2013 Themes: Snakes and Ladders
- Europe lingers: The full-blown European crisis has been with us now for almost 4 years. It appears to morph into a different shape every few months. We believe political action and inaction in Europe will continue to drive global markets this year. Two important events will occur in 2013, a German election, and possibly a referendum in the UK on its relationship with Europe. In our view, the European Union will have to provide financial assistance to one or more peripheral countries in 2013, we believe this may be delayed till after the German elections to limit the impact on the Merkel government.
- Asia slowdown: The biggest Asian economy is showing some growing pains. 2013 may be the year when China backs away from a policy of growth at any cost and its institutions embrace a more holistic view of economic advance that includes environmental regulation and some liberalization of speech and rights. Though in the short term this might well lead to upheaval and a growth-shock, in the longer term, it will strengthen Chinese consumption. We believe China will underperform other emerging markets over the next year.
- Equities: Global Stocks are almost four years into an expansion that began in March 2009. On average, since the great depression, stocks have risen for just under four years before seeing a correction. We have been skeptical of economic growth driven by monetary stimulus virtually since the beginning, and our view has not changed. We believe the prolonged monetary stimulus has built up imbalances in the system and as policy-makers remove the stimulus, there is a strong probability that stocks will be in for a very rough ride. Many companies have learned a lesson from the credit crisis and we believe stocks with strong balance sheets, robust business models and high-quality earnings will outperform.
- The myth of hyper-inflation: Certain observers have been trumpeting the risk of high inflation as a result of Fed easing. We do not believe this is a likely scenario. Whilst implementing staggering amounts of quantitative easing, the Federal Reserve has bought over two trillion dollars in Treasury and MBS debt over the past four years. This huge balance sheet gives the Fed an enormous arsenal to combat inflation. When it begins to sell its bond holdings, vast amounts will be taken out of the money supply, putting a damper on any inflation. This is why we find inflation protected bonds relatively unattractive.
- A rude awakening for bonds: The Fed has been providing price support for long-dated bonds with its large purchase program and low interest rates. When that price support stops and the market has to stand on its own, we expect bond prices to collapse and rates to rise. There is a chance the Fed halts its QE program and raises rates in 2013 if headline unemployment reaches 6.5%, which is within the realm of possibility given the current trends in jobless claims. As a result, we find long-dated bonds extremely risky and prefer floating rate, short-duration and international bonds.
- The Sun also rises in Japan: Japan has been mired in deflationary malaise for over 25 years. An entire generation of investors has lived through successive mirages of Japanese recovery. We have begun to believe that this time is different. The enormous growth in Japan’s Asian neighbors and its own robust legal institutions make it an attractive destination for investment, tourism and business partnership. Japanese businesses are taking advantage of these opportunities, and though China still possesses a cost advantage, the gap is closing as wages rise in China. We see Japan’s demographics stabilizing and a generational change underway in Japanese business creating an entrepreneurial surge. We believe this presents an attractive opportunity for equity investors.
- Gold: Our regular readers know that we are not enamored of gold. Fiat money has served the world relatively well and provides policy makers with some flexibility. Competing fiat currencies and the opportunity to invest in both real enterprises (via stocks) and geographic communities (via government bonds) provide the modern investors with a variety of options to store wealth. We continue to hold that the price of gold is elevated beyond fundamentals and not sustainable. We see demographic changes that are steadily eroding Asian demand for gold, removing this long ranged support. We expect gold prices to drop in 2013.
- The death of the PC has been greatly exaggerated: 2012 was the year when smartphones and tablets decisively pushed desktop computers from their perch as the primary electronic devices in most homes. Relatively low prices, accessible touch-screen interfaces, wireless internet access and rich functionality are making small devices the desirable option for more consumers. Despite being overshadowed by its cooler, touch-sensitive cousins, the traditional computer remains the one device capable of performing the whole range of computing functions. It will remain an essential business tool for years to come. We think it’s a little too early to call the death of the computer, and that certain PC-related stocks will outperform in 2013.
- Network everything: Though wide access to the Internet is well into its second decade, connected devices have yet to reach their ultimate potential. Over the course of the next decade, we expect to see more devices linked to the broader Internet for specialized and general function. This will include cars and household appliances, opening up new use cases and opportunities for businesses positioned to produce the right set of products and services. We believe the technology sector in general, and Internet infrastructure firms in particular, offer attractive growth potential over the next decade.
- Alternative Energy: Alternative energy businesses have suffered significant losses since 2009 due to a variety of reasons. In the three years since, a couple of trends have converged to make their future look much brighter. Alternative energy at utility scale is approaching cost parity with conventional energy generation, and a nascent environmental movement is developing in the emerging world. These two trends are changing the equation for alternative energy and 2013 should see an increase in investment flows towards non-conventional sources of energy. We think prices are relatively depressed and the sector offers attractive value for long-term investors.