Citigroup - Intl Mkt Outlook: Growth outlook for China & India

Citigroup - Intl Mkt Outlook: Growth outlook for China & India

Global: Dr. Jekyll and Mr. Bond

Joachim Fels | London

Jekyll and Hyde Following the ‘conundrum’ of low long-term yields during 2005 despite rising US short rates, global bond markets staged a (reverse) ‘Jekyll and Hyde’ performance during 2006, pretty much as I envisaged in my 2006 outlook piece a year ago (The Passing of the Batons, 8 December 2005). A sell-off during the first half of the year gave way to a powerful bond rally during the second half when the Fed paused and the signs for an economic slowdown in the US started to accumulate. As a consequence, the US 10-year Treasury yield now trades around 4.5%, only slightly higher than a year ago, but some 80 basis points below the peak of mid-2006. However, gazing into my crystal ball, I visualize a bearish scenario for the G3 bond markets in 2007, with yields moving back to, and possibly above, the temporary highs of last summer.

Three main drivers. In thinking about bond markets, I continue to focus on what I consider the three main medium-term drivers of yields: (1) the economic cycle and (2) inflation expectations, which together shape expectations of future central bank policy rates; as well as (3) the global liquidity cycle, which I suspect has been a key factor influencing the recently vanishing ‘term premium’ in bond yields (see also M. Pradhan, The Term Premium: A Puzzle Inside a Riddle Wrapped in an Enigma, in this issue). Here are my assumptions and expectations for how each of these drivers will develop in 2007.

A global mid-cycle slowdown, but no recession. I assume that the global economy entered a mid-cycle slowdown during the second half of this year that will become more apparent during the first half of 2007. While this is qualitatively consistent with our global economic team’s forecast of a slowdown in global GDP growth from 5.0% this year to 4.3% (see Stephen Roach’s Global Transitions for details), I agree with Steve that the risks to this number are on the downside. Importantly, however, I assume that the slowdown won’t lead into recession, but will give way to a second leg of this expansion, albeit milder than the first leg in recent years, starting some time during the second half of 2007. A crucial assumption here is that the US slowdown remains temporary and largely bottled up in the housing sector, as our US economics team expects (see Richard Berner and David Greenlaw. It’s a Growth Recession, Not a Lasting Downturn, 11 December 2006). If so, at some stage next year, investors will likely revise significantly upwards their expectations for the path of the Fed funds rate in 2008 and beyond.

… with Europe disappointing and Japan surprising. Looking elsewhere, I envisage the euro economy disappointing the upbeat consensus expectations, but Japanese growth surprising on the upside in 2007. Japanese monetary policy is still very accommodative and the yen is super-competitive. Meanwhile, even though there may be a nascent pick-up in potential output growth in the euro area reflecting past corporate restructuring efforts and labour market reforms, cyclical growth is likely to be hit by the removal of monetary stimulus over the past year, fiscal tightening in Germany and Italy, and the trade-weighted appreciation of the euro. As a consequence, while I’m outright bearish on all the G3 bond markets, I do expect euro area bonds to outperform US Treasuries and JGBs in the sell-off, reversing their underperformance of the last six months or so.

Sticky inflation. While my view that this is a mid-cycle slowdown (though possibly a sharp one) rather than the onset of recession is in line with mainstream thinking among investors, my view on inflation isn’t. As I see it, market- and survey-based inflation expectations are too low and are likely to be revised up in the course of next year. The most likely trigger will be higher-than-expected actual inflation rates in the US and, possibly, Europe. One reason is that, in my view, the US economy is experiencing a structural slowdown in productivity growth, following a ten-year acceleration in trend productivity in response to the IT revolution, as US companies have now reaped most of the productivity-enhancing benefits of this revolution. Thus, labour costs per unit of output will rise more rapidly and potential output growth will fall. Moreover, the rise in the profit share to multi-year highs in the US and Europe suggests that some wage pressures are likely to emerge, supported by a growing consensus in society and political circles that workers should get a “fair” (read: higher) share of national income. Break-even inflation rates do not fully reflect these risks, and so I expect inflation linkers to outperform nominal bonds in 2007.

