Member of the Investment Committee
In our January Letter (2013: what will politicians do about the economy), we were waiting to see what the major political leaders, especially those with new and renewed mandates in the USA, France, China and Japan, were each going to do to "get their economies back on track". One year down the line, we are faced with a very mixed picture. President Xi Jinping in China and Prime Minister Shinzo Abe in Japan both acted resolutely with regard to their countries' respective destinies, setting out particularly bold action plans. Conversely, in the USA the Executive's capacity to act is still being hampered by the recurring threat of congressional gridlock, while in France, the eurozone's second largest economy, the fiasco of the government's economic measures is all too apparent. The US economy has the advantage of access to cheap energy derived from shale oil and gas. However, as in the eurozone, the economy will nonetheless have to rely on the global economic cycle to generate profits for its companies. The eurozone continues to waver between austerity and growth policies, political integration and sovereignty, and will only undertake its first serious review of the state of its banking sector in 2014, four years after the crisis erupted. China and Japan are sending them – and investors – a message that merits attention on the power of convictions, leadership and long-term vision.
Conditions in China, Japan and shortly, we believe, in Mexico, are ripe for the implementation of reforms that will bring about economic growth over a lasting, medium-to-long term trend. We are unable in this Letter to go into the ins and outs of the changes that each country is going to undergo, but it is nevertheless enlightening to grasp what is at stake, because it is on precisely this type of powerful trend that major long-term investment decisions are based.
In China last month,...
barely one year into his term as head of state, Premier Xi Jinping presented a programme of structural reforms that will be decisive for the coming decade. His aim is nothing less than to divert the sources of the country's economic growth from a model that was, although imperfect, adequate until 2008 (with growth based primarily on exports to developed countries), to a model in which domestic consumption will have to play a far greater part. The granting of land ownership rights to farmers, the gradual ending of social and financial discrimination against migrants (Hukou status), the deregulation of capital markets, the review of local government budget management, the gradual submission of State-owned companies to free market principles, and the gradual opening up of economic sectors to foreign investment are all part of this holistic approach to improving the governance of the country and taking it forward to lasting prosperity.
the famous "third arrow" of Shinzo Abe's economic plan consists in carrying the monetary and fiscal policies already embarked upon through to completion to stimulate growth through structural reforms. There also, the goals are very ambitious: helping the private sector to shed long-standing regulatory shackles (healthcare, energy), promoting investment and industrial tie-ups, encouraging women into the workplace, making employment regulation more flexible, encouraging innovation, and signing large-scale international free trade agreements.
MEXICO IS ANOTHER EXAMPLE OF THE LONG VIEW.
The Mexican economy's low productivity (for example, turnover per employee at Pemex is one of the world's lowest for oil companies) is now the target of a programme of far-reaching reforms tabled by new President Enrique Pena Nieto. These consist in relaxing job market regulations, boosting non-oil revenues and encouraging competition in strategic sectors such as energy, banking and telecoms.
ANY STRUCTURAL REFORM IS BY NATURE
1) complex, and therefore hard to sell to the public, 2) arduous, as it targets what are often well-entrenched interest groups and 3) suspect, as it involves looking into the future. It is therefore understandable that such reforms are usually met with profound scepticism on the part of investors. It is true that these bold scenarios could be derailed. And even at the best of times, the long march of structural reforms rarely advances at a steady pace. It is therefore imperative that we follow the progress of their implementation closely.
we must pay particular attention to how the authorities manage the trade off between maintaining short-term economic growth and pushing through structural reforms. In Japan, we must look out for the Diet voting through the necessary legislative changes and ensure that greater monetary support remains a viable option, in the event that the two next "arrows" are slow to materialise.
BUT THE CONDITIONS AND, ABOVE ALL, THE POLITICAL WILL ARE IN PLACE, JUST AS THEY ARE IN MEXICO.
Xi is clearly a strong leader who has rapidly grasped the reins of executive power and has demonstrated his determination to face the conservatism of entrenched interest groups head on. Abe enjoys a broad popular support base, convinced of the efforts required if Japan is to regain its past prestige. Pena Nieto enjoys considerable political capital in Mexico and has grasped the historical opportunity of pegging his reforms to the US energy revival. In India, we will know in six months' time whether Narendra Modi, currently Chief Minister of the State of Gujarat, has won the general election. Backed by Raghuran Rajan, the remarkable new governor of the central bank, he may in turn light the flame of the far-reaching reforms that India needs so badly. Ten years down the line, Gerhard Schröder's renowned Agenda 2010 reforms, launched in 2003, are startling evidence for Europe of the virtues of bold reforms. Unfortunately, this example has so far failed to inspire the spread of similar changes in the region, with the exception of Spain, to a certain extent, and certainly not in France.
