INVESTMENT OUTLOOK

Assessment for the coming months

July 2010

The past months in retrospect and a glance ahead

Debt crisis and double dip are the catchwords which hit the headlines these days. As a matter of fact many market observers expect yet another recession around the corner after the sharp one just behind us. So it does not come as a surprise that all major stock indices ended the first half year deeply in the red. But with all this talk about public debt and austerity measures one tends to forget that especially the European export industry is actually producing at full blast: Its industrial output just registered the strongest growth rate in ten years, and the weakness of the euro is nourishing industry expectations that this trend may well be sustainable for the second part of the year, too. – Personally, and for the time being, we continue to view the current downward momentum on the stock markets more like a natural correction within a still prevailing uptrend, which got started in spring 2009 and had lifted stock prices quite unrestrainedly for about a year. It may well be that prices could head yet somewhat lower, but for the time being we see no reason to change our asset allocation fundamentally, all the more since an unwavering strategic asset allocation has proven to be very superior to investment decisions based on gut feeling, let alone panic. Yet we did reduce our stock exposures to some extent.

Commodities

With some exceptions commodity prices moved sideways or even slightly downward during the first half year, and this trend has sharpened a bit during the last quarter, with the last quarter being the weakest for over a year. As to the exceptions, they are mainly precious metals, gold foremost with an increase of 12%, and coffee and natural gas fared even better. The reason for this subdued price development on the commodity market is a general worrying about the prospects for further growth of the world economy, especially in its spearhead markets USA and China (cf. hereafter under The Economy). Based on these worries we assume that commodity prices will continue to tend sideways, with the exception of the gold price, which follows its own dynamics. In our view, the remarkable performance of gold in the past years is mainly due to a lacking investors’ confidence in the world economy in general and in the world currency system in particular. The kaleidoscope of such fears embraces any shade, from a general not knowing what to do, right through to scenarios of a complete breakdown of the international currency system or of the world economy as such, even up to apocalyptic doomsday moods. Yet, on the current high level, we rank the risk of a decline of the gold price higher than the likelihood of a prolonged substantial rally.        

The Economy

During the past months it was mainly the debt crisis which had given rise to worries. As of late however some further clouds have drawn up on the skies of world economy. Reason for more concern is that bad weather fronts may build up especially above the world’s leading economies, USA and China, which will most likely and shortly replace Japan as the world’s second largest economy. In the USA, consumer confidence has taken a serious blow in June, which is bad news for an economy relying for two thirds on private consumption. More negative news comes from the housing market. After the official stimulation program was discontinued in April, demand has come to a virtual standstill. At a yearly rate of 300’000, sales of new homes are on the lowest level since 50 years, confirming those critics saying the stimulation program did not help the housing market at all. Whilst the housing market accounts but for a small percentage of the US gross domestic product, housing has always played a key role for the US economy. Because many Americans own their own houses, they feel any change of housing prices directly and personally. Because of the continuous price erosion since the start of the financial crisis, they sit on houses being worth less and less, and thus they tend to feel less and less affluent, which is why they tend to spend less. Thus the price development on the housing market tends to have an immediate effect on consumer behaviour, in America even more markedly so than elsewhere. Also, the housing market is crucial for domestic banks, their balance sheets being heavily exposed to mortgages. Now, if sinking housing prices caused banks to write off even more losses, their economic function as lenders of capital might get compromised. All told, the housing market is of key importance to American economy, and any bad news coming from that front needs to be taken seriously. On the positive side, and with a shot of gallows humour, the demand for housing has got so poor that it is hard to see how it could get any worse. – As to China, the signs are clear that the overheated economy may cool down considerably during the coming months. As it happens, some haphazard forecasters are already warning from a hard landing in China. They tend to forget that even if the Chinese economy should slow down markedly, there would still remain a growth rate somewhere in the high single digit numbers, according to forecasts of the International Monetary Fund.

Economic forecasts for the next twelve months:

Currencies

It is a time of great upheavals on the currency market. The euro has lost 12% against the Swiss franc since the beginning of the year and thus has even surpassed our negative sentiment opined here at the outset of 2009. For once the euro has drawn all attention formerly monopolized by the dollar. Whilst previously all players seemed to focus on the dollar, the constant worrying about the euro is now the central element driving the currency market. This obviously does not mean to say that all intrinsic problems of the dollar should be referred to in the past tense, as the drop of 8% against the Swiss franc in the past few weeks demonstrates clearly. On another front some pressure was taken off the market by a recent statement of the Chinese government: Seemingly yielding to widespread international pressure they signalled that, in linking the yuan less strictly to the dollar, they would now finally and gradually allow the yuan to increase in value. On the other hand the Chinese government seems to worry about the price erosion of the euro. That is indeed something to worry about for an economy fancying an ever larger slice of international business, the weak euro having strengthened the competitive edge of European exporters substantially on the international markets. So it remains to be seen how serious the Chinese government was with their stated willingness to let the yuan increase in value. Anyway, the euro is likely to continue dominating the currency stage. Should other European states follow in the wake of Greece with its disastrous finances, the euro would no doubt come under further pressure, which could even turn into a full-grown crash test for the euro system itself. Amongst all this turmoil the Swiss franc remains the most reliable currency by a far shot. Since the Swiss central bank has given up its costly and fruitless interventions to weaken the Swiss franc, the Swiss franc has gained yet another 8% against the euro. Although the Swiss exporting industry has managed these contingencies quite well so far, it might find its international competitive position more and more compromised by the current high level of the Swiss franc, which may well be quite dangerous for an economy relying so heavily on exports as the Swiss economy.                 

Currency forecasts for the coming twelve months:

Investment categories

We find ourselves in the paradox situation of falling stock prices despite excellent earnings data, the main reason for this being investors worrying about public debt. It is the typical phenomenon of selective perception, forever inherent to any market: Once a topic dominates public discussion and perception, all other data and information tend to be completely disregarded. Business analysts’ consent is for an earning growth rate in 2010 of approx. 48% for Asia, 41% for Europe and 35% for America; for 2011 they expect an aggregate growth rate of 20%, and 13% for 2012. But instead of rising stock prices, all major indices have ended the first half year deeply in the red: -7% for the Dow Jones Industrial, -15% for the Euro Stoxx 50, and -13%/- 8% for the Nikkei/Hang Seng. Such a widespread discrepancy between fundamentals and price development has not been registered since many decennia. This shows in an exemplary way how profoundly the debt crisis has spoilt market sentiment.  

Industries