Wednesday, January 16, 2013

Which Region Will Do Best in 2013?

t’s the New Year, and it’s always a bit of fun to peer into the crystal ball and see bits of refracted images of table cloth below you while a crook asks you for some money. Ernest predictions of your future life follow (usually prompted by a fleeting glance to see if you are wearing a wedding ring or not) and after a few optimistic words, charlatan and dreamer part company. In a similar vein I shall attempt some geographical predictions for 2013!

China's Economy in 2013

Forgive me for not being inclined to forget everything I’ve learned about economics and markets, but the last time I looked at economies under collectivized control they did not have a particularly good track record. In other words, I’m not convinced that China’s attempts to stimulate its economy back to 7.5%+ growth is going to work as many are hoping it will. Moreover, the indications are that this is not going to be like the 2008-09 stimulus plan and this can be taken as a de facto admission that the previous plan was inefficient. So what next?

I think it better to consider China as an odd proposition. On the one hand, continued gains from private sector inspired productivity improvements, while on the other the government’s currency management (buying US dollars, selling yuan) has threatened the creation of a localized asset class bubble in housing. Pencilling in ‘same again’ GDP growth for China seems a sensible policy to me, but who knows? China can always generate growth (but future problems) by throwing money around.

If I am right about China then don’t expect the mining and resources sectors to do particularly well this year. I appreciate that Caterpillar and Joy Global were beaten up in 2012 over this issue, but these things can go on longer than many suspect. I like to invest with a bit more certainty. Things appear to be getting better for them lately, but if China disappoints then their earnings prospects will be downgraded in the future.

US Strengthens

I think the evidence suggests that the US economy is improving but is suffering from near term difficulty engendered by its politicians. I’m not entering a political debate here. Suffice it to show this chart and remark that neither party has a particularly good recent record with either reducing spending or encouraging social cohesion.

The whole ‘fiscal cliff’ debacle is a red herring. It will get resolved and America will go on, but at some point the whole idea of trading off an increasingly unequal society for a larger public sector has to be reconciled. The public sector isn’t very good at doing these things and its growth encourages vested interests to game resources in their favor. Rant over. The US will do okay in 2013.

I think that US consumer focused stocks are still a good way forward. Within retail I favor the high end and some specialty stores. However, the real story lies with the ongoing recovery in housing, employment and credit issuance. When net household wealth rises, it encourages spending and lending. I would look for the financials like Capital One Financial (NYSE: COF) or American Express (NYSE: AXP) to experience improving conditions. There is some more analysis on the issue here. Charge-offs continue to decline in the US and there are signs that the consumer has stopped deleveraging. Financials can start to lend more as consumers spend.

European Economy in 2013

Europe will surprise to the upside. You heard it here first. I’m increasingly becoming less scared of companies with heavy European exposure. Why?

Europe has been weak for a while, and I would expect yearly comparisons to be a lot easier; companies have had plenty of time to adjust to the dictum of North-Good, South- Bad. Moreover, Italian 10 year Government bond yields have come down to around 4.5% and Spain’s are at 5.25% as I write. The EU has made great strides in restoring confidence, and it is making efforts to install systematic rigor to its government's spending. Europe is hopefully heading to the kind of monetary discipline that the Bundesbank enjoyed for so many years. It is still tough, but things are getting better and I'd like to see Greece thrown out of the Euro Zone, though its debt is not such a big issue for Europe provided the markets understand this.  Do not be scared of European exposure.

With this in mind perhaps it’s time to look at some European stocks or at least companies like McDonald's?  It has some issues in China right now but Europe is still its largest profit center and any upside surprise from Europe would drop favorably into its bottom line.

The Bottom Line

Of the three regions, China’s 2013 is likely to be the hardest to predict. I think the risk is on the downside. The US looks set for a slow grinding recovery and it truly is a stock picker's market, but I'm not complaining. I love such conditions. As for Europe, don’t be surprised if we surprise you.

Happy New Year!

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