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Good morning, markets are called higher this morning. This is what’s happening in the markets today:
The markets rallied yesterday after Bernanke’s speech. The Federal Reserve Chairman hinted that the economy is doing good progress but in order for the progress to be sustained there is need for expansionary monetary policy. Bernanke did not say when or by how much but the fact the Fed said that it needs to intervene is taken as a positive sign by the markets.
The markets like it when the federal reserve intervenes because more money in the economy means greater potential for growth. The Fed had said in the past that its target is a 2% inflation rate and its main priority is inflation rather than growth. However, inflation is contained and therefore expansionary monetary policy could take place. It came as a surprise because elections are coming up next November and I’m sure Bernanke isn’t in an easy situation. But more easing although has negative long term repercussions is considered a good thing short term. Plus it will make up for the lack of growth in the rest of the world particularly Europe.
I’m participating in this rally though I’m fully aware that the markets isn’t rallying for the right reasons. This is why. The increase in prices we are seeing is an anomaly. Normally towards the end of a quarter we see prices consolidating because fund managers are more worried about closing off the quarter than trading in the markets. However there are four trading days left before month end and all those hedge fund managers who did not participate in this rally need to get in the markets and get as much upside as they could before we close off the month. But hedge funds are not the only ones pushing prices up. Also the retail investor who tends to come into the market at the end of the rally starts picking up stock. These two reasons are why the markets are going up. Because in actual fact the value of shares traded on the SPX is still around half that what is normally traded on average. Yes further increase in firepower of the EFSF and ESM is good news, yes further QE3 from the Fed is good news and yes further quantitative easing from China is good news. But if you think about what these governments and institutions are saying is that without our intervention the economy will not keep on growing. Don’t forget the Fed just hinted about QE3 and did not actually carry out QE3. I find it a bit hard personally to see how the Fed will implement QE3 in election year. Regarding Europe, further firepower is good, but why do the Germans want it now? Could it be they are getting cold feet when just a few weeks ago when the IMF said that they will only further contribute to the EU if the EU itself increases its contribution? And lastly expansionary monetary policy is expected to come in from China but nothing is yet for certain. It is dangerous to a certain extent to chase a rally when the markets are up 20% year to date on expectations rather than facts. However, I am still of the view that the US and emerging markets particularly China and Indonesia are what your portfolio should be exposed to.
America is a great place to be invested at this point in time. Jobs are being created, the Fed is helping the economy grow, the economy is expected to grow above 2% whereas Europe is expected to go into recession and the Dollar is expected to strengthen as foreign direct investment in America increases. Wages in emerging markets are increasing, so certain firms have started to produce the goods at home. This is increasing demand for labour in the US. People are spending and the housing market is picking up. The faster the housing market picks up, the lower the unemployment rate will go as the value of housing increases and people won’t be incurring large losses on their property. There is still a long way to go, but despite all the negative sentiment coming out of Europe, the US is making its own way.
Moving on to Europe, this weekend there is a finance ministers meeting. Germany now is considering increasing the firepower Europe has to E1trn. One of the ways it can do this is the EFSF doesn’t remain a temporary fund but instead becomes a permanent fund. The markets will feel comfortable knowing there is E1trn which countries in need of bailout money can refer to. It can also be a dangerous move however because it could be seen that indebted countries can continue adding on to their debt because if the worst comes to the worst they can always find bailout money.
What about the PIIGS? The market is telling us that the country which will follow Greece is Portugal. The 10-year yielding 13% in unsustainable in the monetary union. Although the 10-year is in danger, the shorter dated paper are in a greater threat position than the 10-year. Short term financing is what needs to be dealt with immediately whereas 10 years from now is a very long time in the markets.
A good switch would be moving out of the 10-year Spanish paper and into the 10-year Italian paper. Similar yield but Italy is in a much better situation than Spain. Plus Spain won’t be reaching the target budget deficit of 4.4% in 2012. It will more likely be 6%. On the other hand Italy’s debt/GDP is low at the 4.4% level. What’s interesting about Italy is to see where yields go once they start raising debt longer than 10-years. However, the increased firepower should help the cause and the contagion effect will be contained.
It is interesting to point out that although a lot of awe was made when the 10-year Italian debt hit the 7.3% yield, don’t forget that in 1995 the yield on the 10-year was close to 14% and a debt/GDP ratio of 120% was something that the Italian’s carried for decades. It when they adopted the Euro and started borrowing money at low rates that 7% look like ‘an unsustainable’ level because they can no longer implement expansionary policies themselves.
It is more Spain that is worrying that Italy. Because although growth is poor in Italy, the unemployment rate is at 8%. On the other hand, Spain has a low unemployment rate, a high deficit/GDP and a high unemployment rate of 25%! Without growth, the unemployment rate can’t come down.
Stock to watch: Hugo Boss (Price E86.22, Price Target E95)
Hugo Boss has fundamentally reshaped itself in the past few years, which has led to a significant increase in profitability and return on capital. We believe the brand's prospects are encouraging for the next few years. Our investment thesis is based on the following points: (1)Retail-led strategy is still in its infancy. Supported by its infrastructure project ("D.R.I.V.E.) we see scope to raise the sales mix of Retail and to improve retail disciplines; (2)Significant geographic opportunities, especially in China and the US (3) Category expansion, which is beginning to show some encouraging signs.
For further information on Hugo Boss or other stocks we follow, contact our offices on 25688688.
Good day and happy trading!
Kristian Camenzuli
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