private banking insights – market commentary …...the us its top s&p triple-a rating but also...
TRANSCRIPT
Private Banking Insights – Market Commentary
Washington Drama
With US equity markets reaching new all-time highs last month
and investors’ recurrent obsession with overseas risk factors over
the past few years (Arab Spring, EU debt crisis, Syria, Iran, growth
in China, etc..), the recent focus on uncertainties coming out of
Washington is somehow refreshing.
Investors have first been spooked by the Fed’s decision not to
taper, which seems to have created as much uncertainty as
optimism. A few days later, the political deadlock over the budget
(or more precisely the continuing resolution) led to the first (partial)
government shutdown since 1996. While the direct economic fallout
from this shutdown is likely to be limited (at least initially), investors’
anxiety will grow the longer it lasts and the closer we get to the
October 17th deadline when Congress needs to vote on raising the
nation’s debt ceiling. Only two years ago, during the summer of
2011, a similar deadline and political brinkmanship not only cost
the US its top S&P triple-A rating but also drove equity markets into
a free-fall (the S&P 500 dropped nearly 20%). Our current base
case scenario is that a compromise will be found and that political
leaders will not take the risk (as well as the blame) of repeating the
same mistake. Nevertheless, developments in Washington are likely
to keep investors nervous in the coming weeks. As far as the Fed
goes, the current budget impasse probably means that any change
to monetary policy will likely be further postponed.
1
October 1, 2013
Source for charts: FactSet 10/1/2013
Investment, trust, credit and banking services offered through Webster Financial Advisors, a division of Webster Bank, N.A. Webster Private Bank is a trade name of Webster Financial Advisors. Investment products offered by Webster Financial Advisors are not FDIC or government insured; are not guaranteed by Webster Bank; may involve investment risks, including loss of principal amount invested; and are not deposits or other obligations of Webster Bank. Webster Financial Advisors is not in the business of providing tax or legal advice. Consult with your independent attorney, tax consultant or other professional advisor for final recommendations and before changing or implementing any financial, tax or estate planning advice.SEI Investments Management Corp. (SIMC) and Webster Financial Advisors are independent entities. SIMC is the investment advisor to the SEI Funds and co-advisor to the Individual Managed Account Program (IMAP). SEI Funds are distributed by SEI Investment Distribution Co. (SIDCO). SIMC and SIDCO are wholly owned subsidiaries of SEI Investments Company.
The Webster Symbol, Webster Private Bank and Webster Financial Advisors are registered in the U.S. Patent and Trademark Office. FN01419 10/13
Private Banking Insights – Market Commentary
8
Key Takeaways
• The Fed’s inaction should be seen as a short-term delay. Tapering will soon start, probably early next year, but tapering should not be confused with tightening. Monetary conditions will stay accommodative and the Fed will err on the side of caution
• Despite the current budget impasse in Washington, we doubt that the upcoming debt ceiling debate will turn into the same debacle as two years ago. The most likely scenario remains that some compromise will be found, but the necessary long-term decisions will again be pushed further down the road
• The global recovery is gaining momentum and broadening with Europe finally emerging from years of recession. This more synchronized recovery should lead to a gradual pick-up in global trade and encourage more risk taking on the part of investors and support further upside in equity markets
• The rally in bonds may last a while longer but we expect a resumption of the bear market in the medium term. The great rotation out of bonds and into equities should gather some steam in coming months.
• Within fixed income, we recommend using the recent rally to further reduce duration. We see more value in high yield corporate bonds.
• From a regional perspective, we see better upside potential in international markets, in particular the Euro area and Japan
Among the major markets, Italy and Spain offer the most upside potential given extremely depressed valuations and
earnings. This will be particularly true if the fiscal and monetary policy backdrop improves going forward - i.e., the ECB
balance sheet stops shrinking and fiscal policy is allowed to become more supportive of growth. On that front, it seems
that a consensus is emerging (EU, IMF) that fiscal austerity measures have probably gone too far and the focus should
gradually shift towards implementing structural reforms aimed at improving potential growth rates and international
competitiveness.
Many investors have largely abandoned or have relatively small allocations to Europe. As macro tail risks have receded,
sentiment is gradually improving and we expect European stocks to benefit from a more pronounced shift in fund flows.
If you have any questions or would like more information, please contact your Webster Private Bank portfolio manager.
'89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
16,000,000
18,000,000
US PUBLIC DEBTLEV EL A ND STA TUTORY CE IL ING
Public Debt Subject To Statutory Limit, Total, Mil Usd Statutory Debt Limit, Total, Mil Usd
Private Banking Insights – Market CommentaryPrivate Banking Insights – Market Commentary
2
To Taper or Not To Taper
The Fed surprised investors last month when it decided to
maintain its asset purchase program (a.k.a. Quantitative
Easing) without altering its pace (i.e., no tapering).
The Fed’s inaction was somewhat disconcerting since Fed
officials had been preparing investors for several months
that such a move was likely to occur in September.
Moreover, economic data were generally coming in at or
above consensus expectations prior to the FOMC meeting
and, while rising, bond yields and interest rates did
not appear to pose an immediate threat to the nascent
recovery. Nearly all leading indicators are pointing to stronger growth ahead for most sectors of the economy (capital
spending, labor markets, residential investment and trade). However, ahead of some key fiscal deadlines, the Fed
probably decided to err on the side of caution and provide some insurance against unwelcome developments in
Washington. Previous premature sharp increases in bond yields (in 2010 and 2011) did cause the economy to go
through a soft patch and Fed officials expressed concerns about the potential for rising mortgage rates to undermine
the housing recovery.
