natixis asset management workshop n°6
Speculative bubble yesterday and risk aversion today: What future for equities markets? What place should equities have in a portfolio? What is an appropriate investment horizon? What management style should be favored? Which shares should be given priority?
Newsletter produced by Natixis Asset Management's Communications Department
Just a few of the questions addressed by the speakers invited to the 6th NAM Workshop: Philippe Waechter, Chief Economist, Dominique Sabassier, Deputy CEO and Chief Investment Officer, Wilfrid Pham, Head of Equities Management and Franck Nicolas, Head of Global Allocation and ALM.
Introduced by Pascal Voisin, CEO of Natixis Asset Management, the 6th Natixis Asset Management Workshop (June 10) brought together 221 participants around the question: “Speculative bubble yesterday and risk aversion today: what future for equities markets?” The number of participants reflects the success of Natixis Asset Management’s Workshop concept.
Pascal Voisin, CEO
Organized three times a year around a specific aspect of the current economic and financial news, with presentations by NAM’s experts, the Workshop is attracting a growing public. Chaired by Philippe Zaouati, Head of Business Development, this not-to-be-missed rendezvous devotes most of its time to exchanges with clients: open questions at the end of the meeting, voting by remote control on multiple choice questions* and reactions from the speakers…. Another way for Natixis Asset Management to get to know its clients.
“The last ten years have seen equities markets go through a number of different phases: two rising periods (1999-2000; 2003-2007) and two contracting periods (2001-2003; since 2008) which corresponded respectively to the bursting of the New Technologies bubble and then that of the Sub-prime bubble. This observation raises the question of the wisdom of investing in equities over the long term and of the appropriate strategy to adopt. The environment that is now emerging does indeed suggest that new approaches are required…” Pascal Voisin, CEO of Natixis Asset Management
June 10, 2009 * The detail of the public answers: available on page 7.
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Positive signs of an improvement in economic activity Philippe Waechter Chief Economist
The economic environment is undergoing a noticeable change. At the end of 2008, business leader surveys suggested a deterioration in outlooks in all regions of the world. In the first quarter of 2009, and even more so in the second, their outlooks have acquired a generally more positive bearing.
Signs of recovery – some weak, some stronger… It's in China that we see the fastest pace of change. The extremely interventionist measures taken by the Chinese government have given a substantial boost to domestic demand in that country. This recovery in economic activity has started to spread throughout Asia, and regional trade is beginning to pick up.
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"We do not rule out Victor Zarnovitz’s observation on economic cycles: – just as a gradual entry into recession is usually associated with a gradual recovery, so a sharp entry may well be followed by a recovery just as sharp." n In the United-States, the increase in new orders, the fall in weekly new unemployment claims, and the lower level of household apprehension for the future are strong vectors for recovery and support for economic activity. This movement reflects the concurrence of a dynamic adjustment by businesses Business leader economic sentiment surveys
to a less favorable context and the implementation of economic policy aimed at supporting and stimulating economic activity. At the same time, we are seeing a stabilization of the volume figures on the US real estate market (housing starts, sales, activity indices). This is a very significant first step in the right direction, but prices will no doubt continue to adjust down. Supported by these positive factors, the US economy could emerge from recession during the summer. n In the Euro-zone, the recovery is taking longer and will be generally slower: The principal factor driving the European economy over recent years has been exports. With the euro now relatively expensive, the contraction of world trade since the fall of 2008 is penalizing Europe’s economy. Moreover, the internal dynamic of the European economy will remain limited in the absence of the interventionist economic policy measures that are, for example, contributing to the recovery of demand in the United States. And the difficulties encountered by certain EU countries – Spain, Ireland and Austria notably – will also weigh on the overall recovery of the Euro-zone.
The global economy having suffered major shocks during the summer and fall of 2008, all countries have been affected and economic activity has sharply contracted. However, the pace of recovery in individual countries will vary depending, above all, on the strength of the economic policy measures implemented. The United States and China should be the first to recover towards the end of this year, whereas Europe will have to wait until the second half of 2010.
Sources: Datastream, calculation: Natixis Asset Management
"We are dismissing a W-shaped scenario as we do not perceive any shock likely to tip the global economy back into recession…”
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Monetary policies and inflation Philippe Waechter does not anticipate a resurgence of inflation in view of the low level of labor market tensions and the absence, therefore, of payroll pressures. The inflationary impact of the creation of money only kicks in when an economy is at “full” employment. Before full employment emerges and generates inflationary tensions, particularly in the domain of wages and salaries, we imagine that the central banks will seek to recover
some of the cash they have injected into economies, thereby limiting the risk of inflation. The ECB will very likely maintain its key rates at 1% for quite a long stretch. On the other hand, the Fed will probably adjust in the first part of 2010. When it does so, it will be a strong signal that the global economy is out of the woods.
