December 2011
Investment Strategy
Contents
Introduction..........................................................................................................................5 Summary...............................................................................................................................6 Macro summary ...................................................................................................................8 Portfolio commentary: Modern Investment Programmes.......................................... 10 Theme: A global search for returns ................................................................................ 13 Theme: Finding gold that doesnt glitter ....................................................................... 16 Theme: Macro environment the key to returns ............................................................ 19 asset CLasses Equities............................................................................................................................... 22 Fixed income ..................................................................................................................... 26 Hedge funds ...................................................................................................................... 28 Real estate ......................................................................................................................... 30 Private equity .................................................................................................................... 32 Commodities ..................................................................................................................... 34 Currencies.......................................................................................................................... 36
Investment Strategy
This report was published on November 29, 2011. Its contents are based on information and analysis available before November 18, 2011.
Hans peterson
Global Head of Investment Strategy + 46 8 763 69 21 hans.peterson@seb.se
Jonas evaldsson
Economist +46 8 763 69 43 jonas.evaldsson@seb.se
reine kase
Economist +352 26 23 63 50 reine.kase@sebprivatebanking.com
victor de Oliveira
Portfolio Manager and Head of IS Luxemburg + 352 26 23 62 37 victor.deoliveira@sebprivatebanking.com
Daniel gecer
Economist +46 8 763 69 18 daniel.gecer@seb.se
Johan Hagbarth
Investment Strategist + 46 8 763 69 58 johan.hagbarth@seb.se
Carl-Filip strmbck
Economist +46 8 763 69 83 carl-filip.stromback@seb.se
esben Hanssen
Head of IS Norway + 47 22 82 67 44 esben.hanssen@seb.no
Cecilia kohonen
Global Head of Communication Team +46 8 763 69 95 cecilia.kohonen@seb.se
Carl barnekow
Global Head of Advisory Team + 46 8 763 69 38 carl.barnekow@seb.se
Liza braaw
Communicator and Editor +46 8 763 69 09 liza.braaw@seb.se
This document produced by SEB contains general marketing information about its investment products. Although the content is based on sources judged to be reliable, SEB will not be liable for any omissions or inaccuracies, or for any loss whatsoever which arises from reliance on it. If investment research is referred to, you should if possible read the full report and the disclosures contained within it, or read the disclosures relating to specific companies found on www.seb. se/disclaimers. Information relating to taxes may become outdated and may not fit your individual circumstances. Investment Strategy tracks and monitors various companies continuously and applies no fixed periodicity to its investment recommendations. Disclosures of previous recommendation history may be obtained upon request. Analysts employed by SEB may hold positions in equities or equity-related instruments of companies for which they provide a recommendation. More information about SEBs investment recommendations and its management of conflicts of interest etc. can be found at http://www.seb.se/ upplysningar.se (in Swedish). Historic returns on funds and other financial instruments are no guarantee of future returns. The value of your fund units or other financial instruments may either rise or fall, and it is not certain that you will get back your invested capital. In some cases, losses can exceed the initial amount invested. Where either funds or you invest in securities denominated in a foreign currency, changes in exchange rates can impact the return. You alone are fully responsible for your investment decisions and you should always obtain detailed information before taking them. For more information please see inter alia the simplified prospectus for funds and information brochure for funds and for structured products, available at www.seb.se. If necessary you should seek advice tailored to your individual circumstances from your SEB advisor. information about taxation: As a customer of our International Private Banking offices in Luxembourg, Singapore and Switzerland you are obliged to keep informed of the tax rules applicable in the countries of your citizenship, residence or domicile with respect to bank accounts and financial transactions. SEB does not provide any tax reporting to foreign countries meaning that you must yourself provide concerned authorities with information as and when required.
introduction
Summary
*Forecasts are taken from the seb House view and are based on our economic growth scenario
equities 1
10%
18%
Neutral outlook in the short term, POSITIVE in the long term. Globally no strained valuations, provided that growth does not fall further. A decent macro scenario in the US, significantly weaker in Europe. Emerging market (EM) economies will show continued robust growth after a period of inflation-fighting. Strong performance in Russia, encouraging news headlines from China. Confidence in the EM sphere seems to be returning, though somewhat cautiously. Negative towards government bonds in the OECD countries because of todays very low yields and prospects of some yield increases/risk of price declines. POSITIVE towards High Yield bonds, which based on fundamentals in terms of company health and bankruptcy risk have unjustifiably wide yield gaps to government securities. Given somewhat better risk appetite, EM Debt will also appeal to investors, due to the potential for lower yields/ price increases and stronger currencies compared to the developed market (DM) sphere. positive. Still cautious about Equity L/S and Distressed strategies, but the actions of central banks will create attractive opportunities for Credit L/S managers. From a portfolio standpoint, we view Macro and Trading strategies as good diversification mandates. Neutral. Comparatively stable market performance. World economic uncertainty and volatile foreign exchange markets are contributing to delays in major real estate transactions. Continued heavy demand for less risky quality properties. Neutral. Market turmoil has continued to depress share prices of PE companies; this has resulted in large discounts to NAV. The market has already priced in continued problems. Fundamentals provide good support for todays prices. Neutral. The weak outlook for the OECD countries is hampering good performance. At present, upturns in the commodities market are more indicative of greater risk appetite than of an improved growth outlook. Limited downside for base metals. Gold prices will benefit from the prevailing environment. Diminishing worries about weather developments will lead to falling prices for agricultural commodities. Neutral. In fundamental terms, EM currencies will benefit from interest rate differentials and continued high growth, but greater risk appetite will be needed for appreciation. The USD will strengthen in a bumpy market that will also be sceptical to the EUR. The yen is regarded as overvalued.
Fixed income 2
6%
7%
Hedge funds
4%
5%
3%
4%
15%
27%
Commodities 3
3%
12%
Currencies 4
1
3%
4%
The forecast refers to the global stock market. 2 The forecast refers to a basket of Investment Grade and High Yield. 3 The forecast refers to a basket in which the energy, industrial metals, precious metal and agricultural commodity categories are equally weighted. 4 This opinion refers to the alphagenerating capacity of a foreign exchange trading manager.
Expected return
8% 6% 4% 2% 0% 0% 5% 10% 15% Expected volatility 20% 25% 30% Hedge funds Currencies Real estate Commodities Fixed income*
-5%
2008-11
2009-02
2009-05
2009-08
2009-12
2010-02
2010-05
2010-09
2010-12
2011-02
2011-05
2011-09
Real estate
Fixed income
Hedge funds
Real estate
7% 6% 5%
Historical return
Commodities
4% 3% 2% 1% 0% -1% -2%
1.00
-0.50 0.57 -0.12 0.85 0.25 -0.19
Equities
8%
1.00
-0.30 0.06 -0.38 -0.17 0.19 1.00 -0.05 0.66 0.68 0.14 1.00 -0.14 -0.05 -0.09 1.00 0.38 -0.07
Hedge funds
0%
5%
20%
25%
30%
Currencies
Historical values are based on the following indices: Equities = MSCI AC World EUR. Fixed income = JP Morgan Global GBI EUR Hedge. Hedge funds = HFRX Global Hedge Fund USD. Real estate = SEB PB Real Estate EUR. Private equity = LPX50 EUR. Commodities = DJ UBS Commodities TR EUR. Currencies = BarclayHedge Currency Trader USD.
