I – OUTLOOKS
"Business crisis as usual."
Despite numerous European summits (19 so far!), the deteriorating economic and financial environment in the Eurozone has even worsened in recent weeks. The situation is now critical, as it poses a systemic threat to the world economy. Furthermore, the US economy has shown clear signs of trouble in recent months. As for the emerging economies, their deceleration continues. In this context, and beyond the need to build portfolios based on long-term convictions, active risk management continues to be the cornerstone of our management. This has allowed us to record performances that since the beginning of the year are very respectable for our funds as a whole. Due to the European situation, and in particular due to the weakness of the banking system, the financial risk will persist. The main question that arises today is that of assessing the risk of economic contagion of the European recession to the rest of the world, above all to the United States and China.
Indeed, you can rest assured that while some Eurozone countries are already in the throes of a particularly severe recession, the worst is yet to come for the area as a whole. We believe the downward revisions of growth forecasts in France and Germany are unavoidable. These revisions have already had an impact on forecasts for 2013, but not yet on the current year. Should we expect miracles from every summit of Eurozone leaders? We can legitimately doubt it, so fragile is political cohesion among our leaders. The divergences are still deep between the supporters of a rapid evolution towards European federalism and those who praise the absolute and total maintenance of one's national sovereignty, while demanding at the same time greater solidarity between states and a sharing of sovereign debt.
Should we Germanise Europe or Europeanise Germany? Should we praise the fiscal virtue and promote reforms that will allow our companies to adapt to a constantly changing world or should we instead continue to perpetuate the illusory promise of a welfare state, protector in all circumstances, an interventionist without real economic discernment? A single fact suffices to illustrate the differences. Over the past ten years, unit labor costs have increased by 7% in Germany. Meanwhile, it rose 30% in France and Italy, 35% in Spain and 42% in Greece. The goal of restoring, or rather, building an Economic Union still seems a long way off.
In the short term, and despite the announcement of new measures aimed at allowing the direct recapitalization (and therefore the nationalisation) of banks, and at reducing the cost of refinancing for states in difficulty, phases of financial stress will still materialize, causing a return of risk aversion. Longer-term, the continued decline in the euro could partially offset the weakness in demand, especially for exporting companies that our European management has been banking on, guessing, since the beginning of the year. Despite everything, these factors lead to prudence and vigilance. Our global management therefore maintains a very limited net exposure to both the Eurozone and the single currency.
Although it is no longer in doubt that European financial stress could spread to all global markets, the question of the risk of contagion from the European recession to the US economy still needs to be raised. Overseas statistics dropped significantly in the spring. While the macroeconomic indicator was broadly positive at the beginning of the year, a clear reversal has been observed in recent months. Job creation slowed and key economic indicators fell, despite the stabilization of the housing market.
While the Federal Reserve and Bernanke's releases echoed growing fears about a worsening European economic situation, it is premature to conclude that the US economy is reeling from Europe. In reality, the picture is not all that dramatic. Current data remains in line with economic growth around 2%, which is not bad in the current environment. It is more likely that the decline is attributable to two factors: on the one hand, to a weak growth in real incomes, which, as underlined since the end of March, could curb consumption; on the other hand, to a wait-and-see behavior by businesses with regard to investments and hiring in the face of an uncertain fiscal context (the famous fiscal cliff that threatens businesses and households with an increase that would be harmful for the economy).
On all these points we would like to be quite optimistic. First, Bernanke watches. He has already postponed by a year (end of 2015) the prospect of a rise in the reference rates. He then kept Operation Twist active and said he was ready to take appropriate measures if the economic trend were to justify it, ie that the new quantitative easing (QE3) is ready. As regards the weakness of income growth, let us only recall that oil prices have lost 25% in a few weeks, which will translate into a lower levy on household purchasing power in a few months. Finally, regarding the possible end of the Bush-era tax holidays, we believe for sure that both Republicans and Democrats will know how to postpone their expiration.
If there is one country that can afford to postpone the deadlines (“kick the can”) of fiscal consolidation, it is the United States. In terms of investments, this scenario translates into short-term prudence, justified by moderate expected growth in earnings and possible negative surprises in the period of publication of financial results. Conversely, and provided that Europe doesn't screw things up, the market should remain underpinned by reasonable valuations and levels of liquidity that will remain plentiful in a context of moderate global growth.
The universe of emerging countries contributes to this moderation of global growth. Let us not forget that too abrupt growth had led most of these countries to inflationary tensions that needed to be stopped. Currently the situation is mixed. Brazil and India, for different reasons, are the countries where we remain cautious. The former has experienced excess credit growth and faces a mini subprime crisis (however unmatched by its US big sister), while reforms are late on Dilma Roussef's agenda. However, significant room for maneuver in terms of monetary policy can still be exploited, which should allow the correction of the Real, which remains overvalued, to continue. As for the second, the inability to introduce reforms, persistent inflation and a bad start to the monsoon season are factors that still lead us to short-term caution.
