Market Outlook

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					                                                                                  September - October 2009

Market Outlook
Monthly Update – ING Investment Management

Key points                                     Markets thrive on fertile ground
• No sign of an end to the ‘risk rally’        After green shoots, over the past weeks investors have had to
• High economic growth for next 6 months       accustom themselves to a new ‘in’ phrase: sweet spot. Financial
• Higher earnings forecasts for 2010           markets are currently in the midst of a sweet spot: an economic
                                               recovery environment, improving corporate earnings, falling
• Long-term outlook remains uncertain          inflation and central banks pursuing highly flexible monetary
                                               policies. Risky assets, such as equities, thrive in this type of
 Bonds                                         environment.
 10-year bond yield (3-month forecast)
                                               Equity markets are therefore still in the midst of a robust upward
    US                             3.5%
                                               trend. Price rises are also reasonably widespread across regions
    Euro zone                      3.0%        and sectors. The energy, materials and industrials sectors are
    Japan                          1.5%        profiting most from the strong economic recovery in many
 Investment grade credits             +        emerging markets. These are undergoing a V-shaped recovery,
 High-yield credits                   =        as the far-reaching fiscal and monetary stimulus packages are
 Emerging market debt                          encouraging economic growth thanks to the absence of high
                                               levels of debt in the private and financial sectors. Moreover, the
    Hard currency                     =
                                               equity prices of financial service providers around the world are
    Local currency                    +        busy making up for lost time after their dramatic price drops at
 positive (+), neutral (=), negative (-)       the end of 2008 and early 2009. Defensive sectors such as
                                               utilities, telecom and health care are lagging behind, as are
 Equities                                      consumer-related sectors.
 Energy                                    +
 Materials                                 =   View: earnings forecasts adjusted upwards
 Industrials                               -
                                               Although equities are no longer cheap and have reached their
 Durable consumer
 goods/services                            -   fair value levels, we believe that there is further upward potential
                                               for equity prices. The main driver behind further price rises is
 Consumer staples                          -
                                               earnings improvement among companies. In the US, corporate
 Health care                               +   earnings reached rock bottom in the second quarter; in Europe
 Financials                                =   earnings are reaching their lowest points now. This is about six
 Technology                                +   months earlier than predicted. This is chiefly due to dramatic
 Telecommunications                        +   cost-cutting and lower interest charges. Earnings growth of 20%
 Utilities                                 =   or higher in 2010 is therefore perfectly possible.
 positive (+), neutral (=), negative (-)
                                               However, we maintain our neutral view for equities compared to
                                               bonds. This is mainly due to the continuing pressure on
 Region                                        consumer spending in the longer term caused by rising
 United States                             -   unemployment, low real wage growth and the need to reduce
 Europe                                    +   debt levels, especially in the US. We also believe that bonds
 Japan                                     =   such as investment grade credits contain further potential. The
 Emerging markets                          =   10-year bond yield may also fall slightly further in the euro zone
                                               over the next few months, which is positive for government bonds.
 positive (+), neutral (=), negative (-)

ING Maandvisie
Economy: job growth crucial to economic recovery

Economic growth gathering pace                        growth of at least 150,000 jobs a month is
                                                      required for a reduction in the unemployment
Most economic indicators demonstrate that the         rate. In the euro zone in July, unemployment
global economy’s recovery is gathering pace.          rose to 9.5%; research indicates that
Western economies are benefiting from                 companies are still cutting their workforces.
company stock replenishment, government               This strategy could be pursued for some time
stimulus packages and greatly improved                as companies continue to seek improvements
financial conditions (rising equity prices, falling   in earnings. Incidentally, trends on the labour
risk premiums, low interest rates). We expect         market are what are known as lagging
these stimuli to result in economic growth in         indicators. The labour market can ultimately be
the US and the euro zone of about or even             expected to imitate the upturn in economic
above the long-term average in the next two           activity.
quarters. In the US, growth could be about 3%
for the next six months.                              Unemployment will not peak until next year