Currencies
HistOriCaL risk anD retUrn (nOvember 30, 2001 tO OCtOber 31, 2011)
2011-12
Summary
50%
60% 70%
80%
90%
Current
-0.8 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Fixed income Private equity Hedge Commodities Real estate Currencies
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Equities Private equity Fixed income Commodities Hedge Currencies Real estate
Return in 2011 is until October 31. Historical values are based on the following indices: Equities = MSCI AC World EUR. Fixed income = JP Morgan Global GBI EUR Hedge. Hedge funds = HFRX Global Hedge Fund USD. Real estate = SEB PB Real Estate EUR. Private equity = LPX50 EUR. Commodities = DJ UBS Commodities TR EUR. Currencies = BarclayHedge Currency Trader USD.
macro summary
Macro summary
ing Central) Europe has emerged alongside exports as an economic engine, but the regions expansion is about to weaken as slower growth in global demand hampers its exports. Highly export-dependent Hungary, the Czech Republic and Slovakia (with exports equivalent to 70-80 per cent of GDP) are especially vulnerable. To some extent, growth will also decelerate due to lower capital spending by businesses, but the deceleration in GDP growth will be far gentler than in the euro zone. Except for Hungary, public sector debt is moderate. As a result, the need for austerity measures will be smaller than in Western Europe, and this will benefit domestic demand. In 2012 Poland, Latvia and Ukraine will continue their moderate budget tightening, while fiscal policy will become slightly stimulative in Russia, Estonia and Lithuania. Consumption and capital spending can thus hold up relatively well as export growth slows. Inflation will remain low in most Eastern European countries, mainly due to large output gaps.
GDP growth has trended lower in both China and India since early 2010, but so far this deceleration is moderate. The growth rate remains above 9 per cent in China and 7.5 per cent in India. Although the risks of a harder landing in 2012 have increased, mainly due to European economic and sovereign debt problems, our main scenario is still that both economies will experience a soft landing next year and then accelerate somewhat in 2013.
1.5% 2% 17%
79.5%
10
mODern grOWtH The euro zone issue has been the main controlling element in financial markets throughout 2011 including this quarter. Although stock markets are largely at the same level at this writing as they were in late August, it has been a dramatic ride in recent months. Meanwhile the risk map has been redrawn to some extent. Although the VIX volatility index, also called the fear index, has mostly remained above the 30 mark, the index has been in a downward trend since the turbulence of August. The US dollar, which is another indicator of market volatility, rose more than 8 per cent against EM currencies in September, but has fallen somewhat since then, though it has been trading aimlessly since mid-October. Asian currencies have performed well, however, with a modest decline of about 2 per cent since August. In Modern Growth we have had a defensive attitude since August, with equity holdings of 10 per cent and cash holdings of more than 20 per cent, motivated by great uncertainty and the lack of visibility in 2012. Although there are still many elements of uncertainty, the general mood about the future of Europe is more upbeat than one quarter ago. And above all, a number of assets have fallen to clearly attractive levels. Forward-looking price/earnings (P/E) ratios for equities at the global level are reasonable, and the spread between High Yield bonds and government securities is again above 700 basis points. In the prevailing climate, we prefer to invest in asset classes that can generate returns regardless of market climate. Most forecasters predict less than a 3 per cent rate of company bankruptcies next year, while the bond market is pricing in more than 15 per cent. Corporate balance sheets are historically strong, however, and High Yield bonds look clearly undervalued. Emerging market bonds continue to be attractive with their high coupons, and in some EM countries this is also potential for falling yields (= price gains). After the strong appreciation in the dollar, there is also great potential for exchange rate gains. We have thus gradually increased our fixed income holdings from 27.5 to 34 per cent of the overall portfolio, including 4.5 per cent High Yield and 2 per cent EM debt.
To improve the ability of the portfolio to weather sharp downturns in the markets, we have increased the share of CTA hedge funds to 9 per cent. We also foresee that credit marketoriented managers have good potential to generate returns, both because a number of central banks are now resorting to unconventional methods and because loan pricing is outside of normal limits right now. We are also increasing our allocation to Credit Long/Short by replacing one of our Global Macro managers. In all, we have increased the hedge fund sub-portfolio to 30 per cent of Modern Growth from 26 per cent earlier. In the currencies sub-portfolio, we have previously allocated capital to managers with free investment mandates in the foreign exchange market, but they have not succeeded in generating satisfactory returns in the past few quarters. This is why, consistent with our view of currencies, we are now choosing to take a more active investment approach by seeking exposure to Asian currencies. Late in October we replaced our currency managers in favour of an Asian fixed income fund that invests in short maturities (1-3 years) and in local currencies (to gain currency exposure at limited interest rate risk). On the whole, our positions are not so dependent on stock market performance (and thus global growth) the portfolio should be able to generate returns as long as we do not end up in a global recession. Short-term performance is, however, likely to fluctuate in response to the moves of political leaders and the ebb and flow of risk appetite. Further ahead, we nevertheless expect relatively stable portfolio performance.
17%
10.5% 4% 4.5%
In the equities sub-portfolio, we have selectively bought exposure to markets with the best potential for growth Asia (4.5 per cent) and the Nordic countries (2 per cent). Although these regions tend to be more volatile than global equities, they have shown other good characteristics compared to EM countries generally. Although risk appetite will determine the performance of these markets in the short term, their potential viewed over 1-2 years is strong, provided we do not end up in a global recession. Total exposure to equities in Modern Growth is less than 17 per cent, which can be regarded as a continued defensive position.