Developments in the financial markets have become an integral part of monetary policy decisions. As a result, any
increase in bond yields, not backed by a large enough improvement in economic conditions will probably lead to
‘verbal’ easing from the Fed. Since short-term rates are anchored by the Fed’s forward-guidance, QE was designed
as a way for the Fed to keep some control on borrowing costs along the yield curve. For investors, the decision not
to taper was a clear reminder that the Fed is not comfortable with the recent sharp increase in bond yields and that
asset prices are now a key component of the policy toolkit.
Fed officials are clearly more concerned about the deflationary forces resulting from the past financial crisis
(deleveraging, fiscal tightening) than they are concerned with the inflationary impact of expanding the central
bank’s balance sheet. Indeed, money supply and credit growth remain constrained by the sharp drop in the money
multiplier as commercial banks remain cautious and focus on strengthening their balance sheets. This means
that the traditional monetary transmission mechanism has broken down. Inflation will only become a limiting
factor for the Fed’s unorthodox monetary policy when the economy starts operating closer to full capacity and
money supply/bank lending rebounds more convincingly. Until then, monetary policy will continue to drive asset
price inflation (housing/equities) as positive wealth effects are perceived as necessary in order to support confidence
levels and promote spending as well as risk taking.
Investment Strategy Implications
Five years after the collapse of Lehman Brothers, the global
economy continues to heal but the recovery has been
fragile and uneven from a regional perspective. The US
economy has gradually rebounded from the depths of the
financial crisis but the pace has been slow by historical
standards. Europe suffered a “double dip” recession,
growth in Japan has been anemic at best and the Chinese
economy went through a pronounced slowdown since
2011, after the initial boost from very aggressive fiscal and
monetary policies.
On a global basis, the major central banks have all
implemented aggressive monetary policies in recent years
and remain fully committed to providing additional support
if needed. Policymakers are well aware of the structural
headwinds created by deleveraging forces, increased
regulation and necessary fiscal tightening measures.
Given the necessary adjustments yet to be implemented,
monetary policy will probably remain accommodative for
longer and provide a cushion against potential downside
risks. The recent decision by the Fed should be seen
in this context. Policymakers in Washington, Frankfurt,
London and Tokyo will not hesitate to fine-tune their
policies and/or forward guidance as soon as they perceive
that markets are moving too fast and/or lead to a premature tightening of overall financial conditions.
This should be seen as a positive for equity markets since persistent low yields should encourage additional flows toward
stock markets. The financial crisis was followed by years of risk aversion and investors have had to deal with numerous
tail risk events, which have prompted massive fund flows toward perceived ‘safe-haven’ bond markets. Given a lack of
attractive investment opportunities in bond markets, investors are likely to continue to gradually take on more risk in their
portfolios. While bond funds have seen massive outflows since June, inflows into equities have been inconsistent and
still very sensitive to rapid mood swings among investors. This risk-on/risk-off pattern should become less pronounced
going forward as the economic recovery gathers steam and, more importantly, becomes more broad-based. Indeed, for
the first time in many years, the major economies will all have a positive contribution to global growth. Given the extent of
the previous moves in the opposite direction (particularly over the past 5 years), the “Great Rotation” has barely started
3
10/10 4/11 10/11 4/12 10/12 4/13 10/13
1.51.5
2.02.0
2.52.5
3.03.0
3.53.5
4.04.0
4.54.5
5.05.0
2.63
4.32
SHARP INCREASE IN MORTGAGE RATEIMPACT FROM POTENT IA L FED TA PERING
US Treasury Constant Maturity - 10 Year - Yield 30 Year Average Mortgage Rate, Percent - United States
'04 '05 '06 '07 '08 '09 '10 '11 '12 '13
3.03.03.53.54.04.04.54.55.05.05.55.56.06.06.56.57.07.07.57.58.08.08.58.59.09.0
US MONEY MULTIPLIERST IL L DE PR ESSE D
Money supply M2 / Monetary Base
'08 '09 '10 '11 '12 '130
160,000
320,000
480,000
640,000
800,000
960,000
1,120,000
1,280,000
-550,000-500,000-450,000-400,000-350,000-300,000-250,000-200,000-150,000-100,000-50,0000
Source: Investment Company Institute
MUTUAL FUNDS - NET NEW CASHFLOWSFIXED INCOME (+$1tn ) vs EQUITIES ( -$430bn)Cumulative Total since January 2008
All Equity Funds, Millions of USD (Right)All Bond & Income Funds, Millions Of USD (Left)
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
40,000
45,000
50,000
55,000
60,000
65,000
70,000
75,000
-24.0
-16.0
-8.0
0.0
8.0
16.0
24.0
32.0
HOUSEHOLDS NET WORTHUP $19 TRILL ION SINCE BOTTOM IN 1Q09
(% 1Q Ann) Households Net worth (Right)Households Net worth (Left)Recession Periods - United States
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13-4-4-3-3-2-2-1-100112233445566778899
RISK PREMIUM COMING DOWNFORM RECORD HIGH LEVELSS&P500 EA RNINGS YIELD - 10Y BY
Private Banking Insights – Market CommentaryPrivate Banking Insights – Market Commentary
2
To Taper or Not To Taper
The Fed surprised investors last month when it decided to
maintain its asset purchase program (a.k.a. Quantitative
Easing) without altering its pace (i.e., no tapering).
The Fed’s inaction was somewhat disconcerting since Fed
officials had been preparing investors for several months
that such a move was likely to occur in September.
