US Federal Reserve Bank Chairman, Ben Bernanke, triggered a minor earthquake in the financial markets with his announcement that the Fed would start to reduce its bond-buying programme in the second half of the year, according to Bank J Safra Sarasin report.
“In the coming months, investors will have to get used to the fact that cash infusions will not be available, at least not in the USA. This rehabilitation or process of adjustment will be accompanied by increased volatility in all asset classes during the summer months,” it added.
However, Bank J. Safra Sarasin regards any setbacks in the third quarter as buying opportunities because economic growth is likely to pick up again towards the end of the year. Aside from the equity markets, the US dollar should directly benefit from the upswing in the US economy. Bank J. Safra Sarasin expects the shale gas boom to give the greenback further strength because the revolutionary method of energy extraction has a positive effect on energy costs and, as a result, on the competitiveness of US industry.
After the sharp rise in long-term interest rates in June, Bank J. Safra Sarasin expects interest rates to stabilise in the third quarter because the global economy will not meet the high growth expectations initially. This might even prompt the US Fed to postpone the announced tapering of its bond-buying program until the fourth quarter. After a brief pause in growth in the third quarter, economic momentum should start to pick up again in the fourth quarter. Concerns that emerging markets will abandon their expansionary monetary policies, despite weaker growth rates, appear overdone. On the contrary, central banks in emerging market countries are likely to support growth in the second half of 2013 by pursuing a more expansionary monetary policy. Global leading indicators will bottom out in the third quarter, which means that what was previously a headwind for the equity markets will turn into a tailwind in the fourth quarter.
“Investors’ mandatory stint in the rehabilitation centre should continue in the third quarter until they have become accustomed to the lack of cheap money and slightly higher interest rates. If further turmoil erupts, good buying opportunities should open up in various asset classes during the summer months because economic conditions are expected to improve towards the end of the year,” Philipp E. Baertschi, Head of Research and Chief Strategist at Bank J. Safra Sarasin, said.
Despite the reversal in US monetary policy, the interest rate climate for equities will remain friendly in the second half of the year. Since short and long-term interest rates remain at low historical levels, the price/earnings ratio for equities could climb as high as 20 in the coming years. Equities therefore have significant price potential in the medium term. That said, earnings disappointments could unsettle investors at the beginning of the third quarter. But with the change in cyclical indicators, good buying opportunities should emerge in the third quarter. After the setbacks, Bank J. Safra Sarasin sees the biggest opportunities in defensive Swiss and UK equities, which are not cheap, but offer good earnings growth. While Chinese equities are inexpensive, they currently lack the catalyst for a price rally. Earnings performance is also a decisive factor for sector selection.
The healthcare, consumer staples, consumer discretionary and insurance sectors recorded above average earnings growth in the past, while at the same time posting above-average price gains. In the difficult macroeconomic environment, investors should continue to focus on equities with above average earnings growth.
Fears that the Fed might quickly reverse its monetary policy are likely to prove exaggerated in the short term. This should lead to lower yields in the third quarter. In the medium term, Bank J. Safra Sarasin expects a slight pickup in yields due to the slow healing process in industrialised countries. Set against the backdrop of a slightly less restrictive US monetary policy than expected, emerging market bonds should recover from their weakness.
The credit markets were also very strongly affected by the global rise in interest rates and credit spreads. However, the surplus liquidity of central banks, which led to strong demand for corporate bonds, will not disappear overnight. This is especially true for Europe, where a tighter monetary policy and a change in the credit cycle are not imminent. Supported by fundamentals, the valuation and technical factors, Bank J. Safra Sarasin expects credit spreads to narrow until the end of the year.
The boom in the exploration of onshore energy sources in the USA, which has lasted about six years, reached a peak in 2012. The energy sector is now in a consolidation phase, as prices for natural gas and crude oil have fallen back due to higher production output.
The new energy resources in North America, the world’s biggest energy consumer, should last for several generations and will have a dampening effect on prices. This trend could become even more pronounced, depending on whether the USA exports large quantities of its natural gas and whether other nations eventually follow its lead and decide to tap into their own shale gas reserves as well. There are no signs of a rapid alignment of natural gas prices across the globe, which throws up arbitrage opportunities in North America and other aspiring energy producers such as Australia and Africa. Given this scenario, the US energy sector and industries with high energy costs (but also high proportion of sales in their home markets) still present attractive investment opportunities.
The drop in US natural gas prices created by the boon in shale gas production has three important consequences for the US economy. 1) It supports a renaissance in individual industrial sectors (especially chemicals). 2) it counters a potentially speculative spike in oil prices, thereby helping to stabilize the global economy. 3) It reduces the US current account deficit and results in a stronger US dollar. The combination of a reversal in interest rate policy and the energy boom should support a significant recovery in the US dollar.