34%
30%
11
mODern aggressive After their big downturn in August, equities continued to fall during September. Share prices recovered slowly in October, however, amid hopes that euro zone leaders were moving towards finding a credible solution to the euro crisis. Late in October, they finally unveiled a plan that was positive on the surface, but lacked details. The plan could be regarded as more of a common declaration of will and a political roadmap than a final plan for a solution. Risk appetite and thus the performance of various stock markets and asset classes changes daily in response to political statements. In todays market situation, asset prices are mainly being driven by the political advances and reversals occurring in Europe. Since August, most economists have revised their global growth forecasts for 2012 downward. Meanwhile corporate earnings expectations for 2012 have been lowered. These revisions have been larger in the EM sphere (about 13 per cent since the end of July compared to 7.5 per cent for Western countries). Expectations for Asian companies have been lowered by about 12 per cent. Meanwhile, US macroeconomic indicators have provided upside surprises, and China is apparently moving towards an economic soft landing. Taken together, this is a scenario that points to continued global growth next year. In Modern Aggressive, as in Modern Growth, in late August we had a defensive attitude with equity holdings of 20 per cent and cash holdings of more than 20 per cent, motivated by great uncertainty and the lack of visibility in 2012. Although there are still many elements of uncertainty, the general mood about the future of Europe is more upbeat than one quarter ago. And above all, a number of assets have fallen to clearly attractive levels. Forward-looking price/earnings (P/E) ratios for equities at the global level are reasonable, and the spread between High Yield bonds and government securities is again above 700 basis points. As the markets began to stabilise, we gradually began to increase our exposure to markets with the best potential for growth Asia (9.5 per cent) and the Nordic countries (5 per cent). Although these regions tend to be more volatile than global equities, they have generally shown other good characteristics compared to EM countries generally. Although risk appetite will determine the performance of these markets in the short term, their potential viewed over 1-2 years is strong, provided we do not end up in a global recession. Total exposure to equities in Modern Aggressive is 36 per cent. High Yield bonds make up about two thirds of the fixed income sub-portfolio, which accounts for 30 per cent of Modern Aggressive. Most forecasters predict less than a 3 per cent rate of company bankruptcies next year, while the bond market is pricing in 7-10 per cent. Corporate balance sheets are historically strong, however, and High Yield bonds look clearly
undervalued. The remaining one third of the sub-portfolio consists of emerging market bonds, which continue to be attractive with their high coupons, and in some EM countries this is also potential for falling yields (= price gains). After the strong appreciation in the dollar, there is also great potential for exchange rate gains. We are maintaining our fixed income positions. To improve the ability of the portfolio to weather sharp downturns in the markets, we have increased the share of CTA hedge funds to 7 per cent. In this hedge fund strategy, returns vary significantly from one manager to another, and we have thus chosen to supplement our existing CTA portfolio with another manager who takes sufficiently high risks to fit into Modern Aggressives risk profile, but who still has a good track record and risk control. Global risks and the volatility of the financial system in Europe are continuing to hamper highly-leveraged business models, especially private equity. Although discounts to net asset value are again at high levels, we are choosing to remain on the sidelines due to generally high risk driven by uncertainty about the balance sheets and funding ability of banks and the liquidity situation in the market. Altogether, the Modern Aggressive portfolio is again exposed to market risk, but more selectively targeted to regions that are expected to drive global growth in the future. Return flows are, however, still spread across fixed income, hedge funds and commodities to ensure stable performance.
6% 7.5% 36% 20% Cash Commodities Hedge funds Fixed income Equities
30.5%
12
theme
13
How shall we view various assets given this perspective? equities Equities will remain attractive as an asset class in portfolios. Such factors as the growth of the underlying market, good pricing (low valuations), productivity increases and stable or preferably slightly rising prices are important. But in a climate of smaller economic fluctuations, selection will become more important. Because we will be living for a long period in a world that will still be dealing with large debt problems, it will become even more vital to identify where real growth is. Regions and economic sectors with good potential will generate better returns. The currencies of debt-burdened regions will also eventually be a challenge. It is conceivable to divide sectors and regions into three categories: Those with rapid growth in demand, currencies with good potential and rising productivity. Those that will basically grow at the pace of global GDP. Those with major debt problems that will affect demand. This analysis leads us in roughly the right direction, but if we wish to continue to genuine return-based investing, we must study the characteristics of the various equities. We must then select companies that have good balance sheets, stable sales and preferably a limited dependence on economic cycles. These companies should also have a stable dividend history. As an illustration, we asked SEB Enskilda to rank Stockholmlisted companies for us. The table below shows companies in which cyclical effects on dividends can be regarded as limited.
COMPANY
Market capitalisation (SEK m)* 7.2 4.7 6.8 5.0 4.5 5.1 5.2 4.7 56,307 193,468 41,998 401,309 22,287 340,945 68,986 15,069
tele2 teliasonera skanska astraZeneca securitas Hennes & mauritz sCa Holmen
14
In another ranking, we looked at companies that have generated a direct return of at least 3 per cent annually over the past decade (see the chart below). The chart also shows the beta value of these companies and indicates that the share price of this type of company moves less than the stock market as a whole, one of the criteria we specify for a good returnbased investment.
bond markets
Bonds are the classic return-based instrument, but government bonds have lost much of their attractiveness as yields have fallen. Nevertheless, corporate bond markets have now moved into the spotlight for various reasons. One of the big changes in Europe today is that more and more banks must trim their balance sheets. This means that companies will increase their borrowing directly via bond markets. The European corporate bond market will evolve exactly like the North American one. Our current view of corporate bonds is presented in the Fixed income section later in Investment Outlook. Here we will only focus on the structural change that will make corporate bonds a worthwhile form of investment for many years to come. We have recently invested quite a lot in corporate bonds, especially in the High Yield segment. This has given us valuable experience on how this asset class works. Our assessment is that corporate bonds have good risk characteristics, provided we practice healthy diversification.
20% 18%
Direct return (%)
1.2 1 0.8
Beta
0.74
0.28
COmpanies WitH HigH DireCt retUrns Have FLUCtUateD Less tHan tHe market
When we list those companies that have provided yearly direct returns of at least 3 per cent during the past decade (right-hand chart) we see that virtually all of them have had a beta value below 1, i.e. their share prices have fluctuated less than the exchange as a whole. This is a good example of exactly the combination we want to achieve in return-based investments: stable income flows at low risk.
Holmen
Stora Enso
Ekornes
Sanoma
Wartsila
Fabege
Peab
Veidekke
Kemira
Castellum
Kesko
Fortum
Uponor
NCC
SCA
15
theme
16
tricky. At present, credible long-term solutions to Europes debt problems appear to be the most important catalyst for such a peripeteia, as the turning point is called in a Greek drama. The second way of identifying opportunities amid the prevailing uncertainty is to analyse which of the assets that have fallen have done so for fundamental reasons, as conditions actually deteriorated, and which ones have merely been swept along in the price decline. Among the latter, the greatest potential may be found. One such example is Nordic equities, especially compared to equities elsewhere in Europe. It is not surprising that nonNordic European equities have generally been hurt, considering the problems in parts of the region. Non-Nordic Europe will be struggling for a long time with the effects of large debts and deficits, and a large proportion of its weak performance is definitely justified. And obviously the problems of these countries will affect the more strongly performing economies of the Nordic countries, just as weaker non-Nordic European demand will hurt exports from Nordic companies. But bearing in mind that the share of Nordic exports destined for emerging markets has steadily increased, and exports from non-Nordic European companies have been affected at least as severely, it is difficult to see fundamental reasons why Nordic companies as a category have fallen more than a broad European index (see chart). There is some justification for arguing that on the whole, Nordic stock markets have a larger element of cyclical companies that are likely to be more severely affected by increased uncertainty about growth. But it is also possible to suspect that the Nordic region is being punished because of the relatively small size of its stock exchanges (investors are selling off holdings in small peripheral markets). UnCertainty HUrts smaLLer markets mOre
110 105 100
Index
Larger-than-average price declines have also affected stock markets in the worlds emerging economies, especially in Asia, even though these countries seem to have the fastest growth and stable economies. The simple explanation for the relative weakness of Asian stock markets is these countries historical track record of instability and volatility, combined with the small size of many of their stock markets. This argument is beginning to sound threadbare, however. Another explanation may be that in uncertain times, markets do not seem to want to pay extra for growth, which may be a common explanation for value pockets that certain market segments are battered unfairly in turbulent times.