Question from the public: “What is your outlook for the euro/dollar exchange rate?” Philippe Waechter: “It all depends on Fed policy. If the Fed raise rates while the ECB keeps its rates stable, the dollar could well appreciate. And the dollar will appreciate even more as the United States will have less need of external capital than in the past because the savings rate of American households is once again growing. The trade deficit, which gives a good indication of America’s external financing requirement, had been halved from 60 billion to 30 billion dollars.” Franck Nicolas: “Two other factors could nevertheless weigh on the dollar’s appreciation: The size of the US government’s budget deficit – which suggests future tax increases – and China’s wish to create a second reserve currency in order to eliminate the “all dollar” situation”.
Leaps and bounds of economic activity – and valuations
United States - Breakdown of profits (cumulative % in Added Value) Non financial companies
Regarding corporate earnings, the contribution to GDP from non-financial companies has shrunk, but is not at a particularly low historical level. In recent years, the distribution of profits has moved in favor of shareholders. The proportion of dividends in profits has in certain cases very substantially increased (in the United States for example). Although this benefits shareholders, it can have a negative effect on companies who tend to reduce their corporate savings and therefore have less cash flow to finance their activities and development. A rebalancing of the distribution of profits (which had remained stable in the USA for many years before the current decade began) is probably necessary in order to give companies the means to finance their development. This would ultimately be favorable to equities markets as well.
Source: Bureau of Economic Analysis - Calculation: Natixis Asset Management
Question from the public: “Do you not think that the rise in government deficits and in unemployment negatively counter-balances the positive signs of economic improvement?” Philippe Waechter: “Public debt is today at vertiginous levels; but it has the virtue not only of offsetting the increase in household savings, of contributing to the reduction of household and corporate debt, but also of supporting economic activity. It therefore limits the risk of an additional shock to economic activity. At another level, governments have adopted the following philosophy: to manage a sharp economic shock, you must finance it now and pay for it later… even if it takes 10 or 15 years to fully amortize its cost. On the employment front, labor markets will continue to deteriorate in Europe, but in the United States the situation is beginning to change. Recent statistics suggest that an improvement is not far off.”
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Interesting stock picking opportunities Wilfrid Pham Head of Equities Management
"We do not believe we are facing a Japanese scenario”. The situation we are currently facing is in fact quite different…” The current situation differs from that encountered in Japan during the 1990s in several areas: n Firstly, corporate debt levels were high in Japan whereas US and European companies today have a relatively “healthy” exposure to debt; n Unlike what happened in Japan, Western governments have made very rapid monetary policy adjustments in reaction to the current crisis; n The economic stimulus measures instigated by governments have been both global and massive whereas the Japanese government decided to initiate major public works; n Individual States have recapitalized their banks or increased their stakes in them, whereas the Japanese government allowed its banks to collapse; n Accounting standards have been relaxed whereas they were tightened in Japan; n Lastly, the communication has been managed differently: Japan opted for total transparency whereas Western countries have sought to minimize the factors that could spook the economy and/or markets.
"As far as equities markets are concerned, we are convinced they won't fall back to the low levels already seen, even if certain risks remain… " According to Natixis Asset Management, equities markets have already touched their lowest points. A durable upward trend on equities is however unlikely given the number of risks still haunting markets: the contraction of corporate earnings (even if cost reductions have been faster than expected), the financial system still “on a drip”, the risks of further bankruptcies… The rebound over recent weeks does not look particularly excessive when you consider that the rise since the start of the year is only 5%. The improvement of the economic environment justifies current valuations with a PE ratios(1) of 12x to 13x in a context where access to credit is returning to normal and revenue figures should start to improve.
"We expect to see equity markets gain between 5 and 10% by the end of the year. Nevertheless, volatility will remain strong and the breath of the range of corporate earnings forecasts will probably widen... " For the whole year 2009, a top-down approach suggests a 38% contraction whereas the bottom up approach suggests only -10%. The gap between the two approaches is much smaller in our forecasts for 2010 with respectively +19% and +16%. Markets will probably behave less directionally, offering interesting stock picking opportunities. Natixis Asset Management’s initial preferences are, in the short term, for the major market capitalizations, for companies that can afford regular dividend pay-outs and enjoying high-quality business models. In view of current valuations, it is preferable to invest first in defensive stocks as well as TMT stocks(2).
(1) PE = Price / Earnings ratio: ratio of current market capitalization to current earnings, i.e. the ratio of the share price of a company to its after-tax profits per share. (2) TMT = Technologies, Media and Telecommunications.
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Five strategies to mix... depending on the evolution of markets
Franck Nicolas Head of Global Allocation and ALM
What strategy should be adopted in the current context? To answer this question which has become all the more interesting given that the last ten years has seen two down-trends and to up-trends, we have conducted a comparative study of five management strategies. Profile Benchmark Risk Return
Strategy Rebalancing Hedging Dynamic floor Valuation Trend-following
Counter-trend X
Follower
X X X
n The first relies on a monthly adjustment of assets conducted automatically; n The second relies on the acquisition of protection via the purchase of puts, and has the advantage of building in an anticrisis insurance, but also has the disadvantage of losing some of the upside performance when markets trend upwards; n The third strategy is based on portfolio insurance techniques: it consists of defining a floor below which the investor does not wish to descend (a loss of 20% vs. the highest NAV for example). Advantages: no premium payments, no definitive monetarization. Disadvantages: risk of intervention at the wrong moment and of the portfolio slowly becoming more sensitive; n The fourth strategy is based on valuation: it consists of selling shares when their valuation is excessive compared with
bonds and of buying shares when bonds are excessively valued. Advantage: it has a good predictive capacity. Disadvantages: risk of entry and/or exit far too ahead of the actual movement. n Lastly, the fifth strategy – total trend-following – consists of selling shares when indicators such as sliding averages suggest a downward trend and of buying shares in the reverse scenario. Advantage: it allows the capture of durable trends. Disadvantage: the risk of repeated and unfruitful interventions when no particular trend emerges and risk of inertia when markets are genuinely changing direction.
