US dollar may plunge further towards year-end

Jan Amrit Poser, Head of Research and Chief Economist
The US dollar will benefit only briefly from the euro crisis. In fact, it might even become the uglier currency by the end of 2012, according to Bank Sarasin’s Global View released on Monday.

The Review titled ‘the storm is not over yet’ argued that the longer the US dollar rally lasts, the more pressing the question becomes as to how much longer it can provide a true alternative to the euro.

“The economic slowdown could prompt the US Federal Reserve to expand dollar liquidity, or renewed wrangling over the US debt ceiling could unsettle investors. The Swiss National Bank will maintain the EUR/CHF exchange-rate floor and will thwart any further appreciation of the Swiss franc. Also, the Bank of Japan might intervene against the strong yen in the second half of this year. The British pound is vulnerable to downside risks to the economy. On the whole, though, the various forces that act on the main currencies are likely to offset each other, so Bank Sarasin does not expect to see any major currency movements before the end of 2012,” it added.

“The escalation of the eurozone debt crisis in the second quarter of 2012 has dimmed the prospects for the months ahead, although a turnaround in emerging markets is possible in the second half of the year,” it said.

Bank Sarasin analysts expect that the growth slowdown will adversely affect returns on risk assets in the third quarter of 2012. Further setbacks are likely on the stock markets, providing opportunities in emerging market equities. Safe government bonds also remain unattractive at the present record-low yield levels. In comparison, corporate bonds are much more attractive. Money-market and real estate assets are interesting alternatives in light of the mounting economic risks.

The euro debt crisis worsened dramatically in the second quarter of 2012, and now it is going to require far-reaching initiatives on the part of policymakers to safeguard the solvency of the eurozone countries, to perfect the monetary union and to stave off the creeping credit crunch in Europe. The economic growth slowdown in the US and emerging-market countries will also soon prompt policy intervention. However, the effects of monetary and fiscal policy actions often kick in with a time lag. Hence, there is no hope of Europe returning to a growth path before 2013. The risks to the economy are clearly on the downside for the time being. Despite the necessary expansion of central-bank balance sheets, Bank Sarasin does not see any threat of inflation as long as households and governments still need to deleverage.

“The eurozone needs a Big Bang on the part of policymakers to stop the downward spiral. The economic cycle in the rest of the world hinges substantially on such intervention, but accompanying actions by central banks in the US and emerging economies are also needed to halt an impending downturn,” Jan Amrit Poser, Head of Research and Chief Economist at Bank Sarasin, said.

“Since the risks for the third quarter are weighted to the downside, investors should position themselves defensively to avoid major setbacks. The potential market dislocations will open up opportunities in the stock and corporate bond sectors that investors should seize,” Philipp E. Baertschi, Chief Strategist at Bank Sarasin, said.

In expectation of a Greek exit from the euro and more bank insolvencies in Spain, banks in the core countries also cut back trade credit guarantees in the second quarter of 2012 and are hoarding cash. Leading economic indicators are signalling that while Italy and Spain have slipped into a recession, core countries like Germany are also increasingly being sucked into the maelstrom. In order to break the vicious cycle between sovereign governments and banks, a banking union needs to be set up as quickly as possible. In addition, a partial mutualisation of sovereign debt will be inevitable. Meanwhile, the tidal wave from Europe now also appears to have reached the US. The ISM manufacturing index is clearly indicating that the business climate in the US has entered a renewed downturn at the same time as in Germany. The slump has already spilled over to the employment market in the meantime and now threatens to undermine consumer confidence.

What’s more, economic data on the real economy in China continue to show a growth deceleration from a high level. China still hasn’t been able to shift its economic model from exports to domestic consumption. After a series of reserve requirement ratio cuts, the People’s Bank of China has now also lowered lending and deposit interest rates. Lending activity has picked up vibrantly in the meantime, raising hopes that there will be a soft landing soon, though the wait continues for now. India as well has reported a slowdown in growth. However, the sharp depreciation of the rupee should cushion the downturn.

The euro debt crisis and weak growth prospects are darkening the stock-market outlook. Although stocks are inexpensive relative to bonds, Bank Sarasin believes that earnings estimates appear poised to plummet and thus put pressure on valuations. It is Bank Sarasin’s view that defensive markets like Switzerland and the UK should be favoured amid this environment. By the same token, defensive sectors like healthcare, information technology and real estate are likely to outperform cyclical sectors in the third quarter of 2012. The analysts at Bank Sarasin see the biggest risk of setbacks in US equities and in financial- and manufacturing-sector stocks. Since the business cycle could turn around first in emerging markets, Bank Sarasin recommends adding exposure to stocks in those countries on price dips.

Against the backdrop of the eurozone debt crisis and slowing economic activity, central banks in industrialized and emerging-market countries will further loosen their monetary policies in the second half of 2012. That should keep sovereign bond yields in the core industrialized countries low, in Bank Sarasin’s opinion. In fact, real yields on sovereign debt are even negative right now, which is why many investors have discovered corporate bonds as a new safe haven. Corporate bonds were remarkably resilient in the first half of 2012. However, despite supportive fundamentals and strong demand, the debt crisis and recession fears could cause credit risk premiums to rise in the second half of 2012. But more attractive valuations and defensive positioning on the part of investors should prevent a selloff. Emerging-market bonds could lose ground in the near term as a result of local currency depreciation. In the long term, though, emerging-market sovereign debt remains attractive in view of the region’s strong fundamentals.

Investment strategies focused on assets with relatively stable revenue streams are called for in times of elevated uncertainty. Companies with a high proportion of revenues that recur year after year are accordingly attractive. They can finance themselves relatively inexpensively, for instance, and rank among the winners in a climate of financial repression. The valuation of the stocks in the High Recurring Revenue Focus List compiled by Bank Sarasin’s equity analysts is attractive at an average price multiple of around 12 times earnings and an average dividend yield of 3%. The list of recommended stocks includes Actelion (Switzerland), Air Liquide (France), Basilea (Switzerland), Ecolab (US), Fresenius Medical Care (Germany), Intertek (UK), Mobimo (Switzerland), Pirelli (Italy), Rexam (UK), Sodexo (France) and Swiss Prime Site (Switzerland).

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