Index
90 85 80 75 70 Dec 2010 Feb Mar Apr May Jun Jul Aug Sep Oct 2011
Per cent
95
37.5 35.0 32.5 30.0 27.5 25.0 22.5 20.0 17.5 15.0
120 110 100 90 80 70 60 Dec 2010 Feb Mar Apr May Jun Jul Aug Sep Oct Nov 2011
USA, CBOE, Volatility Index (VIX) Nordic countries, OMX, VINX, 30 Index Emerging Markets, MSCI, USD Index US, Standard & Poors, 500 Composite Index
Europe, STOXX, Financials, Index, EUR Nordic Countries, OMX, Financials, Index, EUR World, MSCI, All Countries Index (LOC)
Repatriation of capital has benefited the larger American stock market and created outflows from the smaller stock exchanges of the Nordic countries and Asia.
Companies in the Nordic financial sector (mainly banks) have seen their share prices fall almost as much as those of their colleagues elsewhere in Europe despite clearly lower exposure to crisis-plagued countries and more stable financial positions.
17
shares may be justified. But when an entire category of potential growth companies is valued as if their earnings will be no higher than the market in general, there must be exceptions cases of undeserved share price declines. Some examples might be companies with fundamental support for their earnings forecasts, such as larger exposure to emerging markets or proven stability in generating earnings. The same reasoning (to close a large circle) can be applied to the markets in Asia. Smaller fluctuations in growth due to reduced export dependence and a higher share of domestic consumption, coupled with greater financial stability, indicate that as a group these markets might be assigned higher credibility and thus higher valuations compared to other countries than was previously justified. Other examples of assets for which the market has perhaps not succeeded in separating the wheat from the chaff may be Nordic banks, whose shares have fallen as much as those of their non-Nordic European colleagues, even though they are affected to a much smaller extent by the European debt crisis (see chart) and better capitalised than their non-Nordic European colleagues an appealing combination. Listed private equity (PE) companies have also been hard hit by the prevailing financial market uncertainty. They are being traded at larger discounts to net asset value (NAV) than during previous crises, except in the midst of the turbulence following the Lehman Brothers crash. Although the financial situation seems about equally uncertain, there are very few indications that there will be as deep a recession as three years ago. The financial stability of PE companies is also substantially higher, which may also indicate that discounts to NAV may be exaggerated, at least as soon as more stable risk appetite returns (see also the Private equity section).
over time, these investments have paid returns in the same range as the stock market, but at lower risk. This combination usually means that their market prices fall less during downturns and rise less during upturns. Lower risk does not necessarily mean that High Yield funds gain less ground than equities during all upturn phases. We have studied how the prices of different assets have tended to move during the past two decades following periods when the VIX volatility index has climbed above 30 or 40. Such high volatility levels usually indicate great market uncertainty and coincide with large selloffs, which often also represent buying opportunities (traditionally for equities). Our studies also show that stock markets as a group, twelve months after an upturn in volatility, have in fact performed well, but also that High Yield investments have delivered a return that exceeds most other asset classes, both in terms of average return and stability.
Corporate bonds with lower credit ratings (HY) 5.0% -2.8% 25.7% 23.7% 52.0% 14.7% 19.7%
When volatility has risen, it has usually been accompanied by positive market performance not so surprising in itself. Worth noting, however, is that High Yield bonds exceeded both equities and commodities in the recovery phases, both on average and in terms of the best/worst period.
18
theme
19
alternative scenarios
Given the high level of economic and financial uncertainty now prevailing, there is also reason to consider how alternative scenarios might look. a significantly more negative scenario than the one we view as most probable includes a deeper, lengthier recession in the euro zone and a more severe financial crisis that has global contagious effects, with both the OECD countries and the world economy slipping into recession. According to the International Monetary Fund (IMF) definition, a global recession occurs when world economic growth drops below 3 per cent. The risk of deflation, especially in the OECD countries, also increases significantly in this scenario, to which we are assigning a 25 per cent probability. If, on the other hand, the management of European government financial problems proves unexpectedly resolute, at the same time as the American and Chinese economies exceed expectations, this might lead to far more favourable performance than in our main scenario, with gradually accelerating GDP growth both globally and in the OECD countries over the next couple of years. Probability: 15 per cent.
50 40 30 20 10 0
The VIX volatility index which reflects financial market instability has usually fallen during economic upturns, but this pattern has not applied during the current recovery. Instead the index climbed sharply both in the spring of 2010 and in the late summer of 2011. The main reason is recurring worries about European government finances.
20
Increased uncertainty usually causes households to hold off on buying capital goods and causes businesses to postpone capital spending decisions, thereby lowering growth. Mounting concerns about the economy or European government finances or US fiscal policy may thus easily become self-fulfilling. In the next stage, lower growth would worsen government financial conditions, thus creating more worries, causing households and businesses to reduce their consumption and capital spending, and so on. It is therefore an obvious risk to the economy if increased uncertainty about government finances and/or the economy recurs frequently over the next couple of years reflected in a rising or constantly fluctuating VIX index since this would reinforce the vicious circle described above and lead to a trend consistent with our negative alternative scenario.
A more favourable scenario, with gradually accelerating growth, would lead to a favourable period for risk investments. Annual returns on equity investments, for example, should end up at least on a par with the post-war average (11 per cent), while returns on bonds in core countries would probably be lower than the historical average (2.5 per cent). High Yield bonds would provide both a high absolute and not least risk-adjusted return, while investments in the sovereign bonds of some problem countries (such as Ireland) may perhaps result in upside surprises. Conclusion: recurring uncertainty will trigger a worse scenario; greater predictability will lead to a better scenario. In a worse scenario, the pattern in asset markets would be reminiscent of the last financial crisis. Risk assets are not, however, likely to fall as much in value as then, especially not High Yield bonds, and the room for price increases on government bonds in core countries is now clearly smaller. In a better scenario, risk assets would benefit and in many cases should be able to provide returns equal or higher than historical averages. In this scenario, too, High Yield bonds appear attractive in both absolute and relative terms. Bonds of certain problem countries may prove to be jokers in the pack. maCrO tHe key tO retUrns On assets
17.5 15.0 12.5 10.0
Per cent
US, GDP volume growth, year-on-year US, Dow Jones industrial shares US, Merrill Lynch, High Yield index, USD World, Dow Jones Commodity Price Index, USD US, yields on 10-year Treasuries US, consumer prices, year-on-year
Economic fluctuations and other changes in the macro environment for example the trend towards lower inflation since the early 1980s strongly influence returns on assets. Government bonds have been favoured by falling inflation, reflected in gradually lower yields/rising market prices, but such risk assets as equities and High Yield bonds also benefit from lower inflation. Commodities were a fairly boring investment for a long time, but over the past decade they have occasionally offered excellent returns. High Yield bonds usually lose less value during recessions than do equities and commodities.