Moreover, economic data were generally coming in at or
above consensus expectations prior to the FOMC meeting
and, while rising, bond yields and interest rates did
not appear to pose an immediate threat to the nascent
recovery. Nearly all leading indicators are pointing to stronger growth ahead for most sectors of the economy (capital
spending, labor markets, residential investment and trade). However, ahead of some key fiscal deadlines, the Fed
probably decided to err on the side of caution and provide some insurance against unwelcome developments in
Washington. Previous premature sharp increases in bond yields (in 2010 and 2011) did cause the economy to go
through a soft patch and Fed officials expressed concerns about the potential for rising mortgage rates to undermine
the housing recovery.
Developments in the financial markets have become an integral part of monetary policy decisions. As a result, any
increase in bond yields, not backed by a large enough improvement in economic conditions will probably lead to
‘verbal’ easing from the Fed. Since short-term rates are anchored by the Fed’s forward-guidance, QE was designed
as a way for the Fed to keep some control on borrowing costs along the yield curve. For investors, the decision not
to taper was a clear reminder that the Fed is not comfortable with the recent sharp increase in bond yields and that
asset prices are now a key component of the policy toolkit.
Fed officials are clearly more concerned about the deflationary forces resulting from the past financial crisis
(deleveraging, fiscal tightening) than they are concerned with the inflationary impact of expanding the central
bank’s balance sheet. Indeed, money supply and credit growth remain constrained by the sharp drop in the money
multiplier as commercial banks remain cautious and focus on strengthening their balance sheets. This means
that the traditional monetary transmission mechanism has broken down. Inflation will only become a limiting
factor for the Fed’s unorthodox monetary policy when the economy starts operating closer to full capacity and
money supply/bank lending rebounds more convincingly. Until then, monetary policy will continue to drive asset
price inflation (housing/equities) as positive wealth effects are perceived as necessary in order to support confidence
levels and promote spending as well as risk taking.
Investment Strategy Implications
Five years after the collapse of Lehman Brothers, the global
economy continues to heal but the recovery has been
fragile and uneven from a regional perspective. The US
economy has gradually rebounded from the depths of the
financial crisis but the pace has been slow by historical
standards. Europe suffered a “double dip” recession,
growth in Japan has been anemic at best and the Chinese
economy went through a pronounced slowdown since
2011, after the initial boost from very aggressive fiscal and
monetary policies.
On a global basis, the major central banks have all
implemented aggressive monetary policies in recent years
and remain fully committed to providing additional support
if needed. Policymakers are well aware of the structural
headwinds created by deleveraging forces, increased
regulation and necessary fiscal tightening measures.
Given the necessary adjustments yet to be implemented,
monetary policy will probably remain accommodative for
longer and provide a cushion against potential downside
risks. The recent decision by the Fed should be seen
in this context. Policymakers in Washington, Frankfurt,
London and Tokyo will not hesitate to fine-tune their
policies and/or forward guidance as soon as they perceive
that markets are moving too fast and/or lead to a premature tightening of overall financial conditions.
This should be seen as a positive for equity markets since persistent low yields should encourage additional flows toward
stock markets. The financial crisis was followed by years of risk aversion and investors have had to deal with numerous
tail risk events, which have prompted massive fund flows toward perceived ‘safe-haven’ bond markets. Given a lack of
attractive investment opportunities in bond markets, investors are likely to continue to gradually take on more risk in their
portfolios. While bond funds have seen massive outflows since June, inflows into equities have been inconsistent and
still very sensitive to rapid mood swings among investors. This risk-on/risk-off pattern should become less pronounced
going forward as the economic recovery gathers steam and, more importantly, becomes more broad-based. Indeed, for
the first time in many years, the major economies will all have a positive contribution to global growth. Given the extent of
the previous moves in the opposite direction (particularly over the past 5 years), the “Great Rotation” has barely started
3
10/10 4/11 10/11 4/12 10/12 4/13 10/13
1.51.5
2.02.0
2.52.5
3.03.0
3.53.5
4.04.0
4.54.5
5.05.0
2.63
4.32
SHARP INCREASE IN MORTGAGE RATEIMPACT FROM POTENT IA L FED TA PERING
US Treasury Constant Maturity - 10 Year - Yield 30 Year Average Mortgage Rate, Percent - United States
'04 '05 '06 '07 '08 '09 '10 '11 '12 '13
3.03.03.53.54.04.04.54.55.05.05.55.56.06.06.56.57.07.07.57.58.08.08.58.59.09.0
US MONEY MULTIPLIERST IL L DE PR ESSE D
Money supply M2 / Monetary Base
'08 '09 '10 '11 '12 '130
160,000
320,000
480,000
640,000
800,000
960,000
1,120,000
1,280,000
-550,000-500,000-450,000-400,000-350,000-300,000-250,000-200,000-150,000-100,000-50,0000
Source: Investment Company Institute
MUTUAL FUNDS - NET NEW CASHFLOWSFIXED INCOME (+$1tn ) vs EQUITIES ( -$430bn)Cumulative Total since January 2008
All Equity Funds, Millions of USD (Right)All Bond & Income Funds, Millions Of USD (Left)
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
40,000
45,000
50,000
55,000
60,000
65,000
70,000
75,000
-24.0
-16.0
-8.0
0.0
8.0
16.0
24.0
32.0
HOUSEHOLDS NET WORTHUP $19 TRILL ION SINCE BOTTOM IN 1Q09
(% 1Q Ann) Households Net worth (Right)Households Net worth (Left)Recession Periods - United States
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13-4-4-3-3-2-2-1-100112233445566778899
RISK PREMIUM COMING DOWNFORM RECORD HIGH LEVELSS&P500 EA RNINGS YIELD - 10Y BY
Private Banking Insights – Market CommentaryPrivate Banking Insights – Market Commentary
4 5
and equity prices will most likely benefit from a reversal of these flows. As long as corporate earnings continue to rise,
we expect asset allocation shifts away from bonds in favor of stocks to last for several years and end only when bond
markets become cheap and/or equity markets become overvalued.