"There is, therefore, no ideal technique. Investors could benefit from injecting asymmetry into their portfolios by buying protection when markets are calm, or by fixing a floor when markets are volatile..." He may also introduce reasoning based on valuation to detect situations of extreme tension or on trend-following so as not to miss major trends. These contributions to strategy are not incompatible with discretionary management. Receive the full report presented in the NAM Workshop presentation (only available in French) by addressing a request to: communication@am.natixis.com
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Current market conditions suggest an active and flexible approach to portfolio management Dominique Sabassier Deputy CEO – Chief Investment Officer
The rebound is not yet over, but the upside potential looks limited. Growth will most likely be soft and increases in corporate earnings will remain modest. Moreover, the distribution of profits will most likely be less favorable to shareholders. Lastly, household savings rates will probably increase in the United States and the UK, thereby limiting the recovery in consumer spending.
"The rebound is not yet over, but the upside potential looks limited. Hence, the proportion of equities in our portfolios is currently below the historical average level…" In the longer term, markets are likely to remain “sensitive” for quite a long time, which implies that a strictly trend-following strategy would not be appropriate. Rather, it suggests that an active management – flexible in terms of styles and allocations and requiring a certain amount of asset switching – may well be the best approach…and that it may also be time to consider re-investing in hedge funds(1).
With corporate earnings growth likely to be so modest, dividends will inevitably represent a greater proportion of total future profits. Hence the need to invest in convertibles and overweight certain themes (emerging countries, commodities). Greater interventionism on behalf of governments will also have an impact, whether via tax increases or via downward pressure on prices (generating a risk of disappointment in the so-called "regulated" sectors). The crisis will also provoke changes in economic behavior: buyers will be more demanding in terms of prices and there will a reduction in the number of M&A operations. This latter trend should be beneficial to mid-size capitalizations. Lastly, the crisis has accelerated the factoring into corporate valuations of non-financial aspects (governance, environment) and of long-term plans (development projects, etc) rather than of short-term considerations.
Question from the public: “Is it not contradictory to speak of an improvement in the economic environment and yet recommend defensive stocks?” Dominique Sabassier: “The markets have already priced in the recovery of cyclical and financial stocks. On the other hand, defensive stocks are still down since the beginning of the year. We believe they will be the next to recover – particularly the better quality ones and those producing the best yields.” (1) Hedge funds are unlisted Investment funds whose objectives are essentially speculative. They are speculative funds seeking high returns and making abundant use of derivatives, particularly options.
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Philippe Zaouati, Head of Business Development, chaired the discussions and he asked participants in the Workshop to express their analysis of the economic situation and their investment intentions throughout the event. Here are their answers*: What, in your opinion, is the principal risk facing financial markets today? Deflation (Japanese scenario) (17.2%)
Economic stagnation (28%)
What is your outlook for French equities by the end of this year? worse than -15% (6%) better than +15% (10.2%) from -5 to -15% (10.8%)
Medium-term inflation (43%)
Systemic risk (1929 scenario) (11.8%)
How do you foresee your exposure to equities evolving?
Don’t know (2%)
By what type of product are you most interested in today?
No answer: no shares in portfolio (5.4%)
Flat trend (33.8%) Downward trend (12.2%)
between -5 and +5% (31.3%)
From +5 to +15% (41.6%)
Equities funds with benchmarked management (16.3%)
Thematically targeted products (either sector or style) (45%)
upward trend (46.6%)
More flexible equities products (38.8%)
*Public answers to the multiple choice questions were given by remote control.
Natixis Asset Management in brief n The European expert of the asset management division of Natixis n A multi-specialist, with around €278 billion assets under management* n A company offering investment solutions for institutional and
corporate clients, as well as distributors and banking networks
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A special access to the expertise of some twenty international fund managers, notably in the US (Loomis Sayles & Co, Harris Associates, etc.) and Asia (Absolute Asia Asset Management Ltd) via the multi-boutique model of Natixis Global Asset Management *As of 03/31/2009 - Source: Natixis Asset Management.
Contact us Natixis Asset Management - Direction de la Communication - 21, quai d’Austerlitz - 75634 Paris cedex 13 Tel : (33) 1 78 40 81 74 - email: communication@am.natixis.com
Next Natixis Asset Management Workshop: October 14, 2009 in Paris www.am.natixis.com
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