21
equities
A thriller unfolds
Asian and Nordic stock markets should recover lost ground No strained valuations in historical terms, despite stock market rally While sticking to our long-term positive view of equities, we are more defensive in the short term
According to Wikipedia, a thriller is a story that uses suspense, tension and excitement as the main elements, stimulates moods such as a high level of anticipation, ultraheightened expectation, uncertainty, anxiety, suspense (and) excitement and uses such devices as the cover-up of important information. The observant reader will already have spotted the similarity between the thriller genre and the current world of financial markets. Recently, whenever we think we might be close to a normalised market and out of the woods, there has been a tendency towards continued surprises, leading the market in all kinds of directions. Economic, financial and political turmoil has been the norm rather than the exception during the past few quarters. In our latest Investment Outlook (published September 13, 2011) we argued in favour of investors holding on to their equity exposure after heavy market declines during late summer. Markets had fallen dramatically both on the notion of decreased global growth and a growing fear of systemic risk (bankruptcies in financial institutions followed by a liquidity squeeze). According to our models, markets were discounting fairly bearish growth in world GDP of about 2.5 per cent, while economists on average were expecting a more optimistic growth scenario of 3.5-4.0 per cent for the coming 12 months. As a consequence of this discrepancy, we stated that risk/reward ratios favoured maintaining current equity exposure and that policy interventions, preferably global, would hopefully initiate a rebound from fairly depressed levels. By the end of September an increasing belief in an upcoming package solution from European politicians started to get a foothold in the market. At the mother of all EU summits on October 26-27, politicians agreed to expand the European Financial Stability Facility (EFSF) and take steps to recapitalise European banks and restructure Greek debt. Markets reacted quite strongly and most major equity indices ended October up 12-15 per cent for the month. As a consequence of rising equity markets, current implicit expectations of growth in world GDP are at 3.0 per cent (with the S&P 500 at 1285). In the meantime economists have lowered their expectations, thereby narrowing the gap. We are now left with a more traditional approach to equity market valuation, where future growth is the most relevant issue. In this scenario we find it prudent not to increase risk, as we fear that it is too early to write off the ongoing situation in Europe and that the growth outlook is quite uncertain. LOW vaLUatiOns reasOn tO bUy eQUities
80 70 60 50 40 30 20 10 0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
1,800
Source: Factset
Price
One factor that favours equities is todays historically low market valuations. The chart illustrates the ratio of Swedish market capitalisation to expected earnings (P/E) and to book value (P/BV). At present these are well below their 10-year historical averages. We see similar tendencies in Norway and in Europe generally, but the picture is more neutral in the US, where the ratios are currently close to their historical averages.
22
Equities
Stock markets and bond markets currently reflect divergent views on the future path of financial markets. While stocks have rallied since early October, one of the most critical risk parameters in the current EU turbulence Italian government bond yields have risen sharply and are currently well above 7 per cent. This is not a sustainable level and will require action by the European Central Bank (ECB) and EFSF to bring yields down. Factors that favour equities include price/book value (P/BV) ratios and price/earnings (P/E) ratios well below 10year historical averages. This is in strong contrast to the pricing scenario in the last two major equity market downturns in 2001 and 2008. The corporate sector is also in a strong position, with healthy balance sheets and decent flexibility, making it well equipped for unexpected events. Third quarter reports have generally led to a sense of relief, with 41 per cent of Nordic companies having exceeded SEB Enskildas estimates of earnings before interest and taxes (EBIT) by more than 5 per cent. At this writing, the Q3 positive/negative surprise ratio has so far been at 2.2, the highest since the third quarter of 2010. Financial markets are currently behaving in a very risk on / risk off mode. The fact that most equity markets have moved in a synchronised manner makes it more challenging for investors to diversify their equity exposure. The markets total focus on the European sovereign debt crisis has overshadowed fundamental factors that create different conditions from a country perspective, such as growth, indebtedness and monetary policy. There is no quick solution to the euro zone crisis, and worries about sovereign debt in Europe are likely to rattle financial markets from time to time. However, our main scenario is that the global recovery will continue and that the euro project will survive the challenges it now faces. Eventually todays market climate characterised by either flooring the accelerator or putting both feet on the brake pedal is likely to shift to a climate where investors increasingly focus on fundamental distinctions between the stock markets of different countries.
7% 6% 5% 4% 3% 2% 1% 0% 2012 2013
Source: Reuters EcoWin/SEB
23
Equities
economy and fuel risk appetite, but at the same time there is no ammunition left in the interest rate weapon. The market is unlikely to be positively surprised by key interest rates that are parked around zero, since this is already taken for granted, and further interest rate cuts are impossible. However, there is room for further quantitative easing (QE) rounds. For example, we believe that the US Federal Reserve will launch its third such round (QE3) in mid-2012, which is likely to fuel the stock market. In most emerging market countries, however, the interest rate weapon is fully loaded with real ammunition. Reduced inflation pressure in the EM sphere is now also laying the groundwork for central banks to pursue more stimulusoriented monetary policies with a good conscience. The ability of certain countries to sharply lower the price of money is likely to be vital, especially in a climate where global economic growth is well below trend. The potential for economic stimulus via fiscal policy also varies significantly between different parts of the world. In many debt-burdened Western countries, governments are being forced to tighten their fiscal policies to prevent already soaring deficits from growing even faster. They have delivered far-reaching austerity packages in rapid succession, and measures aimed at bringing debt under control are likely to hamper economic growth for many years to come. Especially in emerging Asia, however, the situation is the opposite; governments are ready to flex enormous fiscal muscle if economic activity fades. Financial stability is a factor that is likely to attract investors more and more. It is no secret that debt burdens vary significantly between countries, but meanwhile we do not believe that this is being reflected in todays asset prices. When the markets risk on/risk off behaviour fades, the finances of the US, Japan and the UK which are in tatters to say the least are likely to end up being more closely examined by investors, and financial stability will help guide their allocation by region.
Currency movements are a variable with several dimensions from an investment standpoint. Among other things, a weaker currency may strengthen a countrys competitiveness and vice versa. But in many cases, todays companies are so globalised that it is difficult to know where their production costs and sales are located. Thus the scoring system in the model instead takes into account the direct effect on returns for those who invest in foreign equities. A stronger currency thereby contributes positively to total return, while a weaker currency contributes negatively. In todays turbulent market climate, investors demand high-volume, liquid currencies such as the US dollar, Japanese yen and Swiss franc. Assuming that there will be no quick solution to European problems, the liquidity aspect is likely to continue dominating the foreign exchange market. Once the acute situation in southern Europe eventually calms down, more fundamental factors will set the agenda. This will probably benefit commodity-dominated, EM and Nordic currencies.
