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Global Macro Strategy 10.01

Global Macro Strategy 10.01

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Published by: pololambros on Jan 14, 2010
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Global Macro Strategy Group
1 October 2009
Global Macro Strategy
Trading the Recovery: SixMonths of Clear Skies
Deutsche Bank AG/LondonAll prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from localexchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. DeutscheBank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that thefirm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only asingle factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED INAPPENDIX 1. MICA(P) 106/05/2009
Macro Strategy
Macro Strategy Group
Marcel CassardMichael BiggsJean-Paul CalamaroFrancesco CurtoJanet LearBrad JonesArend KapteynMohit KumarTom MayerMichael SpencerFrancis Yared
DB’s Global Macro Strategy Group consists of senior DB research staff that advises management and clients on broad market risks and global economic and financial developments. The views & forecasts of the Group may differ from those disseminated by their research colleagues.
David Folkerts-Landau
Managing DirectorGlobal Head of Research
   M  a  c  r  o
   G   l  o   b  a   l   M  a  r   k  e   t  s   R  e  s  e  a  r  c   h
   E  c  o  n  o  m   i  c  s
We expect global growth to remain strong until at least the middle of2010
due to a turn in the inventory cycle, easing credit conditions, further fiscalstimulus and sustained low interest rates. We believe the market isunderestimating the quantitative impact of these factors and the length of time(6 - 9 months) it will take for them to work their way through the globaleconomy. For instance, we believe US growth could be twice as high over thecoming three quarters (4%) as the consensus forecast (2.3%).
This global “sweet spot” is historically very rare
—improving economicdata in the context of still extremely accommodative fiscal and monetarypolicies and abundant market liquidity—and provides the perfect mix for arange of risky assets.
On a 6-month horizon, we expect EM assets, high yield credit and gold tooutperform on valuation, economic momentum and liquidity grounds
. USequities are constrained by valuation but could significantly overshoot currentfair value estimates, as earnings forecasts are not yet aligned with the likelynear term growth overshoot. We like short fixed income positions onfundamental grounds, but in the short term the sell-off in rates is constrainedby abundant liquidity and a structural shift back into the asset class.
The main risks to our views over the 6-month investment horizon stemfrom
(1) a soft patch in the economic data (possibly due to a brief period offurther de-stocking and de-leveraging, or the expiration of stimulus schemessuch as car scrap schemes and housing programs), (2) premature tightening ofregulatory requirements, or (3) an even sharper economic rebound that fuelsinflation fears and a rise in interest rates.
Trade Recommendations
InstrumentCurrent ValuationTargetTotal return (to June 2010)Top Trades
Long EM creditCDX-EM2711607.50%Long EMFXRMB/KRW/MXN/PLN5-15%Long EM equitiesMSCI-EM914110520%Long HY creditCDX-HY66250012%Long goldGold1007110010%
Trades with less attractive risk-rewards
Long equityS&P 5001048115011%Short fixed incomeUS 10Y Treasury3.28%4.0%3.5%Long oilCrude Oil (Brent/bbl)68.5759.5%
Source: Deutsche Bank, Bloomberg 
1 October 2009 Global Macro StrategyPage 2 Deutsche Bank AG/London
Trading the Recovery: Six Months of Clear Skies
We expect global growth to remain strong until at leastthe middle of 2010 due to a turn in the inventory cycle,easing credit conditions, further fiscal stimulus andsustained low interest rates. We believe the market isunderestimating the quantitative impact of these factorsand the length of time (6 - 9 months) it will take for themto work their way through the global economy. Forinstance, we believe US growth could be twice as highover the coming three quarters (4%) as the consensusforecast (2.3%).
This global “sweet spot” is historically very rare —improving economic data in the context of still extremelyaccommodative fiscal and monetary policies andabundant market liquidity—and provides the perfect mixfor a range of risky assets.
On a 6-month horizon, we expect EM assets, high yieldcredit and gold to outperform on valuation, economicmomentum and liquidity grounds. US equities areconstrained by valuation but could significantly overshootcurrent fair value estimates, as earnings forecasts are notaligned with the likely near term growth overshoot. Welike short fixed income positions on fundamentalgrounds, but in the short term the sell-off in rates isconstrained by abundant liquidity and a structural shiftback into the asset class.
The main risks to our views over the 6-month investmenthorizon stem from (1) a soft patch in the economic data(possibly due to a brief period of further de-stocking andde-leveraging, or the expiration of stimulus schemessuch as car scrap schemes and housing programs), (2)premature tightening of regulatory requirements, or (3)an even sharper economic rebound that fuels inflationfears and a rise in interest rates.
Beyond mid-2010 we are much more cautious about theoutlook. Economic momentum will stall as the inventorycycle runs its course, stimulus is withdrawn, and yieldsstart to rise on inflation expectations and a closing outputgap, and new regulatory requirements start kicking in. Bythen asset valuations will be stretched and pressure oncredit from a refinancing of HY debt will rise. These risksare real and significant but are unlikely to drive assetprices for now.
The “sweet spot”
