Investment Outlook for 3Q 2008
The Lloyd George Forecast for 2008
Investment Outlook 3rd Quarter 2008
Three months ago we saw a buying opportunity in Asian shares. Today we are again testing the downside limits in various markets. It is unusually difficult to make any forecast with conviction about where the world economy and markets may go in the second half of 2008. The US economy has slowed down but there are pockets of strength in oil and agriculture. Consumer confidence is slow and unemployment has started to rise, but so far there is not overall a recession and it looks as if the US economy will grow about 1%. The US Dollar is beginning to recover from a very oversold level against the Euro, Sterling and Yen.
Overshadowing everything however, is the oil price, now at US $138 per barrel, and forecast by Goldman Sachs to spike up to US$200 per barrel in the next six months, particularly if there is some military action by Israel against Iran, as rumoured. This dramatic increase in energy prices is affecting all global economies, especially emerging economies. In Latin America, Africa and Asia, inflation has jumped: to over 25% in Vietnam, and over 10% in Indonesia, Philippines with India and China at about 8-9%. We have begun to see action by governments, especially in reducing the fuel subsidies. Indonesia, India, Taiwan and Malaysia have all made recent announcements, with Malaysia suggesting complete liberalisation of fuel prices by August and a 100% increase in domestic gasoline as a result. We expect China to take similar action once the Olympic Games are over in August.
Much of the increase in inflation has come from the higher food prices, which typically constitute over 50% of the CPI in most Asian and emerging economies. Once again we believe that there has been an artificial spike in rice and wheat prices, which will subside in the second half, and so we might see overall inflation at a more benign level by the end of the year, with the consequence that interest rates could be lowered and the pressure on currencies reduced. In the past 6 months, the Fed has pumped liquidity into the banking system to counter the effects of the sub-prime credit crunch, and much of this additional liquidity has found its way into Asia. We are therefore at a watershed in terms of whether the Asian markets hold current levels, which are very oversold, and experience a recovery in the second half, which we expect.
In May, the author made a trip to Taipei, to meet some of the senior members of the new Kuomintang administration, which took office on May 20th. This included the Vice President, Vincent Siew and the Chairman of the Cross Straits Foundation and of the Kuomintang Party. I was able to confirm the thesis that there has been a radical change of policy in Taiwan towards China in terms of encouraging dialogue and opening up tourism, trade and investment. We believe that the effect on the Taipei market will be parallel to that of Hong Kong since 2003, when China signed the economic support package CEPA (Closer Economic Partnership Arrangement). Since then, Hong Kong property has in some cases tripled and the Hang Seng Index has more than doubled. Much of this has been driven by wealthy mainland investors and the retail and hotel sectors have also benefitted tremendously: we expect the same to occur in Taipei. The greater China region will benefit from the removal of the possibility of military conflict and the more benign scenario of gradual economic and eventual political rapprochement. It is noticeable that the Taiwan market was the only Asian Market to show a positive performance in the first quarter of the year, anticipating this change.
In India we have had a sharp correction in the Bombay market since the peak in January marked by the IPO of Reliance Power. The local investors are shell shocked by the correction, but we see good buying opportunities as Indias economy continues to grow over 8% and we have confidence in the conservative management of the Reserve Bank of India in handling the inflationary situation by raising interest rates and reserve ratios. On the other hand, we have seen the Indian Rupee correct from a high of 39 to about 43 Rupees to the US Dollar. This has highlighted the over sold software sector, led by Infosys, TCS and Satyam, which has now recovered. Despite the problem in US banks, we believe that the long term contracts held by these Indian software companies with multinational groups, including retailers and airlines, as well as financial groups in Europe and the States, constitute a sustainable business model. Overall therefore, we remain positive on the Indian Outlook over the next 6-12 months.
With regard to over heating Asian economies, Vietnam has become the Canary in the Mine, with 25% inflation, a 70% fall in the adolescent share market, which is still rather small, and falls in property values in Hanoi and Ho Chi Minh. The Vietnamese currency the Dong is now probably 50% over valued, and we liken it to the situation of China in 1994, when the authorities devalued the Renminbi over night by 50% and thus began an export boom for China. We are positive on Vietnam for all the same fundamental reasons high savings rates, young population, strong family structure and work ethic, competitive resource and manufacturing base.
Russia has been a disappointing market for the past year, but has held up well in the general correction of Emerging Markets recently, supported by a strong oil price and perceived political stability as Putin handed over to Dmitri Medvedev in May. GDP growth continues at about 7% and despite higher inflation the Russian share market is selling on a P/E of nearly 10 times. The Rouble is one of the strongest currencies in the world, supported by a $75 billion current account surplus, or 4.4% of GDP. As was true three years ago with Yukos, it seems that the headlines about BP and its Russian partner TNK should be ignored because the gradual rise of energy prices, including natural gas to world levels, will benefit Gazprom and all the other Russian energy stocks. Russias consumer sector is also relatively under developed, and had great potential.
Turning to the last of the BRIC giants, Brazil, many of the same trends are apparent, with a strong currency, the Real, supported by a boom in commodity exports. If Russia is the gasoline pump, then Brazil is the new farm for the world, producing soya beans, coffee and other food products. GDP growth has also improved, to about 5.5% and unemployment is falling with improving wages. Inflation remains under control at about 5% (compared to Argentina, which has soared to over 20%) and real interest rates are still among the highest in the world, with nominal lending rates of about 15%. (Similar pattern to India). Brazil has also had a surprising degree of political stability under President Lula and this has encouraged domestic consumption. One interesting feature of all these large economies is the growth in mortgage lending, with a booming private property market, rising from a low level for the first time.
When we stand back and look at these Emerging Markets in mid 2008, it would be naive to say that they were now independent of the US and Europe, but they do appear to have developed a momentum of their own, with healthy financial surpluses in China, Russia and Brazil, supporting strong government spending on infrastructure and the development of an important middle class. We believe that, notwithstanding the volatility of the last few months, there is a real opportunity for long term investors in world class companies to gain an entry to these major economies that should out perform the long established multi nationals in Europe, Japan and North America.
Robert Lloyd George
19 June 2008