17.5 15.0
CPI inflation, % year-on-year
12.5 10.0 7.5 5.0 2.5 0.0 -2.5 2006 2007 2008 2009 2010 2011
-2.5
24
Equities
There are also many indications that Asian currencies will appreciate in the future. Among other things, stronger Asian currencies will be an important tool for dealing with the enormous trade imbalances that have built up between West and East. A number of Asian countries should also have a positive attitude towards seeing their currency appreciate, since this will help ease inflation pressure. In our model, Asia is represented by China and India, and China wins the contest in terms of its score. The Nordic countries have various similarities with Asia. Their growth rate is admittedly at a much lower level, but their financial stability is good. They also have some room for monetary and fiscal stimulus policies. Another similarity between Asia and the Nordic countries is that major investors still view these regions as peripheral markets. The turbulent stock market movements of the past six months have caused market players to sell their holdings in distant markets and instead shift their demand to highly liquid stock markets. A number of EM stock markets as well as the Nordic markets thus show larger share price downturns than fundamentals would justify (in the range of 15-20 per cent), while US stock exchanges have hovered around zero. Nor are the EM or Nordic countries plagued by minimal growth figures and gigantic debt mountains. In a market climate where investors are increasingly examining the fundamental differences between countries, a number of unjustifiably depressed stock markets are likely to regain some lost ground.
25
Fixed income
27.5 25.0 22.5 20.0 17.5 15.0 12.5 10.0 7.5 5.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2.5
Brazil, key interest rate (SELIC) China, key interest rate (0-1 year lending rate)
India, key interest rate (repo rate) Russia, key interest rate (refi rate)
Key interest rate hikes in the BRIC countries (Brazil, Russia, India and China) appear to be ending, and Brazils central bank has already lowered its rate twice this year. In both China and Russia, the next step is likely to be a rate cut, while there is greater uncertainty about how the Reserve Bank of India will use its interest rate weapon.
26
Fixed income
the coming year. In the case of the ECB, QE efforts mainly purchases of sovereign bonds from troubled countries will be affected by such factors as the future capacity of the European Financial Stability Facility (EFSF). While central banks in the OECD countries are digging everdeeper into their kits to find tools, the time will soon be ripe for a shift to traditional monetary policy easing (key interest rate cuts) in many EM countries. The reason is that previously overheated economies are now gradually cooling and that cost and price pressures will soon ease. Among the BRIC countries, Brazil has already lowered its key interest rate twice this year. India hiked its key rate in October, but signalled that this may mark the end of its hiking cycle. Our basic prediction is that during 2012, many EM central banks will follow the example of Brazil and cut interest rates. The outlook for government bond yields in the OECD countries and the EM sphere is also divergent. OECD inflation will indeed be lower and a number of central banks are large buyers of government bonds, but on the other hand public sector funding needs are enormous. Together with the prospect of gradually rising risk appetite in markets this coming year which usually decreases investors interest in government bonds this ultimately points towards somewhat higher OECD government bond yields in 2012. In the EM countries, public sector deficits are far smaller, money market rates are actually falling, inflation is slowing and government bonds are tempting to investors if risk appetite increases. Conclusion: EM Debt is a far more attractive fixed income investment than OECD government bonds.
financial crisis of 2008 and the first half of 2009, the bankruptcy rate reached about 13 per cent. If contrary to our assumption a recession occurs in 2012, it would nevertheless be far milder than the unusually deep one of 2-3 years ago. Meanwhile HY-issuing companies around the world are in far better financial shape now than during that recession. The latest global bankruptcy statistic for High Yield-issuing companies is 1.8 per cent (12-month figure), and current forecasts from the rating agency Moodys for the coming 12 months are 1.4-2.1 per cent (the average since 1983 is 4.9 per cent). Since the beginning of 2011, only 17 HY-issuing companies included in the global index (1,291 issuers) have gone bankrupt, equivalent to 1.3 per cent. As for the health of companies in the High Yield sector, the positive picture presented in the issue of Investment Outlook published on September 13, 2011 is unchanged: a good earnings trend, substantially lower indebtedness, a considerably higher percentage of liquid assets in balance sheets and extended maturities on company bond loan portfolios. We thus conclude that general risk appetite will remain the primary factor affecting HY market performance. If the prevailing deceleration is a temporary mid-cycle slowdown, and if global growth gradually strengthens during late 2012 and in 2013 in keeping with our main scenario, investments in HY bonds and other risk assets will probably perform better than investments in OECD government bonds. And this would be consistent with the market pattern since March 2009. HigH yieLD bOnDs OUtperFOrming eQUities
112.5 110.0 107.5 105.0 102.5
Index
100.0 97.5 95.0 92.5 90.0 87.5 Dec 2010 Feb Mar Apr May Jun 2011 Jul Aug Sep Oct Nov
Standard & Poors, 500 Composite, Index, CBOT, Dow Jones CBOT Treasury Index Merrill Lynch, High Yield Master Index
Last spring the financial market mood was decent. US equities and High Yield bonds thus beat government bond investments. But since then there have been major shifts, with dramatic price declines on risk assets in August-September followed by a strongly positive October rebound. Since then choppiness has predominated. Investment ranking so far in 2011: 1st Government bonds, 2nd High Yield and 3rd equities.
27
Hedge funds
relative value
Relative Value managers in fixed income investments got a rather good start in July, while August and September provided a more mixed picture. Flight to safe government securities and huge fluctuations in risk appetite characterised the period. Managers with a negative outlook performed somewhat better, and managers who traded actively between long and short positions were able to generate positive results by dealing with flows, macroeconomic news and technical behaviours in a skilful way. The actions of central banks during the quarter and in the future will create attractive investment opportunities for fixed income strategies. In the US, Operation Twist began in September for the purpose of keeping long-term yields down. This may drive investors towards the short end of the yield curve, which could make bank loans and High Yield bonds especially attractive. Some valuations were extreme during the quarter; for example, CDS spreads priced in a bankruptcy level of 20 per cent for senior bank bonds in September. Looking ahead, there will probably be major upturn potential for bonds when there is favourable news about the euro crisis. We are positive towards Relative Value during the next quarter.
equity Long/short
Market conditions for Equity Long/Short have remained exceptionally difficult. Correctly gauging the direction of the market would have required correctly predicting the moves of political leaders and the markets reactions to them, which is an impossible task. Not even market-neutral strategies did especially well; the downturn was 6.1 per cent for the quarter.
