A Flock of Black Swans
Global Interdependence Center Rome - April 2011
Constance Hunter Managing Director and Chief Economist chunter@aladdincapital.com 203-326-6895
Global Equity Markets: Past, Present and Future 2003-2006
It’s a Wonderful Life
2007
The Tide Changes
2008
A Year of Reckoning
2009
A Rising Tide Lifted All Boats
2010
Low Rates, Refinancing and Top-Line Growth
2011
Low Rates, Stock Buy Backs, M&A and Black Swans
2
Wind in the Sails of Equity Markets... Black Swans on the Horizon
• Low Interest Rates
• Earthquake/Tsunami in Japan
• M&A to Accelerate
• Middle East Uprisings
• Share Buy Backs are Starting in Earnest
• European Debt Woes • US Debt Woes
• Cash on the Sidelines
• Chinese Hard Landing Fears
• Earnings Growth Momentum
• Rising Commodity Costs
• Profit Margins High but not Peaked
3
M&A Activity off to a Robust Start for Q1 High cash levels and low interest rates will buttress M&A activity this year
M&A Activity Breakdown
Target Industry
Volume ($bn)
Count
Oil & Gas
60.45
174
Telecommunications
59.46
169
Electric
45.39
72
REITs
41.52
85
Chemicals
24.45
117
Source: Bloomberg
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Significant Amount of Cash on the Sidelines‌ a Powerful Technical Factor Money Stock: Savings Deposits, including MoneyMarket Stock: Savings Deposits, including Money Deposit Accounts (SA, MMDAs Bil $) SA, Bil.$
6000
6000
5000
5000
4000
4000
3000
3000
2000
2000
1000
1000 96
97
98
99
00
01
02
Source: Federal Reserve Board/Haver Analytics
5
03
04
05
06
07
08
09
10
Outperforming Equity Markets are in Growing Economies Strong growth and inflation trump rate increases; markets outperforming Countries in Rate Hiking Mode 220 200
Indonesia
Turkey
South Korea
Brazil
Norway
Canada
China
180 160 140 120 100 80 60
Source: Haver Analytics 6
Mar-11
Dec-10
Sep-10
Jun-10
Mar-10
Dec-09
Sep-09
Jun-09
Mar-09
Dec-08
Sep-08
40
Quantitative Easing has yet to help equities as much as organic growth It does not help that countries engaging in QE also have high debt QE Countries Equity Market Performance Since LEH 130 UK
Germany
US
Japan
120 110 100 90 80 70 60
Source: Haver Analytics 7
Mar-11
Dec-10
Sep-10
Jun-10
Mar-10
Dec-09
Sep-09
Jun-09
Mar-09
Dec-08
Sep-08
50
Quantitative Easing Can’t Overcome the Burden of High Debt High debt hampers market performance, the US is underperforming Canada Countries with High Debt - Performance Since LEH 120 US
Portugal
Japan
Ireland
Greece
110 100 90 80 70 60 50
Source: Haver/Bloomberg 8
Mar-11
Dec-10
Sep-10
Jun-10
Mar-10
Dec-09
Sep-09
Jun-09
Mar-09
Dec-08
Sep-08
40
Market Performance Since Lehman Brothers Collapse Countries with lower government debt are outperforming Government Debt and Equity Market Returns Post LEH 120.00% 100.00%
Indonesia Turkey
Return since Lehman
80.00% 60.00%
South Korea China
40.00%
Brazil Norway
20.00%
Germany Canada
0.00%
Spain
UK
US Portugal Japan
-20.00% Ireland -40.00%
Greece
-60.00% 0%
50%
100% 150% Gross Debt Level
Source: Haver/Bloomberg 9
200%
250%
When will U.S. Debt Levels Weigh on Profit Margins and Share Prices? S&P 500 and Profit Margins 1700
15 14
1500
13 12 11
1100
10 9
900
8 S&P 500
7
700 Profit Margin
6
Source: Bloomberg 10
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
Sep-02
Mar-02
Sep-01
Mar-01
Sep-00
5 Mar-00
500
Profit Margin
S&P 500
1300
The Spanish Market is Weighed Down by the Poor Economy Spanish IBEX and Profit Margins 18000
25
16000 20
15
12000 10000
10
8000 IBEX
5
6000 Profit Margin
Source: Bloomberg 11
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
Sep-02
Mar-02
Sep-01
0 Mar-01
4000
Profit Margin
IBEX
14000
Diverging Economies Will Lead to Diverging Markets Country / Region
GDP Q/Q Industrial Annualized % Production
CPI
Current Budget Balance Account as a PMI Reading as a % of GDP* % of GDP
US
3.1%
5.3
2.2%
-8.8
-3.4
59.9
Canada
3.3%
5.93
2.2%
-2.1
-2.5
69.3
UK
-1.9%
3.9
4.3%
-9.0
-1.7
55.0
Japan
-1.3%
1.8
0.1%
-7.9
3.3
51.0
EUR Area
1.1%
5.92
2.4%
-4.1
-0.3
58.2
China**
10.1%
27.69
5.0%
-1.7
4.1
51.7
Brazil
3.0%
2.75
5.9%
-2.5
-2.9
52.7
India**
2.6%
9.4
