Saxo Bank publishes its investment outlook for Q3 2014

As we enter the third quarter, despite general complacency, investors continue to face bleak macro imbalances that need correcting, while energy’s shadow looms large as the conflict in Iraq rages.

Saxo Bank predicts a relatively positive third quarter. The Bank remains positive that US growth will return after a primarily weather-related disastrous Q1 (-2.9%). It also sees stocks outperforming bonds and forecasts that further USD weakness will likely be limited. Volatility should pick up from record lows as we near the end of the Fed’s QE3. Finally, the bank believes oil will remain elevated but within a fixed range.

Nonetheless, Steen Jakobsen, Chief Economist, says that a permanent imbalance in the market whereby only 20% of the economy - listed companies and banks - receives 100% of the available credit and political capital, is suffocating the remaining 80%, namely the SMEs. Stock market valuations appear ‘reasonable’, but only because of the resultant lower cost of capital for the select 20%, enforced further by a pervasive belief in QE and a widespread preference for investing in equities.

Further threats to the anticipated recovery include China’s property market and its high refinancing needs, growth in France or Germany plummeting thanks to lower exports to Asia and continued elevated energy prices. Higher energy prices have a negative impact on consumption by contributing to a broader erosion of consumers’ disposable income.

Jakobsen commented, “Without a transfer of money from the 20% back into the 80%, we will face a decade of ‘Japanisation’. A correction of this imbalance is essential to reset the world economy. The consensus that a little bit of growth is enough is worrying, and ignores the bigger picture.

“In January the IMF, the World Bank, ECB, FED and most bank economists were falling over themselves to proclaim 2014 as the year of recovery, but as we enter H2, Europe looks vulnerable, budget deficits are rising and political backroom deals are being struck to buy more time. The US needs 2.9% annualised growth in Q2 to just register zero growth for the first half of 2014 – and Asia continues to believe it can engineer a “soft landing”, something I see as equivalent to an attempt to turning a super tanker around in a river.”

Equities

Peter Garnry, Head of Equity Strategy, underlines the continuing importance of holding equities to see any meaningful capital growth. The relative repricing between equities and bonds has continued in 2014 as total return in equities relative to bonds remains below the equity risk premium line since 1995. He commented: “Equities are still the most attractive asset class, they are now fairly valued and are by no means in bubble territory.”

FX

There has been a considerable jump in oil prices on destabilisation in Iraq, but this jump in percentage terms is still relatively modest. The most negatively affected currencies in the event of a further surge higher in oil prices are those that both rely heavily on energy imports and are the most energy-intensive in terms of units of GDP. India, South Korea and South Africa appear especially at risk from energy intensity of GDP, while Turkey, Poland and Hungary are emerging market currencies extremely reliant on imports for the vast majority of their consumption.

John J. Hardy, Head of FX Strategy, added: “We have just emerged from a period of unprecedented calm in oil prices, so the move will likely have to stretch much further for us to witness wider fall-out and spill-over into currencies.”

Saxo Bank’s top FX trading themes for Q3 2014 include short EURJPY, short AUD vs. USD and CAD, long NOKSEK on dips, and long MXNTRY.

Commodities

Despite the recent outperformance of commodities, conflict in Iraq is casting an ominous shadow over the global oil supply. If the march of Sunni militants cannot be halted, an elevated oil price is inevitable heading towards 2015.

The energy market must deal with the possibility of global crude oil supply exceeding demand for the first time in recent memory, thanks in part to the rise in non-OPEC production, and the average price of Brent crude is likely to move lower towards USD 105/barrel. After 2013 saw gold’s first annual loss in 13 years, Saxo Bank is cautiously optimistic for its prospects later in 2014 after averaging 1,225 USD/oz during the first quarter.

Ole S. Hansen, Head of Commodity Strategy, added: “Iraq’s targets now look unreachable which raises even further the pressure on Saudi Arabia to increase production and avoid oil markets from becoming too tight.”

Link to report: https://www.tradingfloor.com/publications/quarterly-outlook