Some stocking fillers for the Christmas break......

Global Leading Indicators are looking up

Global Leading Economic Indicators (GLEI) are signalling that the unfolding growth slowdown will be shallow and short lived.

BCA’s GLEI bounced again in October. Encouragingly this reinforces the positive turning point of the prior month. The bounce was also broad based: both the U.S. and non-U.S. indicators ticked higher. While global industrial production growth is set to slow in the months ahead, this leading indicator implies that downside risks to growth are limited and that a renewed bout of strength is likely in the second half of 2007. Bottom line: The rise in the GLEI is positive for growth sensitive assets such as equities, and underscores that the bond market rally is in its later stages.

Global Central Bank Policy: In Transition

Monetary policy worldwide will likely enter a transitional phase next year where the key central banks will either stop raising rates or even begin cutting them.

Global central bank policies are currently out of sync. While the Fed has abandoned its tightening policy, the European Central Bank is still preparing for additional rate hikes. Meanwhile market-based expectations for the Bank of Japan are rising. Going forward, expect to see global monetary policy become more aligned, as the central banks that are currently hawkish will have little reason to pursue further monetary tightening as the year progresses. Already, the growth slowdown is encouraging global inflation momentum to weaken rapidly, which heralds a faster than expected drop in CPI inflation in most parts of the world. Bottom line: If anything, policy rates could drift lower next year, especially in countries where growth weakens to a below trend pace.

Bullish Supply-Side Dynamics

The dominant force in the world economy is the supply-side expansion.

The sources of this expansion are far from exhausted. Going into 2007 this theme will manifest itself in three significant ways that will stimulate low inflation growth. First, the globalisation process will continue to deepen. Second, the corporate restructuring process in Japan and Europe is likely to continue. Third, the boom in capital spending in the developing world has staying power, and corporations in the developed world are getting on-board. These three forces mean that the traditional Phillips Curve for the aggregate world economy is flattening rapidly. In other words, supply-side reforms and globalisation have allowed the world economy to grow at a faster rate than before without generating inflation.

Private Equity in 2007 

The sector has added significant value in recent years but, despite healthy portfolios, the potential for further exits and earnings-based uplifts, returns may well normalise from their recent highs. There is then the potential for a more testing backdrop, and high levels of cash and immature portfolios may be a drag.  

Is a slowdown in returns seems inevitable? Over the past four years, the compound share price total return of the Private Equity (PE) sector is 22%, some 600bp ahead of the FTSE All Share. Realisations have significantly exceeded new investment and high levels of liquidity and relatively immature portfolios are now a feature, and they could drag on returns over the shorter term. Expect to see further disposals and earnings-based valuation uplifts, and lower NAV returns over the next 12 months relative to the last two years. In addition, with the sector now trading on a modest premium to net assets, there would seem to be little scope for any further re-rating. 

A strong global economy has offered a supportive backdrop in recent years, and a slowdown is underway. US and Japanese data continues to soften, with concerns over the US housing market and its potential impact on the US consumer. Competition in the PE sector continues to intensify, due to the volume of funds raised in recent years and also from infrastructure and hedge funds. Concern continues to be expressed about the level of funds raised, excessive debt multiples (and entry valuations) and it would seem to be a matter of when (and not if) we see a high profile failure. Also, note the recent launch by the US Department of Justice of an anti-competitive inquiry into potential collusion by large buyout houses! Bottom line: The storm clouds may be gathering for Private equity. 

UK interest rates 

Net mortgage lending has been soaring recently. Given the strength of leading indicators of the housing market, mortgage demand should remain robust into next year. At the same time, broad money growth remains extremely healthy, while credit growth perked up this month to reach a 16-year high. The upward revision to the annual rate of UK GDP growth in Q3 announced this morning adds a bit more support to the case for a further rise in interest rates early next year. Growth rose from the previously estimated 2.7% to 2.9%, the highest rate since Q3 2004. 

Thailand

Thailand’s policy blunder this week is a one-off and does not portend investor unfriendly actions from other emerging Asian policymakers.

Thai equities rebounded sharply after policymakers backtracked and eliminated the capital controls (on stocks) announced on Monday. Nonetheless, there are several implications for Thai and other emerging markets. While policymakers will avoid abrupt measures such as those implemented in Thailand, Asian policymakers want to cap the strength of their currencies. Consequently, the risk/reward profile for most of Asian currencies is not attractive in the short term.

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HAVE A VERY HAPPY CHRISTMAS

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.