8.8%
-5.0
-2.7
56.5
Russia
11.4%
6.5
9.4%
-3.4
4.8
55.2
South Africa
4.4%
1.7
3.7%
-5.3
-5.5
54.8
South Korea
2.0%
17.3
4.5%
-1.6
2.0
53.4
Mexico
5.1%
7.2
3.5%
-2.1
-1.0
n/a
*The Economist poll or Economist Intelligence Unit Estimate FY2010 Source: Bloomberg, Haver, The Economist 12
** Y/Y data, not SAAR
Consensus Forecasts not Aligned with Fundamentals It does not help that countries engaging in QE also have high debt P/E
Forward P/E
Mean Forecast
Max Forecast
Min Forecast
US
14.2
12.7
11.45%
27.43%
-7.11%
Japan
17.6
16.7
23.72%
48.60%
1.68%
Norway
13.3
11.1
7.54%
36.93%
-14.18%
Turkey
11.0
10.0
14.63%
39.02%
-5.93%
Spain
9.4
10.6
11.71%
38.01%
-14.29%
Portugal
12.5
13.0
14.11%
34.23%
-7.40%
Greece
27.3
11.3
11.25%
44.99%
-6.53%
Ireland
neg
17.8
11.64%
45.25%
-3.24%
Source: Bloomberg Consensus Forecasts
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Divergent Performance over Past Two Years Annualized Return versus Volatility (2) High
40% FTSE 250
Commodities 35% Independent Credit Fund
30%
Return
S&P 500 25% CS Leveraged Loan Index
20% Barlays U.S. Credit Total Return
15%
Barclays U.S. Credit Excess Return
10%
Low
5% 0% Safe
2%
4%
6%
8%
10%
12%
14%
16%
Volatility
(1) Annualized
standard deviation of monthly returns ending with February 2011 Source: Barclays, Credit Suisse, Bloomberg, Aladdin Capital
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18%
20%
Risky (2)
23 months
US Forecast: Above Trend Growth for the Next Two Years Fiscal and Monetary Stimulus producing higher growth‌.. But can it last?
Year
Annual Rate
Year-End Forecast
GDP
PCE
Private Investment
Residential Investment
2010
2.4%
1.7%
6.2%
-4.2%
9.7%
1.6%
3.30%
2011
3.5%
3.1%
10.7%
-3.1%
8.0%
1.8%
3.65%
2012
4.3%
2.7%
11.0%
9.0%
7.5%
3.5%
5.10%
2013
2.6%
2.7%
5.0%
7.5%
7.0%
2.8%
4.50%
2014
2.9%
2.9%
4.9%
8.5%
6.5%
3.1%
4.80%
Source: Aladdin Research
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Unemployment Inflation 10-yr Yield
Conclusion • Equities have strong tailwinds… But caution is warranted • Strong GDP growth is necessary for equity markets to grow at rates that compensate for the volatility • QEII and Bush tax cut extensions function as a massive stimulus for the U.S. in 2011 • The U.S. economic recovery continues and gains momentum (3.5% real GDP for 2011). • High debt levels borrow from future growth and equity markets seem to discount this. • Restructuring and stimulative government policies continue to support markets…
• … But Black Swans hover on the horizon
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Constance Hunter - Bio
CONSTANCE HUNTER, Managing Director & Chief Economist. Prior to joining Aladdin, Ms. Hunter was with Galtere Ltd., a global macro hedge fund, where she served as a Chief Economist. Prior to and concurrently with, Galtere Ltd., she was the Managing Member and Chief Investment Officer of Coronat Asset Management. In that role, Ms. Hunter identified macro themes and invested in global equity and FX markets to capitalize on these themes. Prior to founding Coronat, Ms. Hunter was a Partner and Portfolio Manager at Quantrarian Capital Management, a hedge fund that invests in Asian markets. In addition, she has worked as a Portfolio Manager at Salomon Smith Barney, Inc., and Firebird Management, LLC. Ms. Hunter received a Bachelor of Arts from New York University, as well as a Masters of International Affairs from Columbia University.
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Disclaimer This document was prepared by Aladdin Capital Management LLC, and reflects the current opinion of the contributor. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This document is for informational purposes only and does not constitute a solicitation or an offer to buy or sell any investment security, nor provide investment advice. Neither Aladdin Capital Management LLC nor any officer or employee of Aladdin Capital Management LLC or any affiliate thereof accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents.
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