As far as China is concerned, the slowdown is evident, although it seems to us to be equally controlled. Real estate sales are picking up. A car scrapping incentive has been introduced for rural areas and a whole series of targeted measures have been taken, in addition to the first rate reduction decided during the month. Recently released economic data confirms a progressive improvement in growth which is expected to stabilize at around 8% this year and perhaps slightly lower next year. This context has made investors nervous, perhaps excessively, taking into account the fact that in this structural slowdown of the Chinese economy, the government on the one hand retains control of the situation and, on the other, has more than any other country of an important margin of manoeuvre. In particular, and despite a phase of political transition, the pace of reforms, especially in the financial sector, already seems to be accelerating.
In the short term, it's hard to be satisfied with your portfolio, whatever your equity allocation. The outperformance of emerging markets over developed markets is not apparent given the possible contagion of European financial stress to the global sphere; raw materials have fallen but mining companies continue to invest and the more "defensive" sectors seem widely valued but companies in the more cyclical sectors report a decline in the order book. The long-term vision remains clear and in favor of growth and improvement of living standards in emerging countries. For our part, therefore, the need remains to keep allocations in line with this medium-term valuation and at the same time to manage risks more in the short term.
Eric LE COZ, Deputy Managing Director of Carmignac Gestion
II – INVESTMENT STRATEGY
CURRENCIES. FURTHER DECLINE EXPECTED FOR THE SINGLE CURRENCY.
After a month in May during which the euro depreciated in the face of the marked worsening of the economic and financial situation in the Eurozone, in June we witnessed a recovery of the single currency, especially following the European summit at the end of the month. In our opinion, the euro still remains vulnerable, on the one hand to the continuation and worsening of the European economic situation. On the other hand, in any phase of financial stress in the Eurozone, the dollar and the yen play the role of safe-haven assets and risk management tools for our funds. As a result, we maintained significant exposures to the dollar and to a lesser extent to the yen in the Carmignac Investissement, Carmignac Patrimoine and Carmignac Global Bond funds.
Furthermore, moderate global growth makes emerging countries and therefore their currencies more or less vulnerable. We have therefore decided to partially hedge exposures to more vulnerable currencies, such as the ruble, the Mexican peso and the Brazilian real in our Carmignac Emerging Patrimoine and Carmignac Emergents funds.
THE BONDS. PRUDENCE MAINTAINED IN THE EUROZONE.
German government bonds, after having represented the preferred safe-haven asset for bond investors in a difficult European context, were affected by fears of the launch of European sovereign debt sharing or at least of increased participation by Germany in rescuing the countries' economies peripheral. We therefore neutralized our Bund exposure at the beginning of the month via corresponding futures sales. This helped us, as 1,20-year German bonds rose from 1,58% to 1,56% over the month, while US XNUMX-year bonds, to which we had maintained our exposure, remained stable at XNUMX%.
We will remain cautious towards Europe for the weeks ahead and continue to avoid government bonds outside of Germany and the US. At the end of the month, the modified durations of the Carmignac Patrimoine, Carmignac Emerging Patrimoine, Carmignac Global Bond and Carmignac Securité funds stood at 4,5, 6,3, 5,5 and 1,4 respectively.
ACTIONS. BEWARE OF ANALYST REVIEWS!
World markets rallied in June, ending the period with a nearly 4% gain on the last day of the month. For the reasons explained in the editorial, our very cautious positioning did not allow us to take advantage of this sudden return of optimism. Beyond the (temporary?) decline in risk aversion, the synchronous slowdown in the global economy will translate into downward revisions to earnings growth estimates. While one might reasonably think that some of these downward revisions are already priced in, we are nevertheless tempted to wait until the quarterly earnings season gets underway before reviewing our positioning.
In a context that remains uncertain and fragile, it still seems appropriate to us to favor the mixed funds of the Patrimoine range. Since the beginning of the year, the returns of the three funds in this range, Carmignac Emerging Patrimoine, Carmignac Patrimoine and Carmignac Euro-Patrimoine, have come in at 8,6%, 3,8% and 6,4% respectively.
RAW MATERIAL. THE SHORT-TERM DOWNHELPS THE LONG-TERM TREND.
Continued above-quota production by OPEC members and a notable downward revision of demand growth estimates by the International Energy Agency got the better of oil prices, which fell in the month under review alone the 25%. This decline has driven the sector in its wake, in particular the mid caps and oil services.
On the other hand, this drop in energy prices should favor metal producers, especially gold, for whom we were concerned about the rise in production costs. A sector outperformance was confirmed in June and some takeovers confirm the attractiveness of valuations.
The metals sector still looks fragile according to Chinese macroeconomic data. Such is the short-term market analysis, which seems to us potentially too pessimistic given the acceleration of major infrastructure projects advocated by the Chinese government. In addition, Rio reiterated its optimistic long-term view, confirming a costly project to develop its iron ore production in Western Australia.
ASSET ALLOCATION. IS IT POSSIBLE TO BE TOO CAUTIOUS IN THE CURRENT CONTEXT?
The performance of funds of funds was affected by the market rebound on the last day of the month, while we had maintained a defensive positioning in view of the 19th European summit since the beginning of the crisis.
Has the situation really changed since the last summit? It's too early to tell as of this writing, but it's not certain. In a context of global slowdown, the economic (and not just financial) situation of the Eurozone will remain worrying throughout the summer. The ground our funds have gained relative to their respective indices remains respectable and we prefer to err on the side of caution rather than blissful optimism for now.