Since March 09, the economic data have continued toimprove and are now pointing to a recovery over the next3 quarters that, in the US for instance, could be a full 2ppin excess of median consensus expectations. This wouldbe much more in line with the trajectory of historicalrecoveries, with growth averaging some 4% over the nextthree quarters (Figure 1).
Figure 1: US consensus forecasts too low
-4%-2%0%2%4%6%8%09q209q309q410q110q2Full range of forecasts25-75% of forecastsAvg of past recoveries (excl. 'double-dips')Median forecastUS GDP QoQ
Source: Deutsche Bank, BEA, Haver 
Economic recovery has been reflected in improvements inPMIs, global IP and export growth, and is now alsoincreasingly apparent in some consumption and housingindicators. In 3m/3m terms, global IP growth has reachedits fastest pace since early 2004 (Figure 2). PMIs and theLeading Economic Indicators index are likewise pointingto growth in excess of 5 % in Q3, while retail sales wouldsuggest a growth number of about 5%.
Figure 2: Global IP grows at fastest pace since 2004
2226303438424650545862200120022003200420052006200720082009-35-30-25-20-15-10-5051015Global PMI outputGlobal IP, 3m/3m saar (rhs)July IP growth estimate based on75% of the sample that havereported thus far
Source: Deutsche Bank, Haver, Markit 
The improvements in economic data are not confined tothe US and are taking place at a global level. Market datasurprise indices have now shown nearly continuousimprovements since March, despite continuous upgradesto economic forecasts. Stress in money markets,meanwhile, have thawed to pre-Lehman levels (asevidenced by compression in Libor-OIS spreads) thoughwe have yet to see a decisive improvement in aggregatenet credit provision from banks to households andcorporates in advanced economies. By contrast, in EM
1 October 2009 Global Macro StrategyDeutsche Bank AG/London Page 3
there is tentative evidence that the credit impulse isstarting to turn, providing a significant additional boost todomestic demand (see below).
Quantifying the Economic Impact
We expect the momentum to continue over the comingquarters as the inventory cycle turns, financial marketsstabilize, the fiscal stimulus takes effect and central banksmaintain very ample liquidity. The market is broadly awareof these factors but in our view underestimating theirquantitative impact and the length of time it will take themto permeate through the economy. We discuss this inmore detail below.
1. Inventory cycle turning:
The cumulative de-stocking observed in the US over lastfour quarters was greater than anything seen since WW2(Figure 3). In real terms stocks fell by 1.2% of GDP in Q2,and contributed -1.4% to qoq annualised real GDPgrowth. If the pace of de-stocking were to slow so thatUS inventories fell by USD100bn in Q3, USD50bn in Q4and stabilized in Q1 2010, the stock cycle wouldcontribute on average 1.6% to real GDP growth perquarter. This happens without any re-stocking taking placeand already generates two-thirds of the quarterlyconsensus growth forecast for the US.
Figure 3: US: Record de-stocking in Q2
-1.4-1.2-1.0-0.8-0.6-0.4- in stocks as a %of GDPStock contribution to growth, saar (rhs)%forecast
Source: Deutsche Bank, BEA
Developments in the ISM suggest that the inventory cycleis close to turning. The inventories component has startedto increase, and the inventories to sales ratio is falling at arecord pace. If inventories return to appropriate levels,increased demand will have to be met via increasedproduction rather than further de-stocking. The differencebetween the ISM orders and inventories indices has agood 1-month lead on developments in output, andcurrently points to a further surge in output.
Figure 4: Global production backlog building
-20-15-10-50510152019992001200320052007200925303540455055606570Orders - inventories (1 month back)Output (rhs)Global manufacturing PMI
Source: Deutsche Bank, Haver 
2. Credit impulse supporting final demand:
In addition to the turn of the inventory cycle, we expectfinal demand to start recovering over the next 2-3quarters. We fundamentally disagree with theconventional wisdom that recoveries are “credit-less” asthat historical observation is largely one by construction: ifone focuses on the relation between new credit andeconomic activity (rather than the growth rate of the stockof credit) the relationship is 1:1. By the same token, creditdoes not need to mean revert to pre-crisis levels tosignificantly boost domestic demand over the next fewquarters (see below).The collapse in domestic demand over the last fourquarters was triggered by a sharp contraction in newlending. The pace of de-leveraging reached a post-WW2record in Q2 falling from a quarterly annualized level ofUSD1½-2 trillion in both the US and the Eurozone to zero.As we have argued in a number of notes on the creditimpulse, all that is required for demand to rebound is forthe pace of de-leveraging to slow (the intuition is that for agiven level of income, every dollar not used for debtrepayment increases disposable income). Even if the paceof de-leveraging remains constant, the credit impulse willimprove dramatically through the remainder of the year—akin to the dynamics of the inventory cycle (Figure 5)—and private sector domestic demand should follow suit.Indeed, even if banks in the US or Eurozone were not toextend any new credit to businesses and consumers inH2-2009, we would see a boost of 1pp to quarterly GDPgrowth if the de-leveraging were to simply cease.
Thus,the impact of this credit impulse combined with theaforementioned inventory cycle would already besufficient to generate the consensus US growth number
Key releases to watch in this respect will be bank lending surveys inOctober.

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