Deutsche Bank predicts calmer markets going forward
Kevin L. Lecocq, Global Chief Investment Officer for Deutsche Bank Private Wealth Management (PWM) in its Investments Insights Outlook 2013, “Passions to Perform” says:
“The past year has, in my view, demonstrated the power of monetary policy. The European Central Bank(ECB), under its new leader Mario Draghi, finally joined the US Federal Reserve, the Bank of Japan and the Bank of England in injecting massive quantities of money into the financial system. Beginning with the Long Term Refinancing Operations (LTRO, in effect lending cheaply to banks) and followed by the promise of Outright Monetary Transactions (OMT, buying of government debt), the ECB has done much to mitigate the risks resulting from sovereign debt and banking crises in the Eurozone. But as much as policymakers such as Ben Bernanke would hope, easy money does not offer a panacea or indeed probably generate much in the way of growth or jobs. But the flushing of the system with liquidity is a vitally important risk management tool – averting what could have been much worse in 2009 in the US or 2012 in Europe. I believe that understanding central bank behavior was the key to investing success in 2012.
We can now take this risk management framework from the world’s major central banks and apply it to our investment outlook for 2013. We believe we will likely have calmer markets going forward than we have had the past few years. As the risk management doctrine is fully absorbed by market participants, the dreaded “tail-risk” becomes more remote. Already markets have calmed in the past two quarters – and we think this dynamic will continue.
Policy should support equities over fixed income going forward, as we detail later in 
this report. Risky assets (stocks) should enjoy the benefits of higher policy certainty, lower risk aversion and therefore at least a modest price/earnings expansion. Bonds, on the other hand, have been the place where investors have crowded in fear the past few years, with support further extended through outright purchases by central banks. It is impossible to predict when the bond bubble may burst – Japan’s never has – but to preserve the long term value of your wealth, bonds may appear to offer little virtue at today’s low rates.
Emerging market equities have returned similar gains as developed world equities in 2012 but are, in my view, poised to outperform in 2013 – helped by decent top line growth, favorable fiscal and monetary policy, decreased risk aversion and attractive valuations. By contrast, fiscal headwinds will curb some growth in the developed markets, despite good signs of underlying private sector performance in the US.
In summary, we believe 2013 may be a somewhat less erratic year than 2012 or 2011 proved to be. However, our main focus will remain on prudent risk management of your assets. On behalf of the Global Investment Committee, I wish you and your families a happy holiday season and good fortune in the coming year.
Our House View and 2013 Investment Themes (Not complete)
A constrained policy mix in the developed economies
At the end of every year, it is all too easy to assume that the next year will largely be a projection of the current one. To do this, however, risks ignoring new and evolving economic and policy dynamics and can prove dangerous for investment performance. In this piece, we look first at the implications of policy trends observable in 2012, and then attempt to identify some likely new trends for 2013.
In our view, while 2012 was the year where developed market policymakers fine-tuned their policy mix, 2013 will be the year when policy stabilizes.
Monetary policy will continue to manage risks
We started 2012 still thinking that non-traditional monetary expansion could, on its own, foster growth. By the end of the year, it had become clearer that such measures – now used by almost all developed market central banks in one way or another (Figure 1 illustrates their growth) – were in fact more useful and effective as risk management than as a way of stimulating growth. By injecting liquidity to buy certain assets, a central bank behaves like a “market maker of last resort” and sends an informal price signal to the rest of the economy, thereby limiting deflation risks. As we have seen, this process mitigates tail risk very effectively, but also creates some uncertainty in the price discovery mechanism (how the interaction of buyers and sellers determines an asset’s price) and therefore leads investors to be more short term minded and less keen, or able, to capture long-term risk premia related to risky assets. Non-traditional monetary policies therefore have a cost to the economy by making more difficult the optimal allocation of money to the most profitable projects. We believe that this is the true cost of risk management.
Fiscal policy will be driven by sovereign debt
On the fiscal side, the big divide between very accommodative policies and large scale austerity plans is starting to narrow, with almost all developed countries looking to mitigate in one way or another the negative effects of excessive austerity, while also trying to avoid pushing up debt levels yet further in the hope of boosting short-term growth. (Figure 2 illustrates trends in the Eurozone.) In terms of fiscal policy, sovereign debt liabilities constitute a significant constraint for all governments. In this situation, investment decisions, whether made by the private or the public sectors, have to take into account a country’s debt liabilities. In the private sector in Europe, corporations are starting to see that holding large amounts
of cash could lead to unwelcome interest from the fiscal authorities, although at present such discussions are limited to questioning large corporations’ tax optimization arrangements across countries. In the public sector, the necessity of funding areas of the economy that do not create wealth – such as unemployment costs and supporting the Eurozone periphery – sets the priorities. Such a liability-driven approach can lead to sub-par growth.