Tighter global liquidity, higher term premium. The experience of the last few years suggests that, even if short-rate expectations are revised up due to, say, higher inflation expectations or a better growth outlook, this need not translate into a rise in long-term bond yields, because this might be offset by a decline in the term premium. (Recall that the term premium is usually defined as the gap between the expected average short-term interest rates over the lifetime of a bond and the yield on that bond.) Most estimates suggest that the term premium has declined significantly in recent years (see J. Fels and M. Pradhan, Fairy Tales of the US Bond Market, 26 July 2006). While there are several competing explanations for the vanishing term premium, I continue to think that global excess liquidity, created by central banks around the world due to overly expansionary policies, is the main culprit.

While the Fed and the ECB are no longer expansionary on our measures, the Bank of Japan is still at the pump, and perhaps even more important, other Asian central banks along with their peers in the Middle East, Russia and Latin America are still flooding bond markets with excess liquidity as they recycle their growing external surpluses. Excess liquidity is unlikely to drop sharply in 2007, but it should become tighter at the margin. The Bank of Japan is likely to raise interest rates at least twice next year. Thus, G3 excess liquidity is likely to tighten further, at least until the Fed starts to cut interest rates. Moreover, with the global slowdown unfolding, Asian external surpluses will grow less rapidly or even shrink, and lower commodity and oil prices resulting from the slowdown would reduce producers’ revenues. Thus, Asian, Middle Eastern and Latin American central banks would have less fresh money to recycle into global bond markets, and so, somewhat paradoxically, weaker global growth would push bond yields higher.

Market outlook for 2007. I expect a combination of a global mid-cycle slowdown, re-emerging inflation concerns, and tighter global liquidity to push bond prices lower during 2007. In each of the G3 countries, I expect 10-year bond yields to climb towards and possibly break above their temporary highs reached in mid-2006 — 5.25% in the US, 4.15% in the euro area, and 2% in Japan. Investors should brace themselves for steeper yield curves and consider buying inflation protection. Euro area bonds should outperform US Treasuries in the bear market, as the upbeat expectations about European growth are likely to be disappointed. And with liquidity getting less plentiful and bond yields expected to rise significantly, risky assets will have a tough time repeating their stellar performance of recent years. Exit Dr. Jekyll, enter Mr. Hyde!

US growth will improve next year: Bernanke

The world`s largest economy is still on track to expand at a moderate pace over the next year without slowing too much, says chairman of the Federal Reserve

The US economy, which has seen some moderation in its growth over the past couple of quarters, is likely to pick up pace next year, Federal Reserve Chairman Ben S. Bernanke said on Tuesday.

In a speech delivered at the National Italian American Foundation in New York, Bernanke said that the world's largest economy is still on track to expand at a moderate pace over the next year without slowing too much.

"Economic growth will be modestly below trend in the near term, and over the coming year will return to a rate that is roughly in line with the growth rate of the economy's underlying productive capacity," he said in his first speech on the US economy in four months.

Bernanke said some slowing of growth was welcome at this stage of the expansion if the economy is to be sustained without a buildup in inflationary pressures.
Excluding the ailing housing and auto sectors, "economic activity has, on balance, been expanding at a solid pace," he said.

But, the Fed chief acknowledged that inflation still continues to be the major risk to the US economy. Bernanke said inflation is likely to continue to moderate gradually over the next year.

The Fed chairman said that although readings on the core inflation rate have improved modestly since the spring, core inflation nevertheless remains uncomfortably high. "Given the current level of inflation, a failure of inflation to moderate as expected would be especially troublesome," Bernanke said.

Bernanke said that whether further policy action against inflation will be required depends on the incoming data, and in particular how these data affect the FOMC's medium-term forecasts. The Fed chairman said he is watching rising labor costs carefully for signs that employers are passing them on to customers.

The Fed chairman said that the effects of the housing market correction