Quick thoughts for the next 12 months:
Both EU and emerging markets have undergone turmoil within the last 12 months and these events might be correlated. The recession within EU might be trickling down to emerging markets leaving US as the next best option for investors around the globe. EU is currently in recession as we know of. Greece underwent a pseudo referendum this weekend on the question of whether or not to stay in the EU. The Greek people voted for the party that supports Greece staying in the EU, however the elections this weekend have resulted in a fragile political dynamic and still lot of uncertainties remain. With Spain and Italian yields at 7%, banks undergoing major restructuring and governments reporting significant deficits, the countries seem to be in trouble. EU turmoil resulting in restricted lending, stagnant corporate growth and high unemployment has resulted in a decline in consumption and corporate spend alike.
Similarly, with two major emerging markets exposed to EU; China with 17% of its exports to EU and Indian with 16% of exports to EU are negatively impacted by European recession. Others in the Asian club are economies such as Malaysia with more than 14% exposure to EU. Furthermore, manufacturing jobs that are returning to the US only exacerbate the problem for the emerging economies. In addition to these problems, China and India have problems of their own; China with its real estate market and India with its high rate of inflation. Both are expected to face volatility over the next year or two. Easing of monetary policy in china might alleviate some short term concerns; however, fundamental problems with bank leverage and real estate still remain.
The cautiousness in bank lending, slowdown in exports and that in Chinese real estate directly impact consumption and corporate spend in the mainland. With slowdown in these economies, which are major consumer of natural resources, economies such as Australia and Brazil will get impacted. The markets are pricing in a slowdown in these countries as well.
That leaves US. Within US, equities are priced at 12x – 13x times’ earnings, corporate balance sheets very strong and corporate are sitting on loads of cash (almost $2T). A lot of investors are looking for safer havens and have parked their money in treasuries which might be currently overbought – so much so that they are yielding negative yields in real terms. The only reason why investors would do that is because US Govt. assures return of principal if nothing else! With interest rates nowhere to go, treasury market might be overbought and will undergo correction at the first sign of interest rate moves.
That leaves us with US Equity markets. Does that mean the equity markets will rally in short term? Probably not! With almost 20% of S&P 500 companies exposed to EU and almost 35% to 40% firms exposed internationally ( EU & Emerging markets), the markets might undergo short term volatility. Earning comps might not come out that strong YoY, however, US firms are well positioned to take advantage of a turnaround and are one of the best bets for investors, looking both for yields and long term capital appreciation.
2011 and 2012 have seen lot of special situation such as spin-off’s M&A, actual/potential divestitures or potential JV’s in the large and mid cap space. Furthermore, the markets have also seen lot of new regulation & budget cuts post 2008 crisis that will affect the firms going forward. There have also been companies that have emerged from bankruptcies and have started trading post reorganization; these events present ample opportunities for long term investors looking for value plays with significant catalysts attached.
For example - defense sector will see cuts and therefore might lead to consolidation. Healthcare technology providers might benefit from the healthcare regulation. Within homebuilding where I do not see a significant recovery in short term, those who are into home repair & maintenance might come out as winners. Natural gas provides ample opportunities for people to invest in - not in the natural gas producers per se, but in companies that are well placed to take advantage of LNG exports from US to countries in EU & countries like China. There is also need for or demand for natural gas technology which will benefit companies who will export or share it with emerging economies looking to explore natural gas reserves. Furthermore, firms that help build Natural gas infrastructure will benefit too. Water, which has been big on my list, will be a money maker in the next three years, especially firms who are providing water testing systems, analytics, providing water for fracking, transportation and dewatering.
There are more firms I can talk about within the technology space or shorts for companies that are leveraged with exposure to cyclical industries/consumers. I can talk about Gold given easy monetary policy, but am not expert in gold and it’s an obvious choice! Therefore, I will end it here for now.
These are macro views and should not be construed as my views on specific companies trading internationally. Current markets are clearly for investors who are looking to trade medium to long term.