2013: The scenario will become challenging for China, says Pioneer

A phase of gradual improvement of global economic conditions is likely to happen in 2013, following the probable resolution of the fiscal cliff issue in the US, bottoming out of the Chinese economy, and stabilization of the eurozone, accoring to Giordano Lombardo, chief investment officer at Pioneer Investments.

“In the US, positive signals from the real economy are emerging, mainly in the housing market, and we believe that the US Federal Reserve may maintain accommodative policy to support the unemployment redtion,” Lombardo (pictured) said.

The corporate sector is in a healthy condition and he believes that the current levels of profit margin can be sustained in the immediate future.

In the longer term, the US is facing the challenge of managing an exploding public debt, due to recurring high levels of yearly deficit, and exacerbated by potentially massive unfunded welfare liabilities.

Moving to Europe, the ECB has cut the tail risk of a collapse of the single currency, introducing the outright monetary transaction mechanism last summer, and the peripheral countries have made some progress in implementing structural economic reforms, notably in the labour market and pension system.

“The good news for next year is that the additional requirement of fiscal adjustment in the peripheral countries should be lower than in 2012, and this may help economic growth to move back into positive territory in the second half of 2013,” Pioneer said.

The monetary policy should remain very accommodative to avert the credit crunch, while lending conditions in many countries remain very tight, and the so called “balkanisation” of the different national credit markets could continue, before a significant progress is made towards a banking union (not in the short run).

The Chinese economy is bottoming out in the current quarter and there is still room for additional fiscal and monetary expansionary measures to prevent a further slowdown.

“Beyond 2013, we see a more challenging scenario for China, which is facing a challenging shift in its economic model from an investments-led to a consumption-led one,” the firm added.

The new political leadership may now need to move beyond the rhetoric of announcing economic reforms to actually implementing them in crucial areas, such as welfare state, liberalization of the financial sector and the currency market, and further promotion of privately owned enterprises.

“We believe that negative real interest rates, driven by the aggressive action of the Central Banks (financial repression) may continue to push investors into the ongoing search for yield. While we acknowledge that a lot of ground has been covered in terms of credit spread tightening, we remain constructive on this asset class, in an environment where interest could be kept very low for a long period of time, or may rise very slowly,” he said.

Pioneer sees opportunities in high yield both in the US and in Europe. The yield offered by these securities is attractive and default rates are not expected to increase in the near future.

In the search for yield, emerging markets bonds may continue to play a role in investors’ portfolios.

“We look favourably to extending our exposure to the emerging market corporate bond sector, where the credit quality has increased considerably and valuations are more compelling,” Lombardo said.

Giving the cyclical background described above and the current valuation framework of all the asset classes, Pioneer believes that a strategic shift into equities is going to be the major decision facing investors in 2013 and beyond.

“In particular, we see very interesting opportunities in European equities, which currently represent the most under owned equity market amongst global investors,” Lombardo added.

Finally, current equity valuations in Europe are supportive of this outcome.

“Using cyclically-adjusted price-earnings ratios and their relationship with the asset class total returns over the following 10 years, we find that on an historical basis, periods of such cheap valuations have been followed by a decade of annualized double-digit total returns,” Pioneer said.

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