In a global investment strategy, these projects constitute a source of long-term performance that perfectly complements positions taken on the economic cycle. Thus, in addition to our positions on stocks that stand to gain from the eurozone's emergence from recession and the US manufacturing recovery, we are steadfastly invested in these long trends. The accelerating growth to which Mexico can now aspire offers numerous investment opportunities in the chemicals and real estate sectors. In China, the timetable of reforms opens up new perspectives in the consumer goods, energy, healthcare and agri-food sectors. In Japan, in addition to exporters that are gaining from the country's monetary easing policy, we hold a selection of distributors, electricity producers and financial stocks. As always, global investment in long-term convictions, far from the tyranny of stock market indices, lies at the heart of our investment approach.
"A man who does not think for the long term will have problems in the short term". Chinese proverb
Further weakening of the yen expected
The currency markets did not demonstrate very clear trends this month, with the exception of the yen, which continued its steady slide. As the fall in Japan's currency is one of the key components of the reflation plan implemented by the Japanese government, we expect this trend to continue in the coming months. We are therefore maintaining our short positions on the yen. Of the other major world currencies, we continue to favour the US dollar, which accounts for 58% of Carmignac Patrimoine's exposure, while the euro accounts for 28%. The European Central Bank's latest interest rate cut stemmed the single currency's rise, which threatened both the peripheral countries' renewed competitiveness and the price stability target (due to the deflationary pressures that it generates).
We increased our negative modified duration on US interest rates
When US 10-year yields briefly dipped below 2.6% once again at the end of October, we took the opportunity to increase negative modified duration on US bonds during the month. We expect these rates to converge at around 3%, as the economy recovers and US monetary policy reverts to normal. Accordingly, at the end of the month, Carmignac Patrimoine’s overall modified duration stood at -1.5. We continue to find attractive yields in peripheral European debt (especially in Spain and Italy) and credit (European and US banking sector bonds, emerging market corporate debt in strong currencies). Within Carmignac Emerging Patrimoine, the attractiveness of emerging local debt yields is underpinned by the will to keep inflation under control, as demonstrated by the orthodoxy of the new emerging market central bank governors (such as Elviar Nabiullina in Russia and Raghuram Rajan in India). The overall modified duration of our funds remains low at end-November: 2.5 for Carmignac Emerging Patrimoine, 1.1 for Carmignac Global Bond, 1 for Carmignac Sécurité and 0.8 for Carmignac Capital Plus.
Exposure kept high
The combination of a moderate recovery, low inflation and continuing injections of substantial liquidity continue to justify a high level of exposure to equities. This now stands at 50% for Carmignac Patrimoine and 49% for Carmignac Emerging Patrimoine. The equity markets thus continued their steady rise during November, but with significant regional variations. Japan and China clearly took the lead, against a backdrop of greater visibility as to the economic reforms in the pipeline. Although we are convinced that the markets will remain volatile in response to the announcements and commitments given by leaders in China and Japan, we remain poised to exploit long-term positive trends. One of our holdings in stocks exposed to Chinese consumer demand, which performed particularly well this month, is Yum Brands, the company that operates franchises such as Kentucky Fried Chicken and Pizza Hut.
Being more selective
Carmignac Commodities posted a slightly negative performance over the month. We sold a number of positions during the month in order to focus our portfolio on our strongest convictions. Accordingly, we sold oil services company Cameron International as its future remains unclear. We also took profits on exploration and production company Pioneer Natural Resources, whose valuation had become stretched after an excellent run. We are continuing to focus our allocation on the energy sector, particularly as we are not expecting a flood of Iranian crude in the coming months, in spite of the agreement reached with Iran on its nuclear programme.
Adding additional equity exposure
Our funds of funds turned in a positive performance over November. We continued to build up our equity exposure to reach the maximum authorised for each fund. At the end of the month our equity exposure amounted to 99%, 75% and 49% for Carmignac Profil Réactif 100, 75 and 50 respectively. We increased our exposure to the Chinese and Japanese equity markets in particular.
Source: Carmignac Gestion as at 30/11/2013.
Please note that past performance is not a guarantee of future returns and that it may fluctuate over time.