Waaaaaaay back last October, I headed our monthly client report with a quote from the song of an otherwise very dated 1960's movie (I'm old enough to have seen it the first time round), "Those Magnificent Men In Their Flying Machines" which supposedly chronicled the antics of a group of competitors in a London - Paris air race in 1910. The aim was to prove that Britain was "number one in the air". Needless to say an American wins it (jointly with a jolly chivalrous Brit, old boy) after fighting off the French, the Germans, and the proverbial pantomime villain. It had a budget of $6.5m and made $31m at the box office.
The way that markets have been behaving recently reminds me a lot of that 1965 movie: a lot of aerial acrobatics with climbs and falls, but with little thought of danger. Such has been the effect of central bank support, that it seems to have been the equivalent of a $6.5m budget producing a $24.5m profit.
As we've noted before, however, the bears disagree. In their view, loose money will create inflation, although, paradoxically, they also feel that while loose money might have done much for equity prices and the value of property in London and New York, it's done relatively little or nothing at all for employment and real wages.
It strikes us that - usually - you can't have both at the same time, and at present, the existence of still significant amounts of excess capacity (which keep prices down) are more of an issue than the possibility of rising prices at some point in future when capacity is being more fully utlised. Prices will only start to go up when capacity shortages are created by an excess of demand over supply, and we don't seem to be there yet.
So, for the time being, even with the occasional bout of aerial acrobatics, the average trajectory for markets seem likely to continue to be a steady climb, particularly in those countries where central banks remain supportive: the US, UK, Europe and Japan. We still like these, and still favour them for our portfolios for the first half of this year.
In Asia and the Emerging Markets, the picture remains more unpredictable, even if the outlook is not as homogeneous as some have been suggesting. The "good" markets, such as Vietnam, Philippines, Korea & Taiwan, still look fairly robust, whilst the "bad" markets such as the members of Morgan Stanley's "Fragile Five" (Turkey, Brazil, South Africa, India and Indonesia) have specific issues which seem unlikely to lead to a more generalised degree of contagion.China remains a conundrum, with debate evenly balanced between those predicting a crash and those predicting an eventual government driven recovery (we're in the latter camp).
In a sell-off, however, investors tend to be indiscriminate in their charge for the exits, and that's where the buying opportunity comes in: outflows from EM's have amounted to $26bn since the November of last year, but only -$12bn since the beginning of last year (that's because the first half of 2013 saw significant inflows, especially into EM debt, attracted by higher relative yields).
Eventually these outflows will reverse, possibly in conjunction with an acceleration of growth in Developed Markets, which will drag EM's up with them. This will start to reverse the relative underperformance of EM vs. DM, if only because at some point valuation of DM's will run into resistance whilst highlighting the relative value to be found elsewhere.
We're already beginning to see some changes in view: Credit Suisse forecasts that the Indonesian market has upside of 15-20% for 2014, and presumably more, if you assume that this will occur at the same time as a rally in the Rupiah. For EM's as a whole, over the last month or two, earnings upgrades have been bigger and more frequent than those for DM's. The Indian election in April/May could prove a watershed if a new government builds on a lot of the recently constructive work undertaken by the central bank.
Time will tell whether or not this gradual improvement is sustained, but by the second half of this year, maybe those EM aviators will finally get off the ground...
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