The boosts caused by stock replenishment and          The burning question, however, is how far the
government        measures      are      especially   labour market is lagging behind economic
temporary, however. Economic growth is                recovery. With respect to the US, optimists
therefore expected to drop back below the             point to the fact that the strong reduction in
long-term average next year, incidentally             demand for labour over the past year was part
without falling into negative territory.              and parcel of the panic response from US
                                                      industry to the credit crisis and the shock on
Consumers hold the key                                the financial markets following the collapse of
                                                      Lehman Brothers. Now that the system risk
No sharp increase in company investment is            has evaporated, this over-reaction can be
expected for the time being, because current          reversed and optimists believe that there will
use of capital and labour resources is very low       be a recovery in demand for labour over the
and productivity is very high. Consumers              coming twelve months.
therefore hold the key to sustainable economic
recovery. Consumer spending is currently at           However, pessimists point to the fact that since
very low levels, while it generally accounts for      the 1990s the initial phase of economic
60 to 70% of the gross domestic product               recovery has not been accompanied by an
(GDP) in most developed economies.                    upturn on the labour market. In the recovery
                                                      following the 1982 recession, unemployment
Any boost to spending will chiefly have to            began to fall two months after the end of the
derive from income growth. In spite of the            recession. After the 2001 recession, however,
credit mountain created over the past decade,         unemployment did not peak until 18 months
consumption levels are still largely determined       after the end of the recession.
by household income. And this will continue to
be squeezed for the time being. Moreover,             This time we expect the upturn in the number
over the next few years it will be increasingly       of jobs to start slightly earlier than following the
difficult to access credit from banks as these        2001 recession. On the one hand, there was
are in the midst of a long-term deleveraging          certainly a panic reaction last year, but on the
process. Households, chiefly in the US, will          other companies will also continue to be very
also need to reduce their levels of debt.             aware of their operational costs. As they are
                                                      not, or barely, able to raise prices, an increase
Labour market is crucial                              in productivity will be more crucial than ever to
                                                      maintaining earnings growth. A rise in labour
The evolution of the labour market is crucial to      costs would cancel out any increase in
consumer     spending.     In   August      US        productivity. Unemployment is therefore
unemployment rose to a cyclical peak of 9.7%.         unlikely to peak before the second quarter of
The rate at which jobs are being lost has             2010.
decreased over the past few months, but

ING Maandvisie
Equities: earnings could drive prices up further

Fertile environment for equities                       Sector preference leaning towards cyclical

Equity markets are currently experiencing a            In this type of new phase, we also often see a
sweet spot. This period is characterised by the        shift towards certain sectors in the equity
combination of improving economic indicators           markets. We have already witnessed an
and company earnings and ongoing flexible              unprecedented radical shift from defensive to
monetary and fiscal policies. US and European          cyclical sectors. We expect the cyclical sectors’
earnings momentum continues to gather pace,            outperformance to continue, but no longer at
while the momentum is at high, stable levels in        such      high   levels, considering      recent
emerging markets. We expect this to persist            performances and increasing valuations. The
until at least the first quarter of 2010, as central   difference between cyclical sectors will
banks will not yet start to tighten monetary           become more pronounced. Historically, the
policy. The economic upturn is still too fragile       risks run by early cyclical consumer sectors
for that. Nevertheless, this temporary sweet           are greater than those run by late cyclical
spot is a fertile environment for equities.            industrial sectors.