Against this backdrop, we remain constructive on global equity markets. We believe equity markets will move higher
in coming months due to a combination of rising earnings and higher valuation ratios (lower risk premium). Looking
at these drivers however (earnings and valuations), we believe the upside potential is more significant for international
markets.
Abenomics is working
There are growing signs that the Bank of Japan (BoJ) aggressive monetary policy is having a positive impact on the
Japanese economy. In particular, Japan might be able to finally emerge from years of sustained deflation. Indeed,
consumer prices have been steadily increasing over the past few months and, more importantly, inflation expectations
have also moved decidedly higher with 9 out of 10 Japanese consumers now expecting positive inflation trends over the
coming year. Investors seem to share this optimistic view too, with the 5-year breakeven inflation rate now around 1.6%.
These positive inflation developments are not limited to goods prices, which are more directly impacted by rising import
prices due to the weak Yen, but prices are also moving higher in the services sector. This seems to confirm stronger
domestic demand, as well as increasing evidence of positive nominal wage growth.
For more than 20 years, the Japanese economy has been plagued with price deflation and deflationary expectations.
While the economy has continued to grow (modestly) in real terms, nominal GDP has been falling since reaching a peak
in 1995. A return to positive nominal growth will help the Japanese economy on numerous fronts. It will support a more
significant recovery in consumer spending (positive inflation expectations will discourage excessive savings) and capital
spending (as corporate profits will benefit from positive top-line growth). Rising nominal GDP levels will also prove very
beneficial from a public debt perspective as the stock of debt is a ‘real’ burden (i.e. it will not rise with inflation) while
public revenues represent a ‘nominal’ income (and hence, they will benefit from positive inflation).
Over the past 3 quarters, nominal GDP has grown at an annualized rate of 2.3% compared to 3.0% in real terms. While
the GDP deflator (a measure of price inflation at the overall economy level) is still in negative territory, deflation is at least
not resulting in outright nominal economic contraction anymore.
The BoJ’s pledge to double the size of the monetary
base has also contributed to a rebound in private
sector credit growth with bank loans up on a year-on-
year basis. The weakening of the Japanese currency,
a direct consequence of the aggressive monetary
policy, also led to a sharp turnaround in the Japanese
trade balance, which has been in deficit for the past
2 years as a result of prior Yen strength. This will
prove very beneficial for the economy and corporate
profits, particularly at a time when global trade seems
to have bottomed out.
In summary, “Abenomics” seems to be successful in achieving the short-term goals of generating positive nominal
growth and inflation. For these trends to be sustained, structural reforms aimed at improving the economy’s long-term
potential growth rate will have to be implemented. In particular, excess savings will have to come down further and
capital spending will need to rebound. At the same time, the Abe government will also have to keep an eye on the
bond market and implement credible measures to convince investors that the public debt situation will not move out of
control. The decision to press ahead with the scheduled sales tax increase should be seen in this context.
While the sales tax hike (from 5% to 8%) will be implemented in April 2014, it seems increasingly likely that a large
proportion of this hike will be offset by the introduction of a stimulus package, which could include a large cut in corporate
taxes. This would represent another step in the right direction for the Japanese economy which has been characterized
by low sales taxes (often referred to as “good’ taxes) and relatively high income taxes (considered “bad” taxes).
While additional tax and economic reforms will be critical in coming months, the outlook for both the Japanese economy
and equity markets in the near term is very much dependent on renewed Yen weakness. Recent developments
in Washington have led to a reversal in currency markets, but we believe this will prove temporary. The uptrend in
Japanese stocks is still intact and we expect more gains in coming months, driven by a strong rebound in corporate
profits, attractive valuations, and a resumption of Yen weakness.
The Old Continent Comes Back To Life
European stocks have significantly underperformed global equities since the financial crisis, falling near all-time lows
relative to global indices earlier this year. Numerous factors have understandably caused investors to shy away from the
region:
• Concerns about the sustainability of the European Monetary Union
• Out-of-control funding costs for governments and companies as well as worries about a complete loss of access
to credit markets
• Weak banking sector and the vicious feedback loop between banks’ balance sheets and sovereign bond prices
• Deep recession in the European periphery as fiscal austerity measures compounded the impact of tight credit
conditions and rapidly falling business and consumer confidence
• Political instability as well as weak and slow reaction from the European Central Bank (ECB)'80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12
100100
120120
140140
160160
180180
200200
220220
240240
JAPAN : NOMINAL vs REAL GDPENDING DEFLAT ION KEY FOR ECONOMY A ND PROFITS
(INDEX) Nominal GDP, Total, Sa, Bil Jpy (INDEX) Real GDP, Total, Sa, Bil Jpy
'04 '05 '06 '07 '08 '09 '10 '11 '12 '13
-20-20
-10-10
00
1010
2020
3030
4040
5050
BOJ - NOW THE MOST AGGRESSIVE CENTRAL BANKMONETARY BA SE Y/Y % CHANGE
'09 '10 '11 '12 '13
700
800
900
1,000
1,100
1,200
1,300
75
80
85
90
95
100
105
JAPANESE EQUITIES AND USD/JPYR ENEWED JPY WE AKNE SS TO DR IVE JA PA NE SE E QUITIES HIGHER
Tokyo SE Topix Index, Price Return, JPY, Close - Japan (Left)Spot Exchange Rates USD/JPY, Close Daily - Japan (Right)
Private Banking Insights – Market CommentaryPrivate Banking Insights – Market Commentary
4 5
and equity prices will most likely benefit from a reversal of these flows. As long as corporate earnings continue to rise,
we expect asset allocation shifts away from bonds in favor of stocks to last for several years and end only when bond
markets become cheap and/or equity markets become overvalued.
