While 2013 was a fabulous year for US equities, irrational exuberance now engulfs Wall Street.The US stock market is overbought, speculative momentum shares are breaking down and the first 10 per cent correction since 2011 is all too possible. However, large cap equities will be the best performing asset class in 2014 since US economies growth is accelerating, as the October payrolls and Chicago ISM data demonstrate. The rise in the ten year US Treasury note yield to 2.75 per cent means a secular rotation out of bonds to equities will be a dominant investment theme even as $450 billion in share buybacks reduces the equity float and boosts the animal spirits on Wall Street.
Money centre banks that benefit from accelerating economic growth/consumer credit, the housing recovery and a steeper yield curve will benefit from the macro milieu on Wall Street. Citicorp trades at well below book value even as the earnings power of its global consumer bank rises and the profit drag from its Citi Holdings non-performing assets plunges. Bank of America is also compelling at seven times forward earnings.
In retrospect, the US stock market’s spectacular performance in 2013 was due to multiple expansion, not earnings growth. Technology is a sector where it is still possible to find credible earnings growth with low valuation multiples. Cisco and Intel both trade at a mere 11 times forward earnings. In energy,
the shale oil revolution in Texas/North Dakota means investment opportunities in exploration, production, midstream and pipeline Master Limited Partnerships. Occidental Petroleum is restructuring its global business, with a possible exit from chemicals and its Middle East assets to focus on its US shale oil and gas franchise. This could cause a multiple rerating on the shares and narrow their 30 per cent discount to NAV.
Higher US Treasury yields, earnings downgrades and the dominance of state- owned companies/family corporate empires make most emerging markets unattractive for 2014. However, South Korea, the fabled economic miracle on the Han River, is an exception. South Korean exports hit record highs in October as global growth and the tech cycle accelerates. The Bank of Korea has eased monetary policy and the government of Madame Park has passed a supplemental budget. Foreign inflows have returned to Seoul and all is quiet on the DMZ front with North Korea.
I believe Japan will be the best performing developed market in 2014, as it was in 2013. The Bank of Japan’s quantitative earning programme is more than twice as aggressive as the Bernanke Fed, adjusted for GDP. No other major market in the world delivered 51 per cent profit growth in the third quarter, as Tokyo did. The spike higher in US Treasury bond yields and the shock and awe monetary easing of the Japanese central bank means the yen could well fall to 105 against the dollar in the next six months, a steroid shot for Japanese exporters. Japan is still not expensive at 14 times earnings and 1.3 times bank value.
The Nikkei Dow was range-bound in the past two months as the stock market is skeptical about the third arrow of Abenomics (structural reforms) and the impact of the new consumption tax. The world’s fund managers are still underweight in Japanese equities. The Nikkei Dow can trade in a 13000 to 16000 range in the next six months. The most attractive sectors in Tokyo are securities brokerages (Nomura, Daiwa) property (Mitsui Fudosan) and trading companies (Mitsubishi, Itochu), these are all beneficiaries of the reflation theme promised by Prime Minister Shinzo Abe and the Bank of Japan.
Europe is no longer cheap and is the world’s most crowded consensus trade now that France has been downgraded by the rating agencies, Greece faces the Troika, the ECB will subject European banks to a stress test and Spanish bond yields are a mere four per cent. Germany, with its stellar export growth, operating leverage, industrial blue chips and vibrant consumer economy, remains a clear beneficiary of Europe’s post- recession bounce back and a lower Euro after the latest Draghi rate cut.
By: Matien Khalid