28
Hedge funds
Although the number of corporate events continued to decrease, as we predicted in the last Investment Outlook, it was write-downs to current market prices that caused most of the losses. Distressed showed decent resilience to the stock market during July, but could not withstand the continued pressure during August and September. As managers lowered the risks in their portfolios, popular holdings in particular were subjected to disproportionately large downturns. Companies continue to have high cash reserves and generally strong balance sheets. During an economic downturn, various companies will probably seek higher revenues through corporate deals. This is likely to lead to a reasonable investment climate for Event Driven strategies in the future, but todays turbulence in the euro zone will probably hamper activity in the near future. Event Driven and Distressed are not strategies we recommend at present.
On the whole, CTA and Systematic Macro showed positive results during the quarter, but here too the differences were noticeable. Asset allocation was crucial, with fixed income holdings accounting for the largest contribution when risk assets were sold off in the markets. At present, the risk/opportunity ratio looks somewhat different from the beginning of the quarter. Structurally negative managers will presumably tone down their conviction that markets will move in their direction, while more optimistic ones will see an increased probability of being right. Great uncertainty and significantly different market perceptions should create good potential for generating returns. CTA and Systematic Macro are viewed by most observers as a tool for portfolio diversification that is expected to perform well when other asset classes are having difficulty. Holdings in fixed income securities are the single largest position of most managers, which in itself signifies a risk of substantial losses if the market situation improves in the long term, but since managers are now positioned a little more cautiously they can be a little faster in their reactions. Macro and Trading remain our first choices among hedge fund strategies in the near future.
STRATEGY
INDEX Oct-Nov Q3
PERFORMANCE % 2011 YTD (Nov 10) -6.45 -10.97 -5.42 -6.78 -0.85 -7.82 -17.63 -3.51 -3.94 -3.72 2010 5.19 8.92 7.65 1.98 -1.73
HFrX global Hedge Fund HFrX equity Hedge HFrX relative value arbitrage HFrX event Driven HFrX macro
29
real estate
100 90 80 70
USD billion
60 50 40 30 20 10 0
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
Americas
EMEA
Asia Pacific
30
2011 Q3
Europe recorded greater activity in the real estate market during the third quarter of 2011. Activity remained high despite escalating sovereign debt problems, partly because a number of delayed transactions from the second quarter closed in the third. One positive surprise was that volume nevertheless rose both quarter-on-quarter and year-onyear. EMEA = Europe, Middle East and Africa.
Real estate
But we would like to point out that real estate transactions, despite the delays, are still being concluded. An optimist can find a further bright spot: the nearly panic-stricken flight to quality that we saw earlier in the autumn has eased off. This is reflected in the fact that yield requirements for quality properties are no longer shrinking as much. Meanwhile we are seeing some decline in the risk premium in somewhat riskier markets, including the US. This is a signal that some investors have begun to move upward on the risk scale in the real estate market, but it is still too early to determine whether this will be a shortterm trend or the beginning of a turnaround.
31
private equity
Private equity (PE) has performed relatively well in recent months. Since the last Investment Outlook, the SEB Listed Private Equity Fund has risen by 3.5 per cent, with large fluctuations along the way. However, private equity has fallen by more than 22 per cent this year, making it one of the asset classes with the largest declines. The question is whether this downturn is justified, insufficient or exaggerated. In our assessment it is exaggerated, provided that the world (read Europe) is not on its way towards a major financial meltdown and/or a period of marked recession.
2011-01-14
2011-01-28
2011-02-11
2011-02-25
2011-03-11
2011-03-25
2011-04-08
2011-04-22
2011-05-06
2011-05-20
2011-06-03
2011-06-17
2011-07-01
2011-07-15
2011-07-29
2011-08-12
2011-08-26
2011-09-09
2011-09-23
2011-10-07
2011-10-21
2011-11-04
60
Equities: MSCI World Index Private equity: LPX 50 Index S&P Global 1200 Financials
It seems reasonable that the shares of listed PE companies have performed worse than the stock market average, given their higher leveraging and larger dependence on financial stability. But price declines as large as the hard-pressed financial sector seem like an overreaction.
However, there are reasons to believe that the price decline (which has led to the rising discounts) may be exaggerated. NAV remained satisfactory during the past quarter partly because the underlying businesses generally performed well. Reports from American companies in particular show continued good activity in their operations and largely stable earnings expectations. Reported NAV for European companies is also largely stable, but we are seeing some slowdown in earnings growth.
32
Private equity
In some cases, NAV has remained satisfactory because earlier reported NAV was set too conservatively. Many PE companies have reported their portfolio companies at cost, even though in many cases rising profits justified revising their valuations upward. Together with generous premiums for low liquidity (some companies have reported large portions of their holdings at 75 per cent of estimated NAV), this has provided a large valuation cushion. Also illustrating this is the fact that many of the portfolio company divestments that occurred late in 2010 and early in 2011 occurred at premiums of up to 30 per cent on reported NAV. This may at least partly offset the effects of falling company values.
debt. Put simply, the wall of debt problem that companies faced a year or so ago due to gigantic debts that were falling due has essentially been resolved, although stock market turbulence has limited their ability to sell portfolio companies (exit). If the exit market ceases to function and divestments are postponed, the market also tends to adjust its valuations of PE companies accordingly. This is not unreasonable in itself, but there is a risk of exaggeration. The present value of the proceeds from a divestment indeed becomes smaller the longer it is postponed, but since growth is decent this may at least partially be offset by rising value generated by company profits. Another factor to take into account is whether the market may have exaggerated the risk in PE companies. The quality of their portfolio companies is generally higher than many observers seem to believe. Despite high leveraging in many cases, the previous very deep recession and the related financial crash claimed few victims only about 1.5 per cent of portfolio companies went bankrupt at that time. The major challenges that the global economy and financial system are facing naturally have an adverse impact on the PE sector. Because of financial market turbulence, short-term forecasts of valuation trends are out of date before they have a chance to reach their recipients. This also makes long-term forecasts unusually uncertain. It is clear, however, that much of the risks have already been priced in. Since PE companies are significantly better equipped today, with more stable finances and conservative valuations, the risk-return ratio appears attractive. In all scenarios except the most pessimistic of all, the danger of further declines appears more limited than in other high-risk investments, while the potential for recovery should be rather good. There is, however, a potential for weaker performance in the short term, given the turbulence and risk of more long-term effects from the damage that is affecting the European financial system.
2003 2004 2005 2006 2007 2008 2008 2009 2009 2010 2010 2011 2011 H1 H2 H1 H2 H1 H2 H1 H2
Listed private equity
Secondary market
33
Commodites
energy
Despite recently escalating concerns about developments in southern Europe and their impact on global economic growth, oil prices have remained at levels of around USD 110/barrel. A tight supply/demand situation for both diesel and heating oil is keeping prices up. This situation will probably not ease, now that the Americans are entering their heating season with increased demand for energy. In addition, China has been hit by drought, leading to a shortage of hydroelectric power that is being offset by running diesel generator sets. Low European oil stocks, currently at levels close to nine-year lows, are providing further support for oil prices.
