2011outlookworkshop by Clémence Derennes

NEWSLETTER "2011 Outlook" Workshop January 19, 2011

"2011: Squaring the circle?" Will the recovery in the developed countries be sustainable? Is inflation a threat to growth in the emerging zone? Is the sovereign debt issue starting to be resolved? Which strategies and portfolio allocation should we adopt for early 2011? Just some of the questions addressed at Natixis Asset Management's "2011 Outlook" Workshop attended by some 380 participants on January 19 and hosted by Pascal

"The broad-based recovery in activity allows us to again take on risk in some asset classes: equities but also high-yield bonds." 2010 was not without surprises and 2011 could have some new ones in store. As we begin the year, four elements structure the economic and financial landscape: problems with the financing of sovereign debt particularly in the euro zone, uncertainties about the US economy Pascal Voisin which is sending contradictory signals as to the CIO of depth of the recovery, euro/dollar exchange Natixis Asset Management rate volatility and the continued growth of the emerging countries. This latter point finally enables us to foresee a decoupling phenomenon for these economies relative to those of the western countries. Faced with these trends, three key messages. Firstly, the need to remain vigilant since the issues surrounding sovereign debt have yet to be resolved. The broad-based recovery in activity allows us to again take on risk in some asset classes: equities but also high yield bonds. Lastly, the valuation levels of a number of emerging countries and signs of inflationary strains in some (China, India, etc.) argue for a more cautious approach.

Voisin, Chief Executive Officer, Philippe Waechter, Chief Economist, Ibrahima Kobar, CIO Fixed income, Emmanuel Bourdeix, CIO Equity, Asset Allocation and Structured Products and Franck Nicolas, Head of Global Asset Allocation and ALM.

The Natixis Asset Management Workshop on January 19 gathered some 380 participants. www.am.natixis.com CORPORATE AND INVESTMENT BANKING / INVESTMENT SOLUTIONS / SPECIALIZED FINANCIAL SERVICES

A recovery subject to constraints but a recovery nonetheless "The recovery in activity promises to be more robust and more autonomous than in 2010. It will, however, be subject to constraints which will generate volatility."

Philippe Waechter Chief Economist

Growth to be more autonomous and more robust

World business indicators and PMI/Markit Survey

Having been kick-started by intervention from governments

and central banks in the spring of 2009, the recovery

paused for breath during the summer of 2010. The

emerging economies, which had played a major role in

this rebound, needed a period of consolidation while

-10

the stimulus effects of fiscal policies were exhausted.

-20

Since

again

-30

and

-40

been

October, improving

the

business

while

surveys

industrial

have

production

Quarterly change/Annual rate

35 October and November

2004

2005

2006

2007

2008

2009

world trade are also returning to a positive trend.

Industrial production (Source CPB)

Growth looks more homegrown than a few months

PMI/Markit Survey – World Manufacturing Sector (right-hand scale)

ago. It should be more robust and more sustainable,

2010

World trade in volume (Source CPB)

Source: Datastream – Natixis Asset Management

reflecting the behavior of the economic players more than the impetus coming from economic policy stimulus.

…but a recovery without a catch up A broad-based recovery…

Within the industrialized countries, the growth rate seen since

All countries are recording signals consistent with a recovery in

the recovery has been close to its pre-crisis level. There is no

activity: growth in orders and a relative decline in inventories,

catch-up phenomenon. This means that strains on productive

whether in the United States, the euro zone, Russia or Asia.

capacity and the labor market will be limited.

Japan is a laggard.

At the end of 2010, employment in both the United States and the euro zone was markedly below pre-recession levels.

Euro zone - Quarterly GDP growth and New Orders to Inventories ratio

New Orders to Inventories ratio

Households remain worried and should continue to pay down debt.

1.30

In other words, the signals coming from the corporate sector

1.20

are fairly positive but households remain affected by the labor

1.10

1.00

market which is seeing only a slow, inadequate recovery, a

-2

0.90

sometimes excessive level of debt and, in the US case, a real

0.80

estate market which remains weak.

-4

0.70

-6

0.60

-8 -10

Quarterly GDP growth

This explains why there is growth but without a catch up in

0.50

line with the GDP trend growth that would have been seen

0.40

without the recession.

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Datastream – Natixis Asset Management

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Increased divergence within the euro zone countries

105

The growth differential between the northern countries in

100

the euro zone (Germany, France, etc.) and those in the south (Italy, Spain, Greece, etc.) should remain in 2011. To this we

Industrial production (base 100 - H1 2008)

can add the issue of sovereign debt which is creating more

heterogeneous situations.

The Europeans want to rebalance their internal situation by

gradually improving their public finances and finding a solution to the sovereign debt issue. This is why growth is modest and monetary policy will de facto remain accommodative this year.

jan-08

jul-08

France

jan-09 Germany

jul-09 Spain

jan-10 Euro zone

jul-10 Italy

Source: Datastream â&#x20AC;&#x201C; Natixis Asset Management

"To curb the inflation generated by rising commodity prices, the emerging countries may have to revalue their currencies."

