** 24/01/11 - 9.45am - by James Gerrish**
Last week we saw some volatility in the market based on concerns that China was growing too quickly and inflation concerns were going to prompt the central bank to act aggressively in tightening policy. This sent investors scurrying from the mid cap miners in particular - however at times like this its important to step back and take an objective look - and try to avoid as much noise in the markets as possible.
As I suggested in my 2011 Outlook, the two main themes in the market this year will be:
1. Chinese growth
2. US recovery
Does anything that occurred last week change our view on either factor? NO
Figures last week showed China grew a 9.8% last year – a rate as high as this obviously has flow effects to inflationary pressures and we are seeing this dominating the airwaves.
The main issue in China is the fact they peg the Yuan to the US dollar. We all know the USD has been at historically low levels and for good reason as well – printing money – interest rates at 0-0.25%. But keeping the Yuan in line with the Dollar when China is growing at 9.8%, interest rates at 5.81% and inflation ticking up around 4.6% is ridiculous.
It does help the competitiveness of Chinese exports and this is what the US are jumping up and down about, but its also imports inflation – by higher import prices. Think of Iron Ore for the moment which is had a huge run and is now costing Chinese mills up to $180 a tonne (Not bad when the likes of FMG and RIO can pull it out of the growth and ship it off for about $45 a tonne!
But the fact still remains that Chinese growth is strong and has not shown signs of slackening off by any significant margin. Yes, inflation is a concern however we should really be giving the Chinese Central Bank the benfit of the doubt for now. They can raise rates, increase capital requirements for banks to reduce the flow of credit and above all, they can let the yuan appreciate which will reduce the costs of import prices – something the economy will benefit from as domestic consumption improves.
So as you can probably tell I’m still pretty bullish on the story of China and the flow on effects it will have to the Australia economy. However there is no doubting that the market remains nervous about this thematic – we saw this last week when a lot of commentators/media took the opportunity of a couple of days of weakness to push their bearish argument.
Because of this scepticism or concern about Chinese growth, the market will be on edge which leads to heightened swings or volatility. Something I think we';ll need to get used to this year.
This brings me to the US which I believe is showing strong signs of recovery based on recent economic data + company reports. One company report that I always look at closely is General Electric (GE) It's a strong proxy for the broader economic situation in the US. It has exposure in such a large number of industries from small appliance manufacturing to corporate finance, Aviation, Healthcare and Energy.
The stock rallied on Friday night after the company's fourth-quarter profit jumped 51%. Revenue also beat Wall Street's estimates with a pickup in orders for big-ticket equipment and services.
This is the kicker!!! Corporate America has cash and I believe its starting to put it to use – GE’s results go some way of highlighting this.
So how does all this fit into an equity strategy for an Australian Investor? I'll reiterate what I wrote in the 2011 outlook paper.
- For early this year, we retain our view of backing the growth in emerging markets. We want to be long commodities that China and other countries are physically short of. This includes agricultural commodities as food security becomes a more pressing issue. I firmly believe that M&A activity that started to show signs of life late last year will intensify at the start of 2011. This will be further amplified by significant capital available through private equity.
(MCC, FMG, RIO, BHP, WHC, AGO, EQN, RIV etc)- Check emerging markets model portfolio for more ideas
(CLICK HERE)
- As the year progresses we must be more conscious of the recovery coming from the US as they begin to pullback stimulus measures. The main data set to monitor in respect to this is the employment situation. Stimulus will remain active whilst unemployment remains high.
(QBE, CSL, NWS, COH)
- If stimulus is wound down, the US Dollar may find support which will reduce the appeal of commodities and commodity backed currencies such as the Australian Dollar. This will be further amplified when the US moves closer to raising rates – potentially in 2012.
- As the US improves, we want to reduce our overweight call on commodities and start to gain some exposure to an improving US economy and currency. Companies that are listed in Australia that generate earnings from the US should benefit here.
I firmly believe that in 2011, being active in the market will out pace a passive strategy
