QE2 - A Pyrrhic Victory for Animal Spirits?
For global equity investors looking to access EM growth through reasonably-priced and cashed-up large caps listed in the US and Europe (our favored approach to longer-term value investing), we offer two suggestions. First, 2015 dividend futures on the Eurostoxx50 have fallen 11% this year (over which time the market is unchanged), and now imply the level of dividends on the Eurostoxx50 in 2015 will be 9% below that of 2011. Such a fall would likely require multi-year deflation, and in any case, the tail-risk of distress in Europe can be easily and cheaply proxy-hedged, for instance via the purchase of 5yr sub-debt CDS protection on European banks for a cost of ~150bps per annum (with the added benefit that this spread is close to two-year tights). Note that in April last year, 2015 dividends were trading at a 24% premium to 2011 dividends (Fig 8). An alternative for real money investors, based on OECD companies with strong global brands that stand to benefit from the rise of EM consumption, but are not yet trading at a premium valuation multiple to the broader market, was addressed in a recent piece by our colleagues in the CROCI team (see "The Five Uses of Free Cash Flow", CROCI Views, 15 October 2010).
Eoin Treacy's view We have been arguing for some time that the best opportunities in the USA and Europe lie with those companies most leveraged to Fullermoney themes such as the expansion of the global middle class. These include food, industrial resources, retail, cosmetics, fashion, technology and auto companies. The G4 are replete with global companies that dominate their niche, have strong cash flows, impressive growth potential, pay reliable dividends and are outperforming their respective indices. Surely it is with these companies that one might wish to build a portfolio with a view to the long term.
There has been a great deal of commentary about the need for and likelihood of a fresh round of quantitative easing. Markets are already assuming it is a certainty but it is only likely to be implemented if the threat of a double dip recession is seen as imminent, in my opinion. The weakness of the US Dollar has been a boon for domestic exporters but is also raising the cost of imported commodities and is testing the tolerance of the USA's creditors who do not wish to see their investments diluted. Additional quantitative easing is therefore not a risk free proposition.
In the event that additional quantitative easing is pursued by the USA, it would be a mistake to assume that the US economy is a closed system. That additional liquidity will quickly find its way to the most productive or highest yielding assets whether they are equities, bonds, commodities or currencies. The G4 has plenty of attractive investment opportunities in the sectors mentioned above but it is reasonable to expect the bulk of any speculative flows to seek a higher return in the growth centres of Asia and Latin America which should put a bid under assets in these regions over the medium-term, beyond the current overbought condition.