4 2013

US  is following a “Classic cycle” after a housing and credit bust (US is solid line; other countries dashed line)

… after the bubble breaks, the recovery is usually slow.

US can still disappoint if austerity measure kick in two front loaded in Q3. But BCA expects that congress will strike a watered down deal. Also state budgets are all balanced now, apart from Illinois.

In 2014 the growth should be strong!

US interest rates: Beware

Fed policy has changed: While the Fed historically increased rates 6 months before the anticipated closure of the output gap, they will only increase rates at the time were the gap is actually closed. The Fed hereby risks consciously an overshoot of inflation of 3 to 4% in 3 to 5 years years.

According to BCA calculations the markets imply in its forward rate, an increase of 0.14% per Quarter instead of a 0.25% increase expected by BCA (due to inflation pressure).

The likelihood of a bloodbath in bonds in the coming years is therefore high. 

US Equities:

The equity risk premium has been high in the last few years. It willl eventually come down because of higher multiples (increased stock prices) and higher inflation (which will drive nominal bond yields up).

However in 3 to 5 years, when inflation hits its peak the outlook for equity is bad:

As long as inflation is no problem the Fed can always counter a market shock by throwing tons of liquidity. However, once inflation is here Bernanke's options are limited. The time for the Bernanke Put will be over!

US Dollar

Due to strengthening economy the dollar could move upwards in the short term. Long term the Dollar will trend downwards, especially against the Euro. However, asked about the crisi in Europe. He ducked the question by referring to his colleagues covering Europe. 

Gold

Fair value between $ 600 and 1100. Inflation has to be at 18% for 5 years to justify current gold price.

Gold shot up 2005, and is significantly above inflation (CPI)

Even when measured against real rates (TIPS yield, displayed on an inverted scale below), BCA thinks Gold is in dangerous territory, since bond yields could jump suddenly

But… I sat during the presentation next to a senior analyst of the Swiss National Bank, and he confessed that the bown up money supply of the worlds central banks is frightening (see chart above. We are in uncharted water and central banks have no exit plan for QE. This could mean that we have huge inflation at the end, and rocketing gold prices!!!

Returns of Investment of Passion

There has been an interesting article about investments of "Ultra High Net Worth Individuals" (i.e. the super rich  in the weekend edition of the FT. The graph below contrasts the returns of collectibles versus gold and  real estate.

Following trends are interesting to note:

• On the collection side, classic cars did much better than fine arts, although fine arts remains of course the most popular "investment of passion". Overall, collectibles enjoyed an outstanding performance over the last 10 years.
• Within each collectible segment there can be strong price swings, which can be caused by following development:
  Inexperienced investor tend to to inest in secure big names, but as they grow more confident they expand beyond the security of big names.
  At first, this leads to a strong increase in big names and then to a strong drop of those big names. 
• A big shift of wealth is occurring from the old world (Europe and the US) to the new world (Asia, BRIC) 
• Property prices exhibit this shift.
  While property prices in New York only increased 72% over the last 10 years, prices in Hong Kong tripled. 

An important detail to keep in mind is the fact, that collectibles make up only 4% of the super rich's asset.

Also, Bob Shiller stated that a home is not a good investment in general, since the value of a building is depreciating over time:

BCA Webcast: Geopolicy and asset allocation

This is a rather technical piece about geopolitics and asset allocation.
On February 19th, 2013, BCA has held a webcast about "Global Asset Allocation/Geopolitical Strategy Forecast":
USA
Less policy risk due to bipartisan collaboration (although politician still make a lot of noise with extreme positions, behind the scene they are compromising). Normalization of interest rates (i.e. rising interest rates from today's super low levels) is not anticipated by markets today, and could cause problems in the future. Rising yields are bad for bonds, equities and gold.
Europe
France's problem (low productivity) is hiding bhind Italy and Spain. The implementation of structural reforms in Italy in Spain is unsure as their governments are very weak (Monti is gone and Rajoy is weakened by accusation of corruption). But GDP  could grow as austerity policies cease and as exports to growing China and USA rise.

Asset Allocation
We are in a liquidity driven bull market, so don't be underweight equities, especially cyclical stocks (keep your beta high). But liquidity rallies tend to turn around quickly. Hedging with puts on equity indices is prudent. Moreover, we are priced for perfection.
Currencies: Every country is trying to strengthen economic growth by weaken their currency (beggar thy neighbour policy). EPS growth will be influenced as well as the value of respective bond positions.

Central banks are no longer independent

In an interview the  former chief economist of the ECB and monetary hawk, Jürgen Stark made some interesting remarks about global central bank policy:

Central banks (in the US, Europe, Switzerland and Japan) are flooding the financial system not to avert deflation but to support economic growth and decrease interest rates of over indebted government. Hence, there policy is no longer independent. The chart below show the explosion of money supply. Only the central bank of  Japan did not increase its balance sheet (yet), but this might happen soon, as the new PM Abe is demanding a weaker currency.

Today, central bankers are trouble shooters for non-monetary problems like weak economic growth, high unemployment and the burden of interest payments for over indebted governments, which is increasing the bankers power enormously.

The result of the monetary flood is financial repression (i.e. savers lose out due to interest rate not covering inflation anymore) and bubbles in various asset classes (e.g. bonds, swiss real estate etc.).

At the moment the increased money supply is not inflating consumer prices because the liquidity is not fueling the real economy (the liquidity is contained in the financial system fueling asset bubbles). But once the transmission works again and prices increase, it is doubtful whether central banks are willing and able to reduce this monetary sea in due time. In that case we will face substantial inflation!

To protect your investments you have to find real assets which are not yet in bubble theory. As indicated, real estate could be the wrong place to be!

MS Market Outlook for Q1 2013

Morgan Stanley's Outlook for Q1 2013:

• Generally positive with the exception of US fiscal/political uncertainty: improving global growth, decreasing European risk premium, relaxation of Basel bank regulation
• Overweight emerging markets due to their multiyear underperformance
• Cyclicals over defensives: while defensive stocks did very well in 2012, they foresee a rotation into cyclical stocks 
• Financials and Materials are the preferred sectors because of their low valuation.

BCA's Outlook for 2013

BCA Research gives an outlook for 2013:

• Positive surprises are likely in three important areas: the euro area crisis, Chinese economic growth and U.S. fiscal trends.
• The euro area has made good progress. The region should exit recession during 2013, but it will be several years before we will know for sure if the euro can survive.
• The Chinese economy has already started to improve and fears of a hard landing will continue to fade. 
• U.S. politicians will not send the economy over the fiscal cliff.
• The U.S. Debt Supercycle ended in the private sector in 2007, but still lingers on in the government sector. Most likely it will require a market crisis to force politicians to reform.
• Global economic growth should improve in the coming year, but not by enough to put pressure on inflation.
• The search for yield will remain an intense investment theme, implying that high-dividend stocks and fixedincome spread product should continue to do well in 2013.
• Global equities should continue to grind higher against a backdrop of reasonable valuations and easy money. Nevertheless, we only look for total returns from a global equity portfolio to be around a modest 6%.
• Euro area equities should outperform those of the U.S. An improved global economy should also translate into better performance from emerging market stocks.
• Commodities should do better in 2013 on the back of stronger demand. However, gold is likely to
• trade in a range. Commodity prices look vulnerable from a longer-run perspective given their elevated level and the beneficial impact of technology on supply.