With the New Year in sight, it is worth starting to consider the factors that may drive the markets in 2013. The legacy of the financial crisis continues to dog the global economy and markets. However, at least some order is coming to some parts of the world. In particular, we can take heart that both the United States and Chinese economies have come through their worst phases.
There is also a general sense that they have gone some way to partly repair their previous economic excesses. Central banks around the world are pushing every button to provide liquidity to oil the wheels of the global economy.
Finally, investors are showing the first signs of increased risk appetite, which could help to push the liquidity into all corners of the financial markets.
Upbeat US and China
Although the negotiations around the fiscal cliff continue to trouble the markets, the underlying picture for the US economy is more upbeat. US economic data shows the strong underlying trends of improved industrial confidence and a better housing market, although weather-related factors are putting a slight drag on activity.
We would again emphasise the important improvement in the housing market seen over the course of the year. The November Homebuilders survey hit the highest level since May 2006. Equally impressive was the fact that current home sales saw the largest one-month increase in a decade. Housing starts are up 46% year-on-year and 127% over the last three months (annualised rate).
The Chinese economy continues to show good signs of recovery. This encourages us to remain positive on Chinese asset markets. The November flash industrial confidence indicator rose to 51.3 from 48.2. Encouragingly for global growth expectations, confidence in export orders rose to 52.3, the highest level since November 2010.
The ongoing moderate -- but consistent -- improvement is leading to some economists to consider upgrading their GDP forecasts. The economy is showing signs of good momentum without any need for immediate new measures from either the government or central bank.
The most likely policy mix from now on is likely to be a further relaxation of lending conditions in the economy and further targeted spending and reforms by the central government.
As China improves in 2013, we expect Korean rather than Taiwanese equities to show the better returns. The Taiwanese economy is showing signs of a good recovery. The equity market, however, does not give investors particularly good value. While Korean equities trade at a P/E of 8.2 for 2013, Taiwanese equities trade on a prospective P/E of 13.3.
We believe Korean equities will provide investors with greater upside and a more leveraged improvement on the back of a recovery in global growth.
Euro zone blues
As 2012 ends, the problems in the Euro zone still seem insurmountable. The last week has seen more of the same delayed decision-making, intransigence and politically motivated posturing.
The Germans worried about an election next year still try to impose austerity beyond the means of a country such as Greece while the French continue to promote the common agricultural policy (CAP) because of the huge benefits it gives to French farmers. Meaningful reform and pragmatism are apparently beyond the politicians, even though the pressures are still severe.
Consumer and corporate spending
For the nascent global recovery to have legs will require that the current levels of industrial confidence is supported by strengthening final demand, particularly from consumers. The good news is that consumer demand may be helped by a fall in inflation over the coming months.
Global inflation is set to fall to half the run rate of the previous quarter, providing a boost to the real spending power of consumers. Brent oil rose to US$125 at the start of 2012. If the oil price remains at current levels (averaging US$110), the energy component of inflation could be negative.
Capital spending could provide the upside risk to global growth. Large companies are generally flush with cash and should they start to believe in the sustainability of global growth, then we could see capital investment accelerate.
This could be the tech sector’s moment. A potential recovery in capital investment in 2013 should provide a stronger backdrop to a tech sector that has had to rely on consumer products for much of its growth in 2012.
Trade data for Korea for October showed the second consecutive rise in semiconductor exports. The book to bill ratio, which tracks the level of new orders relative to recent sales of semionductors, has started to improve in Japan and is very close to a cyclical low in the United States.
Tech sector heavyweight Apple has shown tentative signs of improvement with a rally in the share price from a low of US$525 to US$572 albeit on low volumes. The most recent peak was US$702.
New Guy in Japan
Japan has already proved to be the surprise of November, with a 9% rally in eight trading sessions. It could continue to provide positive surprises next year. Japan remains in the middle of a structural downturn. However, as we saw under the tenure of Mr Koizumi, the equity market can deliver outsize returns when excitement about reform builds.
The new guy on the block is Mr. Abe. The incumbent government has called for new elections in December and the opinion polls suggest than an LDP -led government is the most likely outcome. Mr. Abe has already set out his agenda – which includes clear political interference in the operations of the Bank of Japan.
The new government will likely be striving for an expansion of quantitative easing with the clear implication of yen weakness. In the past periods where the Yen weakened, the equity market gave good absolute returns. One example was the Koizumi government back in the early 2000s, which saw the first significant bout of quantitative easing, a 20% drop in the yen and a 70% recovery in the equity market.
Hope for India?
For emerging market equities to prove a winner in 2013 will require more countries than just China to deliver growth and promise.
India faces a crucial winter session of parliament in the coming weeks. This will set the scene for whether Indian markets can make a significant positive contribution to emerging market performance in 2013.
The government overcame an initial confidence vote last week. However, there are many hurdles ahead. In a week when global markets rose sharply, India was a notable laggard as optimism faded that we could see a further meaningful phase of reform.
All hope is not lost. The government has lined up 25 bills for parliament’s consideration, including further liberalisation of the financial services sector in insurance by allowing more foreign direct investment and the issuance of added banking licenses. Crucial will be the ability of the government to show sufficient reform and fiscal discipline, encouraging the central bank to cut ease monetary policy still further in early 2013.
About the Author
Gary Dugan is Chief Investment Officer, Asia & Middle East, at Coutts, a global private banking and wealth management services provider that is part of the Royal Bank of Scotland Group. First published on 26 November 2012, this article was re-edited for clarity and conciseness.