! The core macro problem is $8tn of excess leverage in developed markets. This is offset partly by $3.4tn of under-leverage in emerging markets. Thus, global excess leverage is 6% of global GDP. Our central view is that the solution is negative real rates, emerging market re-leveraging and currency appreciation. We consider the following scenarios.
! Core scenario (50% likelihood): Ongoing sub-par recovery: GDP growth of 1.5%-2% in the US, 0.5%-1% in Europe and 8% in China implying 3% global growth this year (20-year average is 3.5%). We think recession is avoided because: GEM account for 49% of global GDP, exceptionally loose global monetary policy, strong corporate balance sheets, underinvested corporate sector, US fiscal tightening is watered down, 0.7% US employment growth, inventories are not excessive and Europe is likely to 'muddle through' with ECB buying more Bonos/BTPs. We believe there will be renewed QE in the US and UK, and a stepped up QE in Japan by year-end. Fair value S&P 500 under this scenario is 1,350. Indexlinked
bond proxies, defensives, quality growth, GEM consumer plays and software outperform. Continental Europe underperforms on recession concerns.
! Recession scenario (20% likelihood): the risks are overly aggressive fiscal tightening (in the US, France, Italy, UK, Japan), no QE in US and the credit crunch in Europe. Under this scenario, EPS fall by 25% and S&P 500 falls to 950. High FCF, defensives and index-linked bond proxies outperform.
! Euro break-up (10% likelihood, rises to 20% if France is downgraded): GDP falls 5% in Europe. EPS fall 40% and S&P 500 falls to 750.
! An acute crisis leads to fiscal integration in Europe (15% likelihood). S&P 500 falls to 1000, but then we revert to the core scenario as the policy response kicks in. European volatility outperforms.
! Sunshine scenario (5% likelihood): growth returns, core Europe bails out the periphery. 1,600 on the S&P 500.
! The weighted average of our scenarios is 1,220 on the S&P 500 (our new year-end target) but we stay a small overweight equities. What's changed? Philly Fed; fiscal tightening in France, Italy, US; on-going credit crunch in Europe; Greece package failing; Eurobond backlash, split in the FOMC.
! What is worse and better than 2008? Better: corporate, bank and US consumer balance sheets, earnings revisions, index linked & BBB corporate bond yields close to all-time lows, Worse: government balance sheets, politicisation of QE in the US, high margins.
! Core scenario (50% likelihood): Ongoing sub-par recovery: GDP growth of 1.5%-2% in the US, 0.5%-1% in Europe and 8% in China implying 3% global growth this year (20-year average is 3.5%). We think recession is avoided because: GEM account for 49% of global GDP, exceptionally loose global monetary policy, strong corporate balance sheets, underinvested corporate sector, US fiscal tightening is watered down, 0.7% US employment growth, inventories are not excessive and Europe is likely to 'muddle through' with ECB buying more Bonos/BTPs. We believe there will be renewed QE in the US and UK, and a stepped up QE in Japan by year-end. Fair value S&P 500 under this scenario is 1,350. Indexlinked
bond proxies, defensives, quality growth, GEM consumer plays and software outperform. Continental Europe underperforms on recession concerns.
! Recession scenario (20% likelihood): the risks are overly aggressive fiscal tightening (in the US, France, Italy, UK, Japan), no QE in US and the credit crunch in Europe. Under this scenario, EPS fall by 25% and S&P 500 falls to 950. High FCF, defensives and index-linked bond proxies outperform.
! Euro break-up (10% likelihood, rises to 20% if France is downgraded): GDP falls 5% in Europe. EPS fall 40% and S&P 500 falls to 750.
! An acute crisis leads to fiscal integration in Europe (15% likelihood). S&P 500 falls to 1000, but then we revert to the core scenario as the policy response kicks in. European volatility outperforms.
! Sunshine scenario (5% likelihood): growth returns, core Europe bails out the periphery. 1,600 on the S&P 500.
! The weighted average of our scenarios is 1,220 on the S&P 500 (our new year-end target) but we stay a small overweight equities. What's changed? Philly Fed; fiscal tightening in France, Italy, US; on-going credit crunch in Europe; Greece package failing; Eurobond backlash, split in the FOMC.
! What is worse and better than 2008? Better: corporate, bank and US consumer balance sheets, earnings revisions, index linked & BBB corporate bond yields close to all-time lows, Worse: government balance sheets, politicisation of QE in the US, high margins.
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