Good morning,

Markets are called to open flat this morning. This is what's happening today:

  • Treasuries have rallied since the Nov. 6 re-election of Obama and a split Congress on concern they’ll be unable to avoid the so-called fiscal cliff, more than $600 billion in spending cuts and tax increases that will be triggered if no budget compromise is reached. The Congressional Budget Office reiterated that a failure to strike a deal would lead to a recession in the first half of 2013;
  • Chinese industrial-output growth probably accelerated for a second month to 9.4%, according to the median economist estimate in a Bloomberg News survey;
  • Chinese data earlier today showed consumer prices in October rose 1.7% from a year earlier, slower than the 1.9% level in September;
  • Gold climbed to a three-week high and is poised for its best performance in 11 weeks as prospects of more stimulus in the U.S. and the debt crisis in Europe boosted demand. The spot price touched $1,735.70 an ounce, the most since Oct. 19;
  • In Europe, finance chiefs won’t make the call to release E31.5 billion of aid for Greece that has been frozen since June when they meet in Brussels on Nov. 12, the official said on condition of anonymity because the deliberations are private. Ministers will await a final report from the so-called troika that oversees euro-area bailouts on Greece’s efforts to meet the conditions of its second rescue since 2010 before taking action, the official said;
  • 10-year Italian debt is yielding 5.012%, 10-year Spain is yielding 5.836% and 10-year Portuguese debt is yielding 8.47%;
  • Brent is trading at $107.47;
  • Apple closed the session at $537.75

The markets have been selling off ever since Obama was re-elected president. This time the problem isn't China or Europe. The reason for this sell-off is simple. The US has a deficit of US$1trn which is unsustainable. Obama now has to present a budget to Congress and if the House and Senate do not agree on the budget, $600 billion in spending cuts and tax increases will be triggered, and the US would be back in recession in H113. Obviously company valuations were based on a growth rate of 2% going into 2013 so you can imagine what is causing this negativity in the market.

The last time President Obama had to deal with the fiscal cliff, he put it on the back burner and solved the problem for the immediate short term by increasing the debt ceiling. This cost the US its AAA rating. This time is different. This time there will be no short term fix. This time congress is telling the President that if his budget for the new year is not accepted, they will implement the austerity measures themselves and the US will go into recession.

But it doesn't stop there. Like Europe was effecting the US negatively when the European crisis unfolded, now the US is effecting the rest of the world. China was just starting to show an improvement in its numbers. The question is, 'how long will this last' now that the US could easily fall back into recession in 2013? But even before the talk of the fiscal cliff, the EU commission reduced the growth forcast for the Eurozone to just 0.1% from a previously expected 1% in 2013. So 2013 is going to be a much more challenging year than people expected. As if all this wasn't enough, the motor of the European Economy is also feeling the pressure as Germany is now slowing down. Germany's strength was being backed by peripheral Europe and the rest of the world. Peripheral Europe have now cut their imports to tackle their debt problems and the US and China are slowing down so demand is not what it used to be.

We are already seeing investors move to safe havens like gold and treasuries. It is quite ironic to see investors move into US treasuries when the problem is the fiscal cliff in the US! But in hindsight we saw treasuries rally even when the US lost is AAA rating. So the question investors are asking now is where to invest. In the high yield market, prices have shot up. Yields on the bund and gilts are at very low levels, dividend paying stocks in the US are getting hurt because of the higher taxes investors will have to pay and the outlook is not looking good so investors are worried about getting into equities.

I'll tackle one at a time. Let's start off with gold. Everytime there is a problem, people rush into gold without taking into account how high the price of gold is already. If you take all the gold reserves in the world and compare the price you are paying to other potential investments, it is a know fact that gold is very expensive. So I don't think its the wisest place to be invested at this point in time.

Neither do i think that an investment in Treasuries, the bund or gilts would make sense at such low yields. Any turn the the market would start shifting yields up and prices would go down hurting your capital.

With regards to high yield I wouldn't worry too much about the valuations at this point in time. Don't forget that alot of companies with high yield bonds are cash rich and this is what's keeping yields low. Ironically, a slowdown in the market isn't the end of the world for bondholders. If the company does not have growth prospects, it keeps holding on to cash in the short term till the situation improves. This means that companies have more cash on their balance sheet then they did before so the probability of them paying back their debt is much higher.

The same applies for banks. When I say banks i don't mean the banking sector but the strong banks with healthy balance sheets like BNP, Barclays, HSBC etc. It is true that because of the crisis these banks are not generating as much revenue from loans as they did in the past. But that is not a reason to sell. The ECB has injected alot of money into the banking system. And the fact that this money is not being circulated but is being kept by the banks is ironically a good thing for bondholders because it means that the banks are cash rich and have more cash then before to pay back their debt.

Then there are equities. I have been saying in my previous blogs that it was time to call it a day in the US and move into Europe and Emerging Markets. It is true that we are seeing a slowdown in Europe as the European Commission cut growth forecasts for 2013 but it is also true that European valuations are much more attractive than US valuations at this point in time. And it is in periods like these that it makes sense to build positions in good companies to be able to take advantage of the rally once things start to improve. Don't forget that companies are cash rich and a lack of growth opportunities could result in companies increasing their dividend policy or use the cash in ways that shareholders get a better return.

Despite the negativity we are seeing in the markets, I see more opportunity. From hindsight I have learnt that when the market sells off, it is time to start picking the good stocks and build a position. On the other hand when everyone is buying the market it makes sense to be a contrarian and sell into strength. There are companies which are doing well despite the slowdown we are seeing. Don't forget that although growth forecasts are being cut, stocks are trading at a discount to their long term average. The problem would be if stocks were expensive. Then a sell-off would be even more of a concern.

Always keep in mind that an investment is equities is not made for the short term. In the short term anything which is unexpected could happen. Be it hurricane Sandy or Obama becoming president, What's important is that the companies you hold remain strong buys for the right reason. In time you will see the return in your portfolio.

Stock to watch: Arkema (Price E73.24, Price Target E87)

Deutsche Bank Comments – Good results despite macro pressures, supported by niche growth: BUY. Arkema reported good Q3s with EBITDA flat YoY despite macro pressures and the base effect. This was 2% above our forecasts due to better-than-expected margins in both divisions. On outlook, mgmt has reiterated its ‘’close to E1bn’’ EBITDA guidance (DBe: E1004m). Post these results, we have modestly increased our 13-14E EPS. We continue to believe Arkema’s assets quality and niche growth (increasingly visible in the new reporting structure) remain underestimated by the market with a valuation at just 8.5x 13E P/E and 5.1x 13E EV/EBITDA (16% and 13% discount to peers). BUY

For further information on Arkema or other stocks and bonds we follow, contact our offices on 25688688.

Good day and happy trading!

Kristian Camenzuli