Black Swans on the Horizon

10/18/2010 12:22 pm EST


Prieur du Plessis

Author, Investment Postcards from Cape Town

The looming slowdown in China and the Eurozone spells trouble for emerging markets and commodities, writes Prieur du Plessis of Investment Postcards from Cape Town.

Manufacturing Purchasing Managers indices (“PMIs”) released for September indicate a rapid slowdown in global manufacturing growth. On a GDP-weighted basis, our global manufacturing PMI (US, Japan, China, Eurozone, and UK) fell for the fifth consecutive month to 53.0 in September.

Among the major economies, only China managed to report faster growth. Growth in the Eurozone weakened mainly as a result of a significant slowdown in Germany [and] austerity measures in the Eurozone’s problem children. Growth in the US slowed, while the manufacturing sector in Japan contracted for the first time in 14 months. Nonmanufacturing and services PMIs of most countries—bar those of the US, China, and UK—registered slower growth in September.

Faster growth in China’s manufacturing sector saved the day for most economies. However, the outlook is not rosy. China’s manufacturing PMI in 2010 is following a weaker trend than the average from 2005 to 2007. If the current gap between September’s historical average (2005 – 2007) and that of 2010 holds in October, China’s manufacturing PMI will fall back to 51.6, compared [with] 53.8 in September.

One may argue that this is not what the equity markets are saying, with the MSCI World Index having had its best quarter in 23 years. Consider that a black swan may soon be entering air space over China and the Eurozone!

The outlook for global equities is extremely uncertain, with the storm clouds of the global currency war, weaker Chinese PMIs, and vast capital flows to risk assets such as emerging-market bonds on the horizon. Although the weaker US dollar will benefit the US, the worsening economic situation in Europe is likely to [undermine] further up side in equity prices.

Trailing price-to-earnings multiples are reasonable, but the risks have increased considerably. We are particularly concerned about non-exporters in emerging markets and especially the financial and industrial sectors. They are as vulnerable as the currencies of their economies. Where exporters and dual-listed mature-market stocks are likely to be somewhat immune to currency sell-offs, the interest-related stocks are exposed to higher interest-rate expectations.

We do not share the extreme bullishness of most market commentators on commodity prices. Although the strength in these prices over the past quarter was a result of strong Chinese demand, most of the recent run-up in commodity prices has been [induced largely by weakness in the] US dollar. The anticipated seasonal weakness in China’s economy is likely to lead non-US-dollar prices of commodities lower during the fourth quarter. Coupled with the uncertainties arising from the currency war, the outlook for commodities [besides] gold is cloudy. Gold is likely to continue to benefit from the currency war as a store of value in these uncertain times.

The weakness of the US dollar is likely to reverse as soon as the seasonal weakness of China’s economy becomes evident and the ramifications of the lower yen and US dollar on the economies of the Eurozone and emerging economies are interpreted. Fickle money may again find refuge in the US dollar as a “safe haven.”

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