Inflation will remain under control
Widespread reliance on non-traditional monetary policy has led to some concerns about a possible resurgence in inflation, but we think this is unlikely, for three reasons. First, the level of growth in the developed economies is still below its potential, meaning that capacity constraints are not likely to put upward pressure on prices. Second, the banking sector, in Europe at least, remains reluctant to lend, and hence the risk of a massive releveraging of certain sectors of the economy is unlikely. Third, no valuations appear obviously unreasonable at this stage, with the exception of sovereign debt – although here the shortage of perceived safe assets means that it is likely to remain expensive for some time.
Implication: a risk-controlled, low growth environment
In 2013 we therefore anticipate a tightly risk-controlled environment, offering low but positive growth perspectives and the potential for a continued fading of tail risks. Individual countries’ policy approaches may not be fully fleshed out, possibly leading to some temporary political market tensions, but during the year policymakers will continue to focus on risk control. As a result, we need to be careful not to superimpose another layer of risk aversion within portfolios that would be detrimental to their performance.
The practical consequence, in our view, is that 2013 should be a good year to select, with care, a portfolio overweighting risky assets in a policy environment that already benefits from an overall risk management process.
Existing High Conviction Ideas reviewed
By Larry V. Adam, Megan Horneman, Christian Nolting
Asian investment grade corporate bonds (Idea initiated October 30, 2012)
Our rationale for launching this idea was that, while Asian investment grade bond spreads were lower than at the start of the year, they were far from tight in an historical context. They also appeared to offer some protection relative to average historical default levels. The HSBC High Grade Bond Index – the reference measure for this idea – has held up well in recent weeks, despite some profit taking, and also a generally increased global appetite for risk in late November. We think that Asian investment grade corporate bonds are likely to continue to fulfil investors’ appetite for carry, in an environment where front-end yields are likely to remain low. They are trading at a decent spread premium relative to US investment grade corporates, yet seem likely to enjoy a superior growth profile to their developed markets counterparts.
Wallet commerce technology (Idea initiated March 26, 2012)
We expect a growing trend towards mobile payment adoption by retailers as smartphone applications grow. This theme considers the way in which such payments, or “wallet commerce”, will provide the opportunities across a range of sectors, for example payment processors, technology owners, communication/system providers, security software and related large cap retailers. We expect beneficiaries to vary across sectors as the “wallet commerce” life cycle develops, and sectors affected will also not be immune to short-term movements – note the falls in technology and telecoms sector stocks over the last few weeks.
US high dividend-paying stocks (Idea initiated January 30, 2012)
With interest rates expected to remain extremely low for some time, high dividend-paying stocks still look attractive both on an absolute basis, and also relative to some fixed income instruments (e.g. US Treasuries). High dividend-paying stocks that have a cash-rich balance sheet, a history of consistent dividend growth and a favourable earnings outlook may be particularly appealing. However, investors’ assessment of high-dividend stocks will also be affected by the extent of apparent macro risks, and the likely impact of these on market volatility and the relative performance of low vs. high beta investments. (In the context of an overall market improvement – for example, following any progress on avoiding the US “fiscal cliff”, high dividend-paying stocks might gain relatively less.) Since this idea’s inception, the reference measure for it, the S&P 500 Dividend Aristocrats Index has risen on an absolute basis, and also relative to the S&P 500.
US technology stocks (Idea initiated April 26, 2012)
In recent weeks, some disappointing earnings reports and product launches have resulted in the S&P 500 Information Technology sector underperforming the overall S&P 500. However, since the idea’s inception, this sector has outperformed the broad index, and we continue to like information technology stocks, for three main reasons. First, the large number of recent new product announcements – for example, the Apple iPhone 5, the Apple iPad mini and the Windows 8 operating system and tablet, in addition to other tablets. Historically, companies benefit from the announcement of new products. Second, Information Technology valuations remain very attractive. Third, the sector’s fundamentals remain good. Earnings growth is expected to be in double digits in 2012 and 2013 and dividends are increasing. In addition, spending on software and equipment is likely to be a key driver of US GDP in 2013.
To download the whole of the Investments Insights go to:
http://www.pwm.db.com/uk/docs/Investment_Insights_Outlook_2013.pdf
Also go to:
http://www.pwm.db.com/global/en/economic_outlook.html
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