Friday, October 16, 2015

16/10/15: IG Conference: Markets Outlook


My speaking points on the topic of the Markets Outlook for yesterday's IG conference:

Short themes:

Theme 1: Markets pricing in advanced economies: 
- EV/EBITDA ratios signal overvaluation; 
- EBITDA/Interest Expenses ratio is at below 2010 levels (below 14%) despite extremely cheap debt.

A handy Bloomberg chart:

- Global debt cycle has turned – sovereigns are not leveraging as fast or deleveraging, but corporates leveraged up. 
- Much of pricing today reflects migration from equity to debt
- In this environment – long only allocations are problematic.

Theme 2: Emerging markets, especially BRICS
- Idea of 3rd Wave – Goldman’s thesis – is based on two drivers: duration of the crisis (‘this can’t be going for so long…’) and firewalls (‘this can’t spill into the developed economies…’) both of which are 
- There are no fundamentals to support robust recovery view
- Again, allocations are highly problematic.

So short-term summary is poor when it comes to hard numbers:
- World economic growth for 2015-2017 forecast is down from 14.1% in 2012 to 10.9% today
- Euro area economy forecasts are flat: 5% in 2012 and 4.9% today, holding relatively steady compared to the rest of the world solely because Europe is now Japanified
- Advanced economies down from 8.1% to 6.6% - another miserably Japanese-styled performance compared to past averages
- Emerging and developing economies from 19.55 in 2012 to 14.0%.

On inflationary targets and rates: the only way we are going to get to the inflationary expectations consistent with monetary policy normalization, is by literally superficially jacking up prices through Government controlled sectors and/or via regulatory policies. Which is to say that any inflation above, say 1% or so in the Advanced Economies, today, will be consistent with stripping income out of the economy to prime up financials (in the short run) and public purse.


Longer themes:

As much as I love the good story of innovation and technological revolutions, I am afraid to say my fear is that we are heading for the twin secular stagnation scenario:

Supply side stagnation: 
- Technological returns (productivity growth and new value added) are tapering out
- Substitutability of labour is rising and with it, risks to economic systems
- Regionalisation of trade and production are gaining ground and markets fragmentation is going to play a disruptive havoc with our traditional market valuations
- So expect more volatility on flatter trend.

Demand side stagnation: 
- Demographics 
- Savings/investment imbalances, 
- Debt overhang – across both advanced economies and, increasingly also, emerging markets, so we have a Myth of Post Financial Crisis Deleveraging (via BAML)

Global Debt to GDP
2010-2015: 220 to 240%
2000-2010: 190 to 200%
1990-2010: 170 to 190%

Or a handy chart

- Wealth and income inequalities, including intergenerational effects
- Rebalancing of economic growth drivers (human capital focus pushes incomes gap wider and deeper, but also clashes with current taxation and political systems)

Key forward is to expect:
- Flatter growth trend and more volatility around that trend 
- Higher volatility / instability in higher moments 
- Financial imbalances accelerating and amplifying
- Financial imbalances / cycles leading real cycles (Excess Financial Elasticity hypothesis)
- Economic volatility spilling, increasingly, into political volatility (political economy). 

Key strategy points:
- Focus on lower debt levels on companies balance sheets
- Focus on companies actually paying attention to core basics, e.g. earnings, sales, profit margins, as opposed to subscription bases, user counts etc
- Focus on companies with strong regional reach (not only in product markets, but in logistics and production bases)
- Focus on companies with revenues linked to multi-annual contracts
- Go defensive, stay defensive in core allocation
- Go speculative with low leverage only and on a small share of total wealth
- Go speculative trades on uncertainty and long 5-10 percentile under-performers

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