• October – a testing month for the markets
• The third quarter was a disaster for risk assets
• Euro zone on the cusp of recession
• Look for opportunities in high yielding equities
• Luxury goods companies still have strong long term growth
• Corporate buyers return for commodities
October could be torrid for investors. The markets eagerly await some news from the policy makers.
Indeed, through October we expect the markets to demand action from the policy makers. During the month Greece will either run out of money or have a further bail out from the Euro zone and IMF. Although G20 is set to meet in Cannes, France in November, Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD doubts the markets will be that patient to wait. In October, market players need to see real action with credible policies to arrest the loss of confidence in the ability of the Euro zone to remain credible as a single currency zone. Without action the financial markets could be looking at the risk of further significant losses. As the third quarter ends, what have we learned? Firstly that the Euro zone is bust as a coherent economic area; secondly that the crisis in Europe has the potential to cause real problems for the global economy and financial markets in 2012; thirdly investors who have suffered losses in recent years will run scared of this crisis by selling anything that looks remotely unsafe. It has been a terrible quarter for risky assets such as equities. US equities ended the quarter down 14%, whilst the Euro zone equities were down 23%.
However, diversification is alive and well, at least in some quarters. US government bonds 10 years + returned 23% over the quarter, a quite extraordinary return. In local markets the DFM fell a modest 6% and the KSA Tadawul market was down 7%. Gold also provided good diversification however a return for the quarter of 8% masks the fact that at one stage the gold price was up 27% quarter to date on the 5th of September.
The quarter ended on a poor note for the Euro zone. Economic data releases already show that a significant slowdown in growth is under way. Euro zone corporate confidence fell in September, with new orders indicator falling sharply. The Greek situation is no closer to resolution with the real threat they will run out of money by mid-September. The Greeks appear to be €30 billion behind on their promised budgetary targets. Meanwhile the broader discussion goes on behind closed doors for the politicians and ECB to bring to the markets something that might resemble a credible plan to arrest the crisis.
The voters of the Euro zone should not be forgotten; a financial crisis could quickly become a major political crisis. Many of the commentators talk about the solutions for the Euro zone problems as if it was just about mathematics or an economic theory. However investors need to be increasingly wary of what the people of the Euro zone think. Protests are getting louder. Even though many people have portrayed last week’s German parliament ratification of the €440bn rescue fund (EFSF) as a victory, however make no mistake, many Germans consider this as the very last financial commitment that will be made by Germany to the countries in crisis. Horst Seehofer, the leader of Bavaria’s Social Christians said his party would go “this far but no further”. The Bundestag president has warned that Germany’s parliament would not give up its fiscal sovereignty to any EU body. In Greece public sector strikes have stopped the Troika of EU ECB and IMF from meeting the Greek government. The Euro zone crisis is hitting the emerging market financial markets hard. There are a number of factors at work. Analysts are now highlighting that the Euro zone banks are a major source of funding for many companies round the world. If Euro zone banks conserve their capital they may withdraw some of their funding of global companies ,therebycreating a more widespread global credit crunch. The volatility of global financial markets alone has caused the cancellation of equity and bond issues around the world. General risk aversion of investors running scared of the crisis has led to emerging market bond funds seeing a record $3.2 billion of redemptions last week. The exception to the sell-off in emerging markets has been the more robust performance of the MENA markets.
In the mess of the market sell-off it is always worth keeping half an eye on opportunities. If you are going to be tempted to buy equities we recommend buying high dividend paying companies. The dividend yields of many of the world’s equity markets are high, however bear in mind that in a global recession companies will cut their dividends. The good news is that many companies have significant cash in their balance sheets which should allow them to continue to pay dividends even in the bad times.
Watch out for two things though; firstly be careful of all financials. Potential debt write offs may impede their ability to pay dividends at the level of previous years; secondly be wary of companies where governments may impose one- off taxes. Remember that whilst governments are short of money, companies have never had so much ‘spare’ cash in their pockets. There is a risk that governments may start to impose windfall taxes or just raise the overall level of corporation tax. Keep an eye on the luxury goods sector. Although the world may be facing a recession in 2012, demand for luxury goods, particularly from the emerging world is expected to remain strong. A recent report from Goldman Sachs points to the potential for mergers and acquisitions in the sector. Many of the luxury goods companies have high cash balances and may look to buy out competitors and strong brands if share prices fall back further. The sector is expected to see well over 10% revenue growth in each of the next three years. Cash balances in companies are at an all time high and we believe many of the brands are on the shopping lists of sovereign wealth funds and private equity firms.
There may be better times ahead for some commodities. The prices of commodities may still be seesawing but there are tentative signs of government and corporate buying. The Qatar sovereign wealth fund is expected to pay $1billion for a potential 30% of European Gold fields of which the initial stake is coming from a Greek construction company. Rio Tinto increased its stake in Ivanhoe mines, a Canadian listed company with a major interest in the Mongolian copper field. In the gold market there have been some signs of some countries’ central banks returning to the markets. Russia, Bolivia and Thailand were buyers through August. In more recent trading sessions both Gold and Silver prices have had their daily highs during trading in Hong Kong suggesting that maybe the Chinese are also back as buyers.
