Investmentfonds - News

Investmentfonds.de 20.01.2012:
HSBC: Lots of bad news in the price

Philip Poole, Global Head of Macro and Investment StrategyKöln, den 20.01.2012
(Investmentfonds.de) - Lots of bad news in the price

-Investor expectations have been driven down as they factored in a deluge
 of negative news

-We now see long-term value in fundamentally attractive investment themes

-In particular we like corporate debt and a number of structural emerging
 markets equity strategies





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A litany of distress

In our investment approach, valuations matter most of all. To generate long-term 
returns investors need to buy financial assets when they are cheap. Not when they 
are expensive.

So how much bad news is now in the price? A lot of negative news has broken in 
recent weeks and should now have been absorbed into the asset prices. Here is a 
top line summary of the recent bad news:

1. At the end of last week Standard & Poor’s downgraded the credit ratings of 
nine Eurozone (EZ) countries, including stripping France and Austria of their 
AAA rating and taking Portugal down below investment grade. This leaves only 
four EZ countries with triple A ratings and, as a result, the European Financial 
Stability Fund (EFSF) was also subsequently deprived of its AAA rating. According 
to the German newspaper Die Welt, on the back of this, plans to leverage the 
(EFSF) to up to EUR1.5trn from EUR440bn “are practically dead.”

2. Negotiations between Greece and representatives of private sector creditors 
broke down at the end of last week, raising concern that there will be a 
‘disorderly’ default rather than a managed debt swap in March when Greece is 
due to repay EUR14.5bn in bond redemptions. This will be impossible unless 
Greece gets the frozen 7th tranche of the support package from the so-called 
‘troika’ (EC, IMF and ECB) which is itself conditional on closing the debt swap. 
Such a disorderly default would trigger credit default swap contracts, likely 
creating a new wave of uncertainty and potential contagion in an environment 
where it would be extremely difficult to compute the impact on individual banks 
and insurance companies given the integrated nature of financial markets and 
institutions.
Although negotiations have subsequently resumed agreement has still to be 
reached and, moreover, investors have also come round to the realisation 
that even a successful conclusion of negotiations on the terms of a swap would 
still leave open the question of investor participation and the risk that private
creditor ‘holdouts’ are subsequently forced into the deal removing any notion 
that this is a ‘voluntary’ rather than a coercive swap.

3. In the background, global economic growth expectations have been further 
downgraded recently and now recession in 2012 is the central forecast for the 
EZ. The World Bank is indicative of the trend: it now believes that the EZ 
entered recession in Q411 and sees a 0.3% contraction in the bloc’s GDP this 
year. It has also lowered its US GDP growth forecast to 2.2% in 2012 from 2.9% 
previously and expects world GDP growth to fall to 2.5% in 2012, down from a 
forecast for 3.6% growth six months ago. According to the Bank, emerging countries 
should take steps to plan for a global economic crisis in line with 2008/09 if 
the EZ sovereign debt crisis intensifies.

4. Corporate earnings expectations have been downgraded but in spite of this 
the Q411 US earnings season that began last month has generally been disappointing. 
According to Bloomberg, in releases thus far fewer S&P 500 companies have beaten 
analyst earnings expectations than at any time over the last 4 years.

5. China has not been immune from the gloom. GDP growth has decelerated 
with Q4 growth slowing to 8.9%, the lowest growth rate for ten quarters, 
increasing concerns about a hard landing in the world’s second largest 
economy. Property prices in China have also been under downward pressure 
which continued into December when residential property prices fell more 
than at any point in the previous 12 months and new home sales fell month-
on-month in 52 of 70 cities monitored, adding to concerns that this could 
have a debilitating effect on the domestic banking system.


Look through the gloom and focus on valuations

Clearly, this is a substantial raft of bad news to hit the market in a 
relatively short period of time. But the limited reaction of markets to 
these events and data releases suggests that it was largely already 
factored into asset prices. In fact, global equity markets are up year-
to-date and most risk assets and currencies have fared reasonably well 
so far this year in spite of the negative news flow.
Additional evidence that investor expectations have been driven sharply 
down by negative news is provided by the so- called activity ‘surprise’ 
indices for the US and the EZ. As the charts below show, in both cases 
the data across a broad range of indicators has generally been coming in 
better than expected recently, in large measure because expectations have 
been trashed to such an extent. This is in sharp contrast to the six month 
period to end September 2011 when the data for the US surprised negatively, 
a factor that was instrumental in the market selling off over that period. 
Things could always get worse than currently expected but the negative tone 
of recent news suggests that there is a lot of angst already factored into 
asset prices.



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In fact, we believe that the correlated 2011 sell-off in most risk assets has 
also created long-term value in a range of fundamentally attractive investments, 
given that it was based more on risk aversion than deterioration in underlying 
fundamentals.
In bond markets we have a clear preference for corporate over safe haven 
developed world government bonds. The latter look expensive on fundamentals 
while companies generally have strong balance sheets, are in many cases cash 
rich and offer an attractive spread over treasuries and other safe haven 
government bonds. For the most part, the corporate spread widening in 2011 
is not credit specific but a reflection of an absence of risk appetite.

Equity markets are also generally trading cheap to their longer- term valuation 
averages on a forward PE basis despite, in some cases, big downgrades in earnings 
forecasts. Not surprisingly, the EZ is the region where there has been the most 
aggressive downward revisions – by close to 80% on average since June. Most 
emerging markets earnings growth estimates have also been revised down. For 
example, earnings estimates for the Indian market have been cut by almost 50% 
since last June. Moreover, both developed and emerging markets equities look 
cheap relative to history on a price-to-book basis. Our preferred measure of 
attraction is price-to-book/return on equity which encompasses both valuation 
and profitability metrics. Again on this metric equity valuations for many 
emerging and developed markets look appealing and we see this as an attractive 
entry point for exposure to powerful long-term investment themes like emerging 
consumption and infrastructure spending.