Against this backdrop, we remain constructive on global equity markets. We believe equity markets will move higher
in coming months due to a combination of rising earnings and higher valuation ratios (lower risk premium). Looking
at these drivers however (earnings and valuations), we believe the upside potential is more significant for international
markets.
Abenomics is working
There are growing signs that the Bank of Japan (BoJ) aggressive monetary policy is having a positive impact on the
Japanese economy. In particular, Japan might be able to finally emerge from years of sustained deflation. Indeed,
consumer prices have been steadily increasing over the past few months and, more importantly, inflation expectations
have also moved decidedly higher with 9 out of 10 Japanese consumers now expecting positive inflation trends over the
coming year. Investors seem to share this optimistic view too, with the 5-year breakeven inflation rate now around 1.6%.
These positive inflation developments are not limited to goods prices, which are more directly impacted by rising import
prices due to the weak Yen, but prices are also moving higher in the services sector. This seems to confirm stronger
domestic demand, as well as increasing evidence of positive nominal wage growth.
For more than 20 years, the Japanese economy has been plagued with price deflation and deflationary expectations.
While the economy has continued to grow (modestly) in real terms, nominal GDP has been falling since reaching a peak
in 1995. A return to positive nominal growth will help the Japanese economy on numerous fronts. It will support a more
significant recovery in consumer spending (positive inflation expectations will discourage excessive savings) and capital
spending (as corporate profits will benefit from positive top-line growth). Rising nominal GDP levels will also prove very
beneficial from a public debt perspective as the stock of debt is a ‘real’ burden (i.e. it will not rise with inflation) while
public revenues represent a ‘nominal’ income (and hence, they will benefit from positive inflation).
Over the past 3 quarters, nominal GDP has grown at an annualized rate of 2.3% compared to 3.0% in real terms. While
the GDP deflator (a measure of price inflation at the overall economy level) is still in negative territory, deflation is at least
not resulting in outright nominal economic contraction anymore.
The BoJ’s pledge to double the size of the monetary
base has also contributed to a rebound in private
sector credit growth with bank loans up on a year-on-
year basis. The weakening of the Japanese currency,
a direct consequence of the aggressive monetary
policy, also led to a sharp turnaround in the Japanese
trade balance, which has been in deficit for the past
2 years as a result of prior Yen strength. This will
prove very beneficial for the economy and corporate
profits, particularly at a time when global trade seems
to have bottomed out.
In summary, “Abenomics” seems to be successful in achieving the short-term goals of generating positive nominal
growth and inflation. For these trends to be sustained, structural reforms aimed at improving the economy’s long-term
potential growth rate will have to be implemented. In particular, excess savings will have to come down further and
capital spending will need to rebound. At the same time, the Abe government will also have to keep an eye on the
bond market and implement credible measures to convince investors that the public debt situation will not move out of
control. The decision to press ahead with the scheduled sales tax increase should be seen in this context.
While the sales tax hike (from 5% to 8%) will be implemented in April 2014, it seems increasingly likely that a large
proportion of this hike will be offset by the introduction of a stimulus package, which could include a large cut in corporate
taxes. This would represent another step in the right direction for the Japanese economy which has been characterized
by low sales taxes (often referred to as “good’ taxes) and relatively high income taxes (considered “bad” taxes).
While additional tax and economic reforms will be critical in coming months, the outlook for both the Japanese economy
and equity markets in the near term is very much dependent on renewed Yen weakness. Recent developments
in Washington have led to a reversal in currency markets, but we believe this will prove temporary. The uptrend in
Japanese stocks is still intact and we expect more gains in coming months, driven by a strong rebound in corporate
profits, attractive valuations, and a resumption of Yen weakness.
The Old Continent Comes Back To Life
European stocks have significantly underperformed global equities since the financial crisis, falling near all-time lows
relative to global indices earlier this year. Numerous factors have understandably caused investors to shy away from the
region:
• Concerns about the sustainability of the European Monetary Union
• Out-of-control funding costs for governments and companies as well as worries about a complete loss of access
to credit markets
• Weak banking sector and the vicious feedback loop between banks’ balance sheets and sovereign bond prices
• Deep recession in the European periphery as fiscal austerity measures compounded the impact of tight credit
conditions and rapidly falling business and consumer confidence
• Political instability as well as weak and slow reaction from the European Central Bank (ECB)'80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12
100100
120120
140140
160160
180180
200200
220220
240240
JAPAN : NOMINAL vs REAL GDPENDING DEFLAT ION KEY FOR ECONOMY A ND PROFITS
(INDEX) Nominal GDP, Total, Sa, Bil Jpy (INDEX) Real GDP, Total, Sa, Bil Jpy
'04 '05 '06 '07 '08 '09 '10 '11 '12 '13
-20-20
-10-10
00
1010
2020
3030
4040
5050
BOJ - NOW THE MOST AGGRESSIVE CENTRAL BANKMONETARY BA SE Y/Y % CHANGE
'09 '10 '11 '12 '13
700
800
900
1,000
1,100
1,200
1,300
75
80
85
90
95
100
105
JAPANESE EQUITIES AND USD/JPYR ENEWED JPY WE AKNE SS TO DR IVE JA PA NE SE E QUITIES HIGHER
Tokyo SE Topix Index, Price Return, JPY, Close - Japan (Left)Spot Exchange Rates USD/JPY, Close Daily - Japan (Right)
Private Banking Insights – Market CommentaryPrivate Banking Insights – Market Commentary
6 7
Over the past few months however, the outlook for the
region has materially improved. Borrowing costs have fallen
sharply and both sovereign and corporate credit spreads
have moved back to near pre-crisis levels. The ECB played
a major role in easing credit conditions and healing the
sovereign debt crisis by introducing two rounds of Long-
Term Refinancing Operations (LTRO) as well as pledging
to do “whatever it takes” to preserve the Euro and ensure
Governments can maintain access to the bond market
through the introduction (although not implemented yet) of
outright monetary transactions (OMT).
