Five reasons I’m bullish for 2013

As money shifts back into equities around the world, 2013 is shaping up to be a 'risk-on' year. And there's good reason to expect the trend will continue.

........ image.

This is an article from Australia's leading insights and research portal for investors, Eureka Report. Start your free trial today at www.eurekareport.com.au or call 1800 458 656.

I returned to work last week even more optimistic than I was before I went, and not just because I was still glowing from the Bali sun.

While I was away the market rallied 2 per cent and although it’s looking ‘toppy’ and looks due for a pullback, I think we are now in the situation where buying on the dips is the best idea. The global recovery is on and, as I explained before Christmas, money is shifting back into equities around the world.

So bearing in mind Nassim Taleb’s dictum that "the only prediction one can safely make is that those who base their business on prediction will eventually blow up”, there are five reasons I am optimistic about 2013 without exactly predicting anything: China, America, Europe, Japan and Risk.

Risk

To start with the last of those, in my view 2013 will be a 'risk-on' year. Well to be honest this started half-way through 2012 when it became clear firstly that the global economy was recovering and secondly that the European Central Bank, with German support, really would do whatever it takes to keep the euro intact. The Fed was already doing whatever it takes to get the US dollar down, and the Reserve Bank was doing whatever it takes to get the Aussie dollar down (not that that’s working yet).

All of which means the returns from cash are miserable and falling. Time to invest then, which means taking more risk, but not too much – thus, bank shares returned 25 per cent in the second half of 2012.

In my view this trend has just begun. For five years investors everywhere have been more concerned with not losing their capital than with making a return and gradually that is changing; they are moving out along the risk curve. This is going to be an important theme for Eureka Report in the months ahead as we help you take advantage of what’s happening. Obviously taking more risk means just that, and the world is not yet a safe place (is it ever?). I think the greatest danger has passed, and while deleveraging will continue to hamper growth there are many positives offsetting that.

China

Sam Walsh must be the luckiest man alive. Not that he doesn’t deserve to be chief executive of Rio Tinto – of course he does, in fact he probably should have taken over years ago (I’m sure he agrees) – but because he takes over just as China’s economy bottoms and turns around and with $14 billion in writedowns tied to Tom Albanese’s tail. All new chief executives would dream of having their troublesome assets all written off and their main customer on the improve.

The data on China that came out last week contained several positives, apart from the fact that growth, at 7.9 per cent, was better than expected. The transition towards greater consumption and less reliance on investment has continued, with consumption now accounting for 4 per cent of GDP growth in the fourth quarter, higher than gross capital formation (3.9 per cent). Growth in retail sales improved from 11.6 per cent to 12 per cent in 2012 and car sales grew 6.9 per cent (5.4 per cent in 2011). The acceleration in consumption happened because income growth, at 9.6 per cent in the cities, was greater than GDP growth for only the third time in a decade.

So the project of converting China from an export and investment driven economy to one that is based on domestic consumption is intact. Income growth is being helped by the remarkable fact that the working age population actually fell in 2012, by 3.5 million – the first such fall ever.

This brings its own challenges of course. It makes it even more imperative that the Chinese authorities reform the economy to promote the return on capital, otherwise economic growth will stall. The state owned enterprise system is deeply inefficient, as you’d expect, which has never mattered too much while the labour force has been growing so rapidly. As it declines, productivity must rise.

But while the long-term picture is clouded, it’s clear that 2013 will see China’s economy continue to accelerate, which should support the iron ore price – if not at $150 a tonne, then certainly above $120. Happy New Year Sam!

America

China is recovering and so is the United States, with housing leading the way. The National Association of Home Builders Housing Market Index is at a six-year high and double the level of January 2011. The "prospective buyer traffic” component of the index is at the highest level since January 2006. The median house price is up 10 per cent year on year, as is the volume of sales. Residential construction has bottomed and the vacancy rate is heading down.

Thanks largely to housing, the US private sector is growing at a pretty rapid clip – about 3 per cent if the government sector is removed from GDP calculation. State and local governments are starting to join the private sector in recovery, with only the federal government continuing to shrink. Moody’s expects local and state governments in the US to expand employment by 220,000 in 2013, a huge turnaround from the previous three years of job losses.

Manufacturing has been slow to move, but that seems to be now happening as well. Industrial production expanded 0.3 per cent in December after a rise of 1 per cent in November. But the December number was held back by a fall in utilities generation: factory output jumped 0.8 per cent in December. As for this year, cheap energy is expected to produce a resurgence of US manufacturing.

There’s a lot of talk that the budget deal will create a big headwind, but that seems to be overdone. There are two main elements to the deal that will produce fiscal drag: the payroll tax increase, which will cut
GDP by about 0.7 per cent, and the spending cuts due to be implemented in March – another 0.6 per cent of GDP. That 1.3 per cent of GDP fiscal drag seems large compared to 2.2 per cent average GDP growth since 2010, but as Anatole Kaletsky points out the IMF calculates that US fiscal drag on the economy was 1.3 per cent in each of 2011 and 2012. In other words, fiscal drag in 2013 will be no greater than the previous two years.

That is, as long as the politicians don’t snatch defeat from the jaws of victory by sending the US into default because of the debt ceiling. They have about six weeks to raise the limit, since the government will run out of money on March 1. Surely they will, although as usual it will probably be at the last minute.

Japan

The new Japanese prime minister, Shinzo Abe, is putting extreme pressure on the outgoing governor of the Bank of Japan, Masaaki Shirakawa, to join the ECB and Federal Reserve in doing the "whatever it takes” waltz – that is, moving to unlimited easing. He’s only got a few months left in the job, but the governor is likely to cave and go at least part of the way to what the boss wants. He’ll then be replaced by someone who will go all the way. That means raising the volume asset purchases from ¥10 trillion to at least ¥15 trillion, and possibly following Ben Bernanke’s lead and announcing a fixed monthly amount for as long as it takes. That’s certainly what Abe wants and he’ll probably get it sooner rather than later.

Meanwhile the prime minister is raiding the fiscal stimulus cookie jar, even though Japan’s public debt to GDP ratio is the world’s highest, at more than 600 per cent. The "emergency economic stimulus measures” announced on January 11 amounted to ¥10.3 trillion or 2.2 per cent of GDP. Including spending by local governments and private companies, the total package is more than ¥20 trillion. Giddy up.

This is a fundamental change in policy for Japan. In response, the yen has depreciated 15 per cent against the US dollar since late September and the Nikkei share index has surged 28 per cent and these trends probably have much further to go if Japan remains committed stimulating its way out of 20 years of deflation. It is great news for Australia and the global economy, although you wonder how Japan’s going to pay back all that debt. I guess inflation is the answer.

Europe

The key thing here is that investors are no longer freaking out that the eurozone will collapse or that someone’s going to go broke in a big way.

Ever since ECB President Mario Draghi made his big "whatever it takes” speech in July, worry has ebbed away like a tide, and that is starting to show up in macro data. Europe remains the most challenged major economy on the planet, but things are gradually improving, thanks to the growing confidence of markets that Greece will not be booted out of the euro.

Because of that, markets are repricing European assets to remove the risk of a break-up. This is an enormously important development and almost certainly means that Europe’s double-dip recession has now bottomed. Most significantly, there are growing signs of a German recovery, with strong residential housing investment and growing household consumption.

image

Follow @AlanKohler on Twitter

Related Articles