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Published by John Papadakos

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Published by: John Papadakos on Jan 05, 2012
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5 January 2012
Disclosures available on www.cheuvreux.com
Cross Asset Research
Special Number 
2012: US$ Bloc trumps Euro Zone
2012 should be an "entry year" for investment in risk assets.Our focus is the potential for a resumption of the bull marketin risk assets, but probably not before the middleor theSummer of the year.
 A degree of rebalancing of growth within the global US$bloc is taking place, allowing a stabilisation of the growthand price regime in America. The US$ is recovering asecurity status, signalling major shifts in international flowsof private and public capital.
The inflationary logic of adjustment in the US$ bloc shouldultimately outweigh the deflationary effects of the euroarea's crisis upon the pricing of financial assets.
The political framework for "EMU II" has been identified. TheFrench Presidential election may determine whether thecommitment of the euro zone to a fiscal union is irreversible.
We reassess our international equity allocation. We areupgrading America and downgrading Emerging MarketsJapan.
Christopher Potts Nicolas Trémel Elisa Belgacem
+33 1 41 89 73 44
+44 20 7621 66 42 +33 1 41 89 73 28+44 20 7621 66 40 ntremel@cheuvreux.com ebelgacem@cheuvreux.comcpotts@cheuvreux.com
Chart 1 - The Distribution of World GDP
Other $ Zone;24%US; 22%China; 11%EZ; 18%Japan; 9%Rest of World;16%
Source: Datastream
Chart 2 - The Global Profit Cycle: Year-on-Year % Change in MSCI World EPS
MSCI World. EPS Consensus (IBES). Y-o-y% change.-50%-30%-10%10%30%50%70%90%19881993199820032008201312m tr EPS12m fwd EPS
Source: Datastream
Global (MSCI world) EPS growth in 2011 is currently estimated at nearly 10%, with adisproportionate contribution from America (15%+). Global EPS growth should slow significantly in 2012, to just 0-5%, with profit recession in Europe. It seems to us that the period of the Asian crisisof 1998 is an appropriate reference. World profit growth could decline to zero in 2012, or even become slightly negative, without this implying the end of the cycle that began in 2009. The latter is improbable because the three pillars of the current global profit expansion are still standing.The EZ represents 18% of world GDP in current nominal values. The global US$ zone (the Americas, the Middle East and most of  Asia) accounts for 50-65%of world GDP, dependingupon where the frontier of US$-dependency is situated. For example, tothe extent that Russia is anoil economy it can be included in this category.The US$ bloc accounts for three times more of theworld's output and  spending than the euro zone.
5 January 2012
Chart 3 - The S&P500 and the DAX in the Decade of the 70sIndex of performance: January 1970 = 100
406080100120140160197019711972197319741975197619771978197919801981S&P 500DAX
Source: Datastream
 In the cycle that followed the collapse of equity values through 1973-74 the conflict between the inflationary bias of US monetary policy and the "culture of stability" of Germany produced  appreciation of the DEM, chronic under-performance of German equities and reciprocal out- performance of DEM-denominated bonds through the second half of the decade. We are witnessingthe same economic-culture conflict today between America and Germany. As in the 1970s thedeterioration of the trade-off between volume growth and prices world-wide has produced a contextof multiple compression in equity markets. However, other effects are not the same. In the current context America has exported inflation to the global US$ bloc, ensuring stability of domestic price expectations at the cost of a significant risk premium throughout the US$-based emerging world. The "stability first" policy championed by Germany for the entire EZ is associated with a systemic risk premium of a deflationary nature at this time. The consequence is the out- performance of US financial assets and - ultimately - a stronger US$.
Chart 4 - A Period of Multiple Compression: the Comparison with 1974-83 for the SPX
PER in the US5101520253035195419641974198419942004201412m tr. PER12m tr. PER growth 1975-1983
Trend PER in the US51015202530351954196419741984199420042014Trend PERTrend PER growth 1975-1983
Deterioration of the global price regime (affecting the emerging world disproportionately) + crisis of sovereign "risk-free" assets =MULTIPLE COMPRESSIONThe global profit cycle has NOT been the problem
Source: Datastream
5 January 2012

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