Global Investing

Emerging markets bear John-Paul Smith first made his call to underweight emerging equities at the end of 2010. In a note released late on Monday he points out that such a position would have paid off handsomely — since end-2010 emerging equities have underperformed MSCI’s World index by 27.5 percent and U.S. MSCI by 37.6 percent.

Smith, who is head of emerging equity strategy at Deutsche Bank, sees no reason to change his call. Reckoning that the cyclical heyday of emerging markets is past, he is advising clients to hold on to developed and U.S. equities at the expense of emerging markets. The reason? China, pivotal for the rest of the EM world for commodities, trade.

Smith writes:

We are maintaining our existing underweight recommendations for GEM versus DM/US and current country weightings within GEM because the ongoing structural deterioration in the sustainable growth rate of the Chinese economy will continue to be the dominant narrative for the GEM equity asset class, in our view. Since the start of the year it has been increasingly evident at the micro level that the massive increase in total corporate financing has not as yet fed through into anything resembling a commensurate pickup in final demand.

Recent data from China would appear to bear that out. Economic growth and industrial data have both disappointed while Fitch has downgraded the country’s local currency rating, warning of risks to the economy from so-called shadow banking. And corporate results have not been reassuring — over 70 percent of companies, whether Hong Kong- or mainland-listed, undershot earnings forecasts for 2012,  according to Thomson Reuters Starmine data.

Smith again:

From a more bottom-up perspective, the ongoing deterioration in the underlying return on invested capital has now reached a point which threatens the viability of the entire economy.

Investors keen to wade deeper into the euro zone’s quieter waters  will have 765 billion euros,  or just over $1  trillion, worth of fresh government bonds offered to them this year, nearly 8 percent less than in 2012,  Deutsche Bank writes in a report.

With the debt crisis quieting down, euro zone assets are among the top 2013 picks for many leading investors, with the likes of Societe Generale and AXA Investment Managers advising to head for the periphery with Spanish and Italian sovereign debt.

Deutsche Bank writes in its Eurozone 2013 supply outlook report, based on the bloc’s ten biggest bond issuers:

Taiwan and Philippines have joined the easing crew. Taiwan cut interbank lending rates for the first time in 33 months on Friday while Philippines lowered the rate it pays banks on short-term special deposits. Hardly surprising. Given South Koreas’s shock rate cut on Thursday, its first in over three years, and China’s two rate cuts in quick succession, the spread of monetary easing across Asia looks inevitable. Markets are now betting the Reserve Bank of India will also cut rates in July.

And not just in Asia. Brazil last week cut rates for the eighth straight time  and Russia’s central bank, while holding rates steady,  amended its language to signal it was amenable to changing its policy stance if required.

Worries about a growth collapse are clearly gathering pace. So how much room do central banks have to cut rates? Compared with Europe or the United States, certainly a lot.  And with the exception of Indonesia and Philippines, interest rates in most countries are well above 2009 crisis lows.  But Deutsche Bank analysts, who applied a variation of the Taylor rule (a monetary policy parameter stipulating how much nominal interest rates can be changed relative to inflation or output), conclude that in Asia, only Vietnam and Thailand have much room to cut rates. Malaysia and China have less scope to do so and the others not at all (Their model did not work well for India).

It’s the economy, stupid. Or isn’t it?

Brent crude has risen 15 percent since the end of last year, focusing people’s minds on the potential this has to choke off the recovery in world growth. But some reckon it is the recovery that’s at least partly responsible for the surging oil prices — economic data from United States and Germany has been strong of late. There are hopes that France and the United Kingdom may escape recession after all. And growth in the developing world has been robust.

Geopolitics of course is playing a role  as an increasing number of countries boycott Iranian oil and fret over a possible military strike by Israel on Iran’s nuclear installations.  But Deutsche Bank analysts point out that world equity markets, an efficient real-time gauge of growth sentiment, have risen along with oil prices.

Their graphic (below) shows a remarkably close relationship between oil prices and the S&P 500. Click to enlarge

We just finished our three-day Reuters 2012 Global Investment Outlook summit in London, New York and Hong Kong, where prominent money managers have discussed their outlook for next year. (For more click here)

Deutsche Bank Private Wealth Management (whose official was also a guest at the summit) is telling its clients the following 10 investment themes for next year.

1. Safe may not be safe Don’t react to uncertainty by automatically taking refuge in traditional safe havens such as cash, sovereign bonds, real estate or precious metals as they may prove less safe than they appear.

It’s not often that economists turn their attention to military hardware, but Deutsche Bank has done just that in its latest world outlook. The subject is aircraft carriers and what it sees as the strange desire among a number of countries to build them.

Russia has suggested it may build up to six carriers, DB notes, while China plans one and Britain and France three between them. Like the true economists they are, DB first questions the need, saying such boats are vulnerable, make no sense for coastal defence and are for projecting offensive power over long distances. Then comes the cost:
  

“To build a serious aircraft carrier costs well above $5 billion. But then you need to build half a dozen escort vessels and the aircraft to produce a battle unit that will require upwards of 10,000 sailors. Since it is for distant power projection, to keep a single aircraft carrier group on constant deployment requires at least two and more likely three groups.”