The Euro area seems to be entering the “sweet spot” of the
business cycle, similar to where the US economy was back
in 2009. Both economic growth and earnings are depressed
from years of painful economic contraction and tight credit
conditions, but at the same time there is increasing evidence
that an inflection point has been reached. Indeed, the
Euro area is finally emerging from a long-lasting recession.
Importantly, the recovery seems to be broad based and has
spread to the periphery. Both Italy and Spain (the third and
fourth biggest economies in the region) have gone through
some painful adjustments over the past few years but are
now in a much better position to grow going forward, given
the meaningful improvements achieved from a fiscal and current account balances perspective.
On the negative side, bank lending continues to contract at a rapid pace, mostly because of banks’ unwillingness to
grow their lending book as they continue to shrink their balance sheets and raise their capital adequacy ratios. The ECB
is well aware of this trend which, to a large extent, renders their monetary policy much less efficient. In recent weeks,
expectations have started to build for the ECB to come up with measures to support private sector credit growth (in
particular for small and medium size companies). While we acknowledge that deleveraging pressures will persist for
the banking sector, we also believe that a more proactive and supportive ECB as well as growing signs of a moderate
economic recovery should help mitigate the impact of tight lending conditions.
Overall, the risk/reward trade-off is becoming increasingly attractive, with significant upside potential in a bull case
scenario and relatively limited downside risks otherwise.
The main factors underpinning our expectations for European equities to outperform global indices are the following:
• Relative prices are near historical lows. Since March 2009 when US equity markets reached their cycle low,
European equities have underperformed by roughly 50%
• The business cycle is more supportive. As previously indicated, the US economy emerged from recession in the
second half of 2009 and Nominal GDP already stands 13% above its pre-recession low. By contrast, nominal
GDP in the Euro area is only 3% higher than before the onset of the 08/09 recession and in some cases, such as
Italy and Spain, economic activity is still below these levels. While the recovery in domestic demand will remain
constrained by elevated unemployment levels and weak credit conditions, the European economy is very much
geared towards global growth, which we expect to strengthen in coming months.
• Corporate profits are still depressed. The double-dip recession experienced by most European economies help
explain why corporate profits are still well below the pre-financial crisis level. Earnings will need to grow by roughly
30% to reach these levels. By contrast, US corporate profits have already benefited from the more explosive phase
of the business cycle, with earnings 20% above their previous highs. As economic activity rebounds, positive
operational leverage should lead to a more vigorous recovery in earnings going forward. Moreover, European
earnings are more pro-cyclical and tend to outperform as the global economy is improving.
• Relative valuations are low by historical standards. Despite the fact that earnings are depressed, price-earnings
ratios across the area trade near their historical discount versus the US market. However, on a price/book basis,
the discount is much more significant at around 40% against the US market, a level which has not been exceeded
since the 1970’s.
• Relative Monetary Policy will turn more supportive. The Federal Reserve might have delayed its decision to
reduce the pace of quantitative easing, but the most likely scenario going forward is that the tapering process will
nevertheless start in the near term. By contrast, the ECB balance sheet has been shrinking in recent months,
resulting in a stronger Euro and relatively tighter monetary conditions. We expect these trends to reverse in coming
months as the Fed gradually takes its foot off the QE pedal while the ECB will likely have to provide additional
monetary stimulus to offset weak credit growth.
• Improving fiscal backdrop. Despite recurrent mini-crises in Washington around specific fiscal deadlines such as
budget or continuing resolutions, very little has actually been done to tackle the medium term fiscal challenges.
On nearly every measure, the fiscal picture looks better in Europe (fiscal deficits, debt to GDP ratios) following the
implementation of painful austerity measures in previous years. While more progress needs to be done towards
fiscal integration, fiscal headwinds are likely to become less severe in the Euro area in coming months.
