Income solutions via equity & credit

- The investment world has a problem: it needs income "European pension funds require a return on assets of roughly 6-8%, safety doesn’t pay much in a backdrop where growth is slower and rates are lower. In the UK pension funds went from 82% in equities in 1990s to 47% today. UK bonds picked up the slack and their weight has quadrupled. But the real yield in the UK and Europe is less than 2%. The solution: corporates are a good home for income - let the battle between Equity and Credit commence."
- An equity strategist’s view: the equity de-rating has gone too far "The real yield gap between government bonds and equities is at a 25-year high (favouring equities). The 12-month forward dividend yield of 4% is above its 30 year average of 3%. Dividends are the performance enhancer in a slow growth environment with range bound markets. We see upside in markets and are not worried about dividend cuts (chart 18)."
- A credit strategist’s view: the equity de-rating could continue "The de-rating of equities will continue given demographic issues and volatility. Credit provides an excellent “middle ground” for income seekers. In particular, BB/B offers income, stability, and upside potential as strategic M&A rise."
- Solutions: in equities, credit and across asset classes "Equities: dividends as a return enhancer for growth & big dividend payers (pg 18). Credit: Risk/Reward opportunities within BB/B bonds (pg 21) Cross Asset Baskets: where we prefer equity to bond and vice-versa (pg 27). Below is our list of a cross-asset preference for equities."

What is the new normal?

- Quantifying normal "The ‘new normal’ has become an established economic concept, reflecting the widely-shared view that global growth and asset returns will be lower for an extended period of time relative to the history preceding the financial crisis. However, there have been few studies that have tried to quantify the ‘new normal’. This note fills that gap."
- New global trend growth is 3%, not 4% "Our model-based estimates suggest that global growth will average 3% over the next decade, about a percentage point slower than in the previous decade. This outcome is both supply- and demand-side driven. Weaker trend growth will be the by-product of slower world population growth and ageing workforces. But it is also the result of continued de-leveraging and weaker productivity growth in many developed economies. Tighter financial market regulation and the associated impact on the cost of capital may also restrain potential output growth."
- Market divergence "In some ways the ‘new normal’ won’t be so new—divergent trend growth between emerging and advanced economies will endure. Emerging Asia and the Middle East are likely to be the fastest growing regions of the world economy over the next ten years. India, China, and Vietnam enjoy the best longer-term growth prospects in Asia, while Qatar, Egypt and Saudi Arabia lead the pack in the Middle East. Still, Asia will slow somewhat in the next decade, whereas the Middle East has the potential to accelerate. Latin America may also do better in the coming decade."
- The risks "Of course, nothing is assured. Downside risks range from the possibility of more severe sovereign debt crises, heighted protectionism, more restrictive financial market regulation, or a hard landing in China. On the other hand, to the extent that advanced economies undertake structural adjustments to mitigate the impact of ageing populations or boost investment in productivity-enhancing endeavours, faster trend growth relative to our base case is possible."
- Implications "Overall, our estimates suggest that consensus forecasts for trend growth are too high. If investors have to adjust downward trend earnings estimates, valuation multiples are unlikely to expand, even from relatively compressed levels. Finally, on our numbers for trend growth in developed economies, long-bond yields of around 3% do not look particularly out of step."

UBS Tectonic Economics 20100903

Seven Reasons to Sell Sterling

- "Over the summer the pound has bounced against the dollar. But we believe the risks are to the downside for our end year 1.35 forecast."
- "There are seven reasons to sell sterling. First, the rest of the BOE Monetary Policy Committee is unlikely to join Andrew Sentance in voting for rate hikes. Second, the beneficial impact of last month’s Budget has now been priced into sterling. Third, the scale of the budget cuts forecast for the next four years will undermine growth. Fourth, exports can’t be relied upon to take up the slack. Fifth, the MPC remains willing to resume quantitative easing if the economy weakens. Sixth, tighter fiscal policy and looser monetary policy can result in a much weaker pound as occurred after the 1981 austerity budget. Seventh, other major currencies like the yen have also experienced prolonged weakness when fiscal policy has been tightened during times of economic weakness."
UBS Foreign Exchange Note 20100712