It does appear, however, that the equity               We are now therefore more positive about the
markets are on the brink of a new phase.               industrial sector, although we still have a
Valuations are approaching fair value levels.          slightly negative view of this. We remain
The price/earnings ratio (PE), the most                negative about both consumer staples and
commonly-applied ratio for indicating valuation,       durable consumer goods.
is currently at about the long-term average. In
Europe, the PE ratio has risen by 90% since            Furthermore, we retain our preference for
this cycle’s trough (from 7.1 to 13.5 as of the        European equities rather than their US
end of August). In the US, the PE ratio has            counterparts. The main reasons for this are
increased by 63%, from 11.1 to 18.1. This              their valuation and price potential. Based on an
brings valuations back to pre-crisis levels.           earnings growth forecast of 23% in 2010, the
                                                       European PE is only 11, substantially below
Equities boosted by earnings                           the long-term average of 13.5. A return to this
                                                       average would mean that European equities
However, this does not necessarily mean that           could still rise by at least 15% in the period up
the end of price rises on the equity markets is        to mid-2010.
in sight. Now that it will be increasingly tough
to achieve any further improvement in the PE           Constraint on equities in the long term
ratio, corporate earnings will have to take on
the task of pushing up equity prices. And this is      In spite of the improved outlook for the short
perfectly possible as a rise in earnings has           term, we continue to be neutral for equities
been forecast. Earnings have already reached           compared to bonds. Company earnings growth
rock bottom; about six months earlier than had         will be constrained after 2010, particularly by
originally been predicted. This means that             poor consumer spending levels. We believe
operational profit margins have bottomed out           that spending growth will be in line with income
above levels seen in previous recessions. This         growth. The outlook for income growth is not
is remarkable in view of the depth of the              encouraging in view of the unions’ weakened
recession.                                             negotiating position. Moreover, the positive
                                                       effects on earnings of cost-cutting will
Even in the event of a moderate recovery, we           gradually      dissipate.   Finally,      flexible
believe that earnings could easily grow by             government policy cannot be maintained in the
double digits. Based on our top-down earnings          long term and households and companies alike
model, earnings in the US and Europe could             will face higher taxation and regulation in the
rise by about 20% in 2010 thanks to cost-              financial sector.
cutting, dramatic rises in productivity and a
slight growth in revenues. This estimate is still
fairly conservative.

ING Maandvisie
Bonds: ongoing improvement across the board
Downward pressure on bond yields

In spite of a high risk appetite among investors,
which is usually good news for risky assets,
                                                    British and continental European housing
                                                    markets will provide a major boost to the ABS

the markets for government bonds have also          We maintain our preference for high-quality
performed reasonably well recently. This has        credits, known as investment grade credits.
led to a fall in bond yields.                       The improving health of the banking sector and
                                                    growing interest among investors in these
The main reasons were a decline in the supply       credits are the main reasons for this. Moreover,
of government bonds, lower volatility and           ever greater numbers of European companies
sustained downward pressure on inflation. We        are using this market as a means of raising
expect the yield on German 10-year                  money, which is in turn helping to mature the
government bonds to fall further to about 3%.       European credit market. This is a positive
                                                    development in the longer term.
One of the reasons for this are the very low
short-term interest rates; the rate which is paid   The changing structure of the global economy
to borrow money for a period of e.g. one year.      is a major reason to be positive about
Investors seeking higher yields will have to turn   emerging markets. Greater flexibility, higher
to longer-term bonds. This shift will result in     growth potential and domestic demand which
downward pressure on the long-term yield.           has proved resilient are major props for a
                                                    further appreciation of emerging market
Risky bonds remain attractive                       currencies compared to the currencies of
                                                    developed countries. We therefore prefer
The high risk appetite among investors              emerging market debt in local currency to its
continues to be a major boost to price              hard currency counterpart.
evolution in the riskier segments of the bond
market, such as credits and emerging market         Finally, we are again slightly more positive
debt.                                               about high-yield bonds and have now adopted
                                                    a neutral position. High-yield bonds have
The strong rally of the past six months has         lagged behind recently, which means that
meant that valuations on these markets are no       compared to other bond categories they are
longer extremely high. The only market in           more attractively valued. Companies which
which these are still too high is the market for    issue high-yield credits are most susceptible to
asset backed securities (ABS). This is chiefly      an environment of low economic growth, as
due to this market not yet having returned to       they have higher levels of debt. However, in
normality; liquidity remains extremely low and      view of the high risk appetite and the
securities transactions are currently practically   favourable growth forecast for the short term,
impossible. We expect liquidity to return to this   we do not expect investors to focus too
market and it will then be a highly attractive      strongly on these risks for the time being.
proposition. Tentative signs of recovery on the

Real estate & cash
In line with the financial sector, real estate      We therefore retain our negative view for real
equities have risen sharply over the past six       estate equities. We believe that other equities
months. Real estate equities have been driven       and credits are more attractive. Finally, we
recently by dwindling concerns about                prefer government bonds to cash. The yields
refinancing and tentative signs that the bottom     on the money market are currently extremely
has been reached in valuations on the direct        low.
property market. Nevertheless, we remain
concerned about the many refinancing
transactions scheduled for 2010. This contains
a risk for the medium to long term. Occupancy
levels and rental prices also remain under
pressure due to the effects of the recession.

ING Maandvisie

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