'09 '10 '11 '12 '13
100100
120120
140140
160160
180180
200200
220220
240240
260260
EMU EQUITIES (MSCI) vs US EQUITIES (S&P 500)R ELA TIVE P ER FORMA NCE SINCE MA RCH 09 LOWSR ebased to 100
(INDEX) MSCI EMU - Price Index (INDEX) S&P 500 - Price Index
'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
75
80
85
90
95
100
105
110
-12
-10
-8
-6
-4
-2
0
2
4
ADJUSTMENTS IN SPAINC/A BA LA NCE POSIT IV E FOR FIRST TIME IN 16 YEA RSIP BA CK TO 1994 LEVELS
Current Account, As A Percentage Of Gdp - Spain (Right)Industrial Production, Total, 2005=100, Sa - Spain (Left)
'05 '06 '07 '08 '09 '10 '11 '12 '13
-45.0-45.0
-40.0-40.0
-35.0-35.0
-30.0-30.0
-25.0-25.0
EUROPEAN EQUITIES - RELATIVE VALUATION vs USP/BV - 40% DISCOUNT
10/11 1/12 4/12 7/12 10/12 1/13 4/13 7/13 10/131.51.52.02.02.52.53.03.03.53.54.04.04.54.55.05.05.55.56.06.06.56.57.07.07.57.5
2.002.14
PERIPHERAL BOND YIELDSSHA RP IMPROV EM ENT IN FUNDING COSTS FOR THE PERIPHERY
Italy Benchmark Bond - 3 Year - Yield Spain Benchmark Bond - 3 Year - Yield
Private Banking Insights – Market CommentaryPrivate Banking Insights – Market Commentary
6 7
Over the past few months however, the outlook for the
region has materially improved. Borrowing costs have fallen
sharply and both sovereign and corporate credit spreads
have moved back to near pre-crisis levels. The ECB played
a major role in easing credit conditions and healing the
sovereign debt crisis by introducing two rounds of Long-
Term Refinancing Operations (LTRO) as well as pledging
to do “whatever it takes” to preserve the Euro and ensure
Governments can maintain access to the bond market
through the introduction (although not implemented yet) of
outright monetary transactions (OMT).
The Euro area seems to be entering the “sweet spot” of the
business cycle, similar to where the US economy was back
in 2009. Both economic growth and earnings are depressed
from years of painful economic contraction and tight credit
conditions, but at the same time there is increasing evidence
that an inflection point has been reached. Indeed, the
Euro area is finally emerging from a long-lasting recession.
Importantly, the recovery seems to be broad based and has
spread to the periphery. Both Italy and Spain (the third and
fourth biggest economies in the region) have gone through
some painful adjustments over the past few years but are
now in a much better position to grow going forward, given
the meaningful improvements achieved from a fiscal and current account balances perspective.
On the negative side, bank lending continues to contract at a rapid pace, mostly because of banks’ unwillingness to
grow their lending book as they continue to shrink their balance sheets and raise their capital adequacy ratios. The ECB
is well aware of this trend which, to a large extent, renders their monetary policy much less efficient. In recent weeks,
expectations have started to build for the ECB to come up with measures to support private sector credit growth (in
particular for small and medium size companies). While we acknowledge that deleveraging pressures will persist for
the banking sector, we also believe that a more proactive and supportive ECB as well as growing signs of a moderate
economic recovery should help mitigate the impact of tight lending conditions.
Overall, the risk/reward trade-off is becoming increasingly attractive, with significant upside potential in a bull case
scenario and relatively limited downside risks otherwise.
The main factors underpinning our expectations for European equities to outperform global indices are the following:
• Relative prices are near historical lows. Since March 2009 when US equity markets reached their cycle low,
European equities have underperformed by roughly 50%
• The business cycle is more supportive. As previously indicated, the US economy emerged from recession in the
second half of 2009 and Nominal GDP already stands 13% above its pre-recession low. By contrast, nominal
GDP in the Euro area is only 3% higher than before the onset of the 08/09 recession and in some cases, such as
Italy and Spain, economic activity is still below these levels. While the recovery in domestic demand will remain
constrained by elevated unemployment levels and weak credit conditions, the European economy is very much
geared towards global growth, which we expect to strengthen in coming months.
• Corporate profits are still depressed. The double-dip recession experienced by most European economies help
explain why corporate profits are still well below the pre-financial crisis level. Earnings will need to grow by roughly
30% to reach these levels. By contrast, US corporate profits have already benefited from the more explosive phase
of the business cycle, with earnings 20% above their previous highs. As economic activity rebounds, positive
operational leverage should lead to a more vigorous recovery in earnings going forward. Moreover, European
earnings are more pro-cyclical and tend to outperform as the global economy is improving.
• Relative valuations are low by historical standards. Despite the fact that earnings are depressed, price-earnings
ratios across the area trade near their historical discount versus the US market. However, on a price/book basis,
the discount is much more significant at around 40% against the US market, a level which has not been exceeded
since the 1970’s.
• Relative Monetary Policy will turn more supportive. The Federal Reserve might have delayed its decision to
reduce the pace of quantitative easing, but the most likely scenario going forward is that the tapering process will
nevertheless start in the near term. By contrast, the ECB balance sheet has been shrinking in recent months,
resulting in a stronger Euro and relatively tighter monetary conditions. We expect these trends to reverse in coming
months as the Fed gradually takes its foot off the QE pedal while the ECB will likely have to provide additional
monetary stimulus to offset weak credit growth.
• Improving fiscal backdrop. Despite recurrent mini-crises in Washington around specific fiscal deadlines such as
budget or continuing resolutions, very little has actually been done to tackle the medium term fiscal challenges.
On nearly every measure, the fiscal picture looks better in Europe (fiscal deficits, debt to GDP ratios) following the
implementation of painful austerity measures in previous years. While more progress needs to be done towards
fiscal integration, fiscal headwinds are likely to become less severe in the Euro area in coming months.
'09 '10 '11 '12 '13
100100
120120
140140
160160
180180
200200
220220
240240
260260
EMU EQUITIES (MSCI) vs US EQUITIES (S&P 500)R ELA TIVE P ER FORMA NCE SINCE MA RCH 09 LOWSR ebased to 100
(INDEX) MSCI EMU - Price Index (INDEX) S&P 500 - Price Index
'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
75
80
85
90
95
100
105
110
-12
-10
-8
-6
-4
-2
0
2
4
ADJUSTMENTS IN SPAINC/A BA LA NCE POSIT IV E FOR FIRST TIME IN 16 YEA RSIP BA CK TO 1994 LEVELS
Current Account, As A Percentage Of Gdp - Spain (Right)Industrial Production, Total, 2005=100, Sa - Spain (Left)
'05 '06 '07 '08 '09 '10 '11 '12 '13
-45.0-45.0
-40.0-40.0
-35.0-35.0
-30.0-30.0
-25.0-25.0
EUROPEAN EQUITIES - RELATIVE VALUATION vs USP/BV - 40% DISCOUNT
10/11 1/12 4/12 7/12 10/12 1/13 4/13 7/13 10/131.51.52.02.02.52.53.03.03.53.54.04.04.54.55.05.05.55.56.06.06.56.57.07.07.57.5
2.002.14
PERIPHERAL BOND YIELDSSHA RP IMPROV EM ENT IN FUNDING COSTS FOR THE PERIPHERY
Italy Benchmark Bond - 3 Year - Yield Spain Benchmark Bond - 3 Year - Yield
Private Banking Insights – Market Commentary
Washington Drama
With US equity markets reaching new all-time highs last month
and investors’ recurrent obsession with overseas risk factors over
the past few years (Arab Spring, EU debt crisis, Syria, Iran, growth
in China, etc..), the recent focus on uncertainties coming out of
Washington is somehow refreshing.
Investors have first been spooked by the Fed’s decision not to
taper, which seems to have created as much uncertainty as
optimism. A few days later, the political deadlock over the budget
(or more precisely the continuing resolution) led to the first (partial)
government shutdown since 1996. While the direct economic fallout
from this shutdown is likely to be limited (at least initially), investors’
anxiety will grow the longer it lasts and the closer we get to the
October 17th deadline when Congress needs to vote on raising the
nation’s debt ceiling. Only two years ago, during the summer of
2011, a similar deadline and political brinkmanship not only cost
the US its top S&P triple-A rating but also drove equity markets into
a free-fall (the S&P 500 dropped nearly 20%). Our current base
case scenario is that a compromise will be found and that political
leaders will not take the risk (as well as the blame) of repeating the
same mistake. Nevertheless, developments in Washington are likely
to keep investors nervous in the coming weeks. As far as the Fed
goes, the current budget impasse probably means that any change
to monetary policy will likely be further postponed.
1
October 1, 2013
Source for charts: FactSet 10/1/2013
Investment, trust, credit and banking services offered through Webster Financial Advisors, a division of Webster Bank, N.A. Webster Private Bank is a trade name of Webster Financial Advisors. Investment products offered by Webster Financial Advisors are not FDIC or government insured; are not guaranteed by Webster Bank; may involve investment risks, including loss of principal amount invested; and are not deposits or other obligations of Webster Bank. Webster Financial Advisors is not in the business of providing tax or legal advice. Consult with your independent attorney, tax consultant or other professional advisor for final recommendations and before changing or implementing any financial, tax or estate planning advice.SEI Investments Management Corp. (SIMC) and Webster Financial Advisors are independent entities. SIMC is the investment advisor to the SEI Funds and co-advisor to the Individual Managed Account Program (IMAP). SEI Funds are distributed by SEI Investment Distribution Co. (SIDCO). SIMC and SIDCO are wholly owned subsidiaries of SEI Investments Company.
The Webster Symbol, Webster Private Bank and Webster Financial Advisors are registered in the U.S. Patent and Trademark Office. FN01419 10/13
Private Banking Insights – Market Commentary
8
Key Takeaways
• The Fed’s inaction should be seen as a short-term delay. Tapering will soon start, probably early next year, but tapering should not be confused with tightening. Monetary conditions will stay accommodative and the Fed will err on the side of caution
• Despite the current budget impasse in Washington, we doubt that the upcoming debt ceiling debate will turn into the same debacle as two years ago. The most likely scenario remains that some compromise will be found, but the necessary long-term decisions will again be pushed further down the road
• The global recovery is gaining momentum and broadening with Europe finally emerging from years of recession. This more synchronized recovery should lead to a gradual pick-up in global trade and encourage more risk taking on the part of investors and support further upside in equity markets
• The rally in bonds may last a while longer but we expect a resumption of the bear market in the medium term. The great rotation out of bonds and into equities should gather some steam in coming months.
• Within fixed income, we recommend using the recent rally to further reduce duration. We see more value in high yield corporate bonds.
• From a regional perspective, we see better upside potential in international markets, in particular the Euro area and Japan
Among the major markets, Italy and Spain offer the most upside potential given extremely depressed valuations and
earnings. This will be particularly true if the fiscal and monetary policy backdrop improves going forward - i.e., the ECB
balance sheet stops shrinking and fiscal policy is allowed to become more supportive of growth. On that front, it seems
that a consensus is emerging (EU, IMF) that fiscal austerity measures have probably gone too far and the focus should
gradually shift towards implementing structural reforms aimed at improving potential growth rates and international
competitiveness.
Many investors have largely abandoned or have relatively small allocations to Europe. As macro tail risks have receded,
sentiment is gradually improving and we expect European stocks to benefit from a more pronounced shift in fund flows.
If you have any questions or would like more information, please contact your Webster Private Bank portfolio manager.
'89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
16,000,000
18,000,000
US PUBLIC DEBTLEV EL A ND STA TUTORY CE IL ING
Public Debt Subject To Statutory Limit, Total, Mil Usd Statutory Debt Limit, Total, Mil Usd