1 020
Millions of barrels
Source: IEA
February December June July September November May August January October Mars April
5 year average
2011
34
Commodities
industrial metals
This autumn, players in the market for industrial metals have primarily been concerned about weaker demand due to lower economic growth, rather than restricted supply. Developments in China are a crucial factor in the trend of industrial metal prices, since China accounts for about 40 per cent of global consumption of these metals. A hard landing in the Chinese economy would thus have a major impact. We expect China to avoid this and to loosen its monetary policy in the near future, which will provide support for metal prices. After price declines in late summer and early autumn, prices of some metals are now below their marginal cost. Obviously production costs higher than the price of a metal is a situation that is not sustainable long term and that will support price increases ahead. Copper is one exception, with the metal being traded with a margin above production cost; it is also the metal that is most sensitive to developments in China. Justifying lower metal prices than today requires a higher risk of a Chinese hard landing. Weaker economic growth in the OECD countries will probably have only a marginal negative effect on prices. This is because demand never recovered after the 2008 crisis and there is thus limited room for further decline. We expect somewhat higher metal prices in the coming year, driven mainly by demand from China and the fact that a number of metals are currently not profitable to produce.
For cotton in particular, we view price increases as probable. The main arguments for this are globally low stock levels and the fact that after last springs decline the price of cotton is now low, at least compared to other agricultural commodities. Since there is competition for arable land, more producers will choose to cultivate other products, thereby decreasing the supply of cotton.
precious metals
Gold is continuing to perform well in the prevailing environment of extremely low interest rates and great uncertainty about economic growth. Volatile stock markets and low risk appetite have historically favoured gold, which is viewed as a safe harbour. After a sharp upturn during the second half of the summer, this trend was temporarily interrupted and gold prices fell by about 15 per cent in September. Now gold has resumed its rising trend, which has been under way since late 2008. High and possibly increased market liquidity, negative real interest rates and systemic risks will be underlying forces that drive gold prices in the future. Government are currently net buyers of gold, thus providing further support. We expect somewhat higher gold prices during 2012.
agri-commodities
It is no easy task to predict whether agricultural commodity prices will rise or fall. Forecasting the future supply/demand situation and thus world price trends requires aside from some idea of global growth and current stock levels an assessment of how weather conditions and thus future harvests will turn out. We believe that prices of agricultural commodities will remain high in the medium term, since there is fundamentally good demand for most types of grains. The La Nia weather phenomenon is not expected to be as powerful as it was in 2010, but it will still create some uncertainty, especially since commodity stocks are low. If it takes a long time before rain falls, this may lead to further drought in already hard-hit areas of the US. Another scenario linked to La Nia is too much rain. If this should occur, there is a risk of damage to harvests in Australia, for example. As long as the risk of production disruptions haunts the market, agricultural commodity prices are likely to remain at high levels. When uncertainty decreases, prices should fall again. We are thus anticipating relatively unchanged prices in the short term, but falling prices in a longer perspective.
35
Currencies
cies such as the US dollar, Japanese yen and Swiss franc gain ground at such times. Meanwhile smaller peripheral currencies such as the Swedish krona, Norwegian krone and many emerging market (EM) currencies lose value. When risk appetite increases, the market shifts its attention to more fundamental factors, like GDP growth, government debt and current account balance. There is a clear dividing line here between OECD and EM countries. As a rule, the EM sphere is showing high growth, low debt and current account surpluses, whereas the opposite is often true of various OECD countries. When risk appetite is high, interest rate spreads play a significant role. When investors take advantage of interest rate spreads, they borrow where interest rates are low and invest where they are high (the carry trade). There is thus downward pressure on the currencies of countries with low interest rates, while currencies of high interest rate countries appreciate. A final, detailed solution to the European debt crisis is far from being in place. Some important steps in the right direction have been taken, but there are still many question marks. The process is not likely to be painless, but will probably occur according to the two steps forward, one step back principle. Fluctuating risk appetite is thus likely to continue dominating markets, which will occasionally favour larger currencies with safe harbour status. Cyclical currencies like Scandinavian and commodity-based ones will face a tough environment during the next six months or so, with fluctuating risk appetite and weak growth. Generally, however, these countries are characterised by fundamentally strong economies and good public finances. Once the acute situation in southern Europe calms down, cyclical currencies are likely to become more attractive as the market focuses more on fundamentals.
-20%
-15%
-10%
-5%
0%
5%
Since September 2011, emerging market currencies have lost value against the USD. The reason is that investors have preferred large, liquid currencies when markets have been turbulent.
During periods when investors flee from risk, the liquidity of a currency is by far its most important feature. Large curren-
36
Currencies
In addition, the European Central Bank (ECB) recently lowered its refi rate unexpectedly to 1.25 per cent, narrowing the interest rate spread compared to the dollar. There are also many indications that the ECB will carry out another rate cut to 1.0 per cent at its next monetary policy meeting in December. On the other hand, the dollar is weighed down by a sizeable current account deficit. It is also an election year in 2012 and the outcome is uncertain, to say the least. President Barack Obamas popularity has fallen and it seems to be extremely difficult to create a broad consensus on US fiscal policy. Despite an even match, in the near future the USD will seem to be the less bad alternative. We expect the EUR/USD exchange rate to move towards 1.25 (today about 1.35).
continue to buy less and less, the authorities are likely to be cautious about letting the yuan rise too fast. In addition, inflation pressure in China has eased somewhat in the past month and the dollar has strengthened on a broad front. Due to the yuans connection to the USD, this has also caused the value of the CNY to increase. We expect the Chinese currency to continue appreciating, with a USD/CNY exchange rate of 6.10 in December 2012. The USD/CNY rate is around 6.35 today.
6.65 6.60 6.55 6.50 6.45 6.40 6.35 Jan Feb Mar Apr May Jun 2011 Jul Aug Sep Oct Nov 6.30
Index
Chinese authorities are likely to continue letting the yuan appreciate in value against the USD, but due to lower global growth, decreased inflation and a stronger dollar, the pace may slow.
Since 2007 the value of the yen has steadily increased, but a key interest rate parked close to zero and a large debt burden in Japan are likely to be negative factors in the yen's future.
37
SEB is a North European financial group serving 400,000 corporate customers and institutions and more than five million private individuals. One area with strong traditions in the SEB Group is private banking. From its founding in 1856, SEB offered financial services to wealthy private individuals. Today the Group has a leading position in Sweden and a strong presence in the other Nordic countries and elsewhere in Europe. SEB Private Banking has a broad client base that includes corporate executives, business owners and private individuals of varying means, each with different levels of interest in economic issues. To SEB, private banking is all about offering a broad range of high-quality services in the financial field tailored to the unique personal needs of each client and backed by the Groups collective knowledge. SEB Private Banking has some 350 employees working in Sweden, Denmark, Finland and Norway. Outside of the Nordic countries, we take care of our clients via offices in Estonia, Latvia, Lithuania, Switzerland, Luxembourg and Singapore as well as a branch in London. On September 30, 2011, our managed assets totalled SEK 240 billion.
www.sebgroup.com/privatebanking