Soaring commodity prices are stoking inflation

CRB index on commodities 650 600 550 500 450 400 350 300 250 200 150 1991

One major reason for the rise in commodity prices is the change in the structure of demand. In the oil market, for example, the growing need of the emerging countries is such that their relative weight in demand is becoming virtually equivalent to that of the developed countries. This change in demand is being experienced by numerous commodities leading to upwards pressure on prices. This is shown in the CRB index chart. Furthermore, the

1994

1997

2000

2003

2006

2009

Source: Datastream â&#x20AC;&#x201C; Natixis Asset Management

monetary conditions facilitate the taking of positions in this type of asset. This increase in prices is feeding through to higher inflation, particularly in the emerging countries. In order to curb this, governments are currently using the interest rate weapon. However, given that these prices are global, they may move to revalue their currencies, which would be more effective. This could be the case for the yuan, the Chinese currency. The Western countries are also affected by these price rises. However, the central banks are currently assuming that this imported inflation will not spread to the rest of the economy and, notably, that it will not lead to pressure on wages. The underlying inflation rate is low and should remain so in the absence of any pressure on productive capacity and given high unemployment. Both the Fed and the ECB should maintain low rates in 2011.

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Sovereign risk, bis repetita "The high yield securities market offers opportunities given their yield and a default rate below its long-term average."

Ibrahima Kobar CIO Fixed income

Sovereign risk is not the same everywhere

824

600

581

400

391

200

220 157

real estate bubble which impacted the banking system.

07 /1 2/ 29 07 /0 2/ 29 08 /0 4/ 29 08 /0 6/ 29 08 /0 8/ 29 08 /1 0/ 29 08 /1 2/ 28 08 /0 2/ 29 09 /0 4/ 29 09 /0 6/ 29 09 /0 8/ 29 09 /1 0/ 29 09 /1 2/ 28 09 /0 2/ 29 10 /0 4/ 29 10 /0 6/ 29 10 /0 8/ 29 10 /1 0/ 29 10 /1 2/ 10

restructure their debt as of 2013, the measures taken by Spain

-200 06

While Greece, Ireland and Portugal will probably have to

while, for Ireland and Spain, they are due to the bursting of the

800

and Portugal, the difficulties arise from soaring public deficits

1000

similarities but there are also some differences. For Greece

and is now affecting Portugal and Spain certainly has some

Spreads versus bunds (10-year) 1200

Tensions remain high. The crisis which hit Greece and Ireland

Italy

look, in our view, enough to reassure markets.

Portugal

Ireland

Greece

Spain

Source: Bloomberg - Natixis Asset Management

Towards a steepening in the yield curve in the United States The upside potential for long-term interest rates looks limited in the euro zone.

The recovery in activity and inflationary expectations linked to

As long as it needs to support European States by purchasing

curve in the US although the Fed's quantitative easing policy is

debt, the ECB will hesitate to raise its official rate for fear of

slowing this move. The Fed is effectively committed to purchasing

triggering a systemic crisis. It will thus take time to follow

US $600 billion of securities by June 2011.

rising commodity prices are driving a steepening in the yield

the Fed were the latter to decide to increase rates and, in any event, the increase should be smaller. Monetary policies should thus remain accommodative. For example, during the 2010 second half, we see the German bund yield at between

CDS indices: Xover vs IG Main

2.90% and 3.40% versus 3% currently. 11 10 9

Strong outperformance of euro High Yield

forecast to November 2011 versus 4.4%).

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/1 0

/1 1 2/ 01

2/ 10

2/ 07

/0 9

/1 0

2/ 04

2/ 01

2/ 10

2/ 07

2/ 04

/0 8

2/ 01

2/ 10

/0 8

/0 7

/0 8

2/ 07

2/ 04

2/ 01

/0 7

2/ 10

2/ 07

/0 7 2/ 04

/0 7 2/ 01

/0 6 2/ 10

/0 6

for this asset class rate below its long-term average (1.8%

2/ 07

3 /0 6

securities market due to their yield and an average default rate

/0 6

opportunities are currently to be found mostly in the high yield

2/ 01

Credit remains attractive in terms of valuation. But the

2/ 04

A market favorable to high yield bonds

Source: Bloomberg - Natixis Asset Management

The year of equities "In a market with 10% upside potential, investors should gradually build positions in euro zone equities and adopt a more cautious approach to the emerging markets."

Emmanuel Bourdeix CIO Equity, asset allocation and structured products

8.00% 6.00%

relative to the other asset classes. The rate of profit for US

4.00%

companies is currently well above the yield on securities,

2.00% 0.00%

10 h-

hrc

+1 Std -1 Std (10 Years)

hrc

Average +1 Std (10 Years)

hrc

Earnings Yield - Bond Yield 10 Year Average

hrc

acquisitions.

-4.00% 89

companies to take on debt to finance share buybacks or

-2.00%

a situation which is extremely rare and should encourage

equities in 2011. Valuation multiples are reasonable, particularly

10.00%

The conditions look to be in place for another strong year for

Earning Yield - Bond Yield (based on 12 Month forward earning for S&P 500 and 10 Yard T-Bill Yield)

Valuations attractive relative to other asset classes

-1 Std

Source: Datastream - Natixis Asset Management

Markets could see 10% upside With prospective valuation multiples of around 11 times,

We prefer US and European equities and particularly those in

earnings growth of between 12% and 15% and the resurgence

the euro zone where there is catch-up potential once sovereign

of M&A transactions, equity markets should see upside of

debt issues are mitigated.

around 10%. The market is likely to benefit from the return of institutions who abandoned equities firstly due to the crisis and then in anticipation of new regulatory standards set to penalize

Take profits on cyclicals

the asset class.

In 2010, the market was positive for cyclicals to the detriment

The increase will not be linear. The market should alternate

of defensives and financials and it now seems appropriate to

between periods of low volatility (when corporate earnings

take profits on the former. It is still too early to be picking up

will take precedence over the macro economy) and sharp

financials, expect for the retail banks whose credit businesses

corrections (the inverse configuration). As a result, we continue

should benefit from a much steeper average yield curve than

to favor a tactical, flexible approach and would take advantage

in 2010.

of the low levels of volatility to purchase attractively-priced

We remain positive on small and mid caps, largely due to the

options offering downside protection.

acceleration in merger and acquisition activity.

A preference for European equities While the emerging market fundamentals remain positive, this year we are more cautious on the asset class. Their growth differential is already priced in whereas, on the contrary, the inflation risks (and potentially a contraction in activity were monetary policies to become too restrictive) have yet to be fully discounted. W W W. A M . N AT IXIS.COM

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Asset allocation: between convalescence and normalization "Lighten holdings of bonds, cyclical stocks, gold, the Swiss franc and the yen and add to positions in defensives, high yield bonds, Russia and the Asian currencies."

Franck Nicolas Head of Global asset allocation and ALM

The equity markets are no longer as risky

Global growth and S&P 500 risk premium (%)

It is time to stop believing in three widely-accepted ideas: The first is that equity markets will generate low returns over

8.0

a prolonged period. This should now be less true: activity is

6.0

showing a slow but more solidly-based pick-up, company

4.0

balance sheets are healthy and the measures taken to consolidate the public finances are in the right direction even if there is still some way to go. Everything points to a recovery in

2.0 0.0

the equity markets and the risk premium which remains high

-2.0

(see chart) should decline if reassuring news starts to come

-4.0

through on the public finances. We can thus start to lighten

Global growth (%)

S&P 500 risk premium (%) 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15

holdings in hedging assets and build positions in long-term

Source: Shiller, FMI, Natixis Asset Management

assets: equities, commodities, etc.

The end of "binary takes all"

A preference for high yield bonds

The second premise: it is a two-speed market and only a few

Our asset allocation has changed (see table). Government

sectors will drive it higher. The improvement in the cycle now

bonds (Germany and France) have played an effective role as

argues for portfolio diversification. The period of "all emerging"

safe havens but there is no longer much to go for in this asset

or "all cyclical" is now behind us.

class. We would lighten positions in favor of private bonds including high yield.

Emerging export plays are less attractive Lastly, even if the emerging markets remain an attractive investment theme on a long-term view, 2011 could see an inflexion point in these markets given the inflationary pressures and governmental determination to encourage domestic consumption.

"In 2011, investors will be better off playing the rise in emerging market currencies than emerging equities and should prioritize securities in the euro zone."

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Lighten on cyclicals and add to defensives In equities, we would prioritize stocks in developed countries.

Playing the appreciation in emerging currencies

We are effectively cautious on emerging equities with the

Similarly, we would start to reduce exposure to gold even if

exception of Russia where we would invest to play the oil

the Chinese central bank will continue to purchase gold to

theme.

increase its reserves.

At sector level, we would lighten on cyclicals, build positions

On the currency side, there is some upside potential for the

in defensives and look to pick up financials as sovereign debt

emerging currencies. On the other hand, we would reduce

issues are gradually resolved.

exposure to the two currencies that served as safe havens last year: the yen and the Swiss franc.

Asset allocation – Model portfolio for 2011 Fixed income Cash € Government bonds 1-3 Government bonds 1-7 International sovereign Euro inflation International inflation Credit High yield Emerging

Currencies Euro Dollar Sterling Yen Swiss franc Australian dollar Canadian dollar Emerging currencies

+ -= + = + = = + + ++ ++ ++

Equities

Alternative assets ++ + + = ++ + + = + = = -

Euro Europe Europe ex euro Cyclicals Growth Financials Defensives Small caps US Japan Pacific Emerging Asia Emerging Europe Latam

= + ++ + + -

Gold Oil Industrial metals Agriculture Real estate Hedge Fund Volatility

Scale from - to ++

Source: Natixis Asset Management Achevé de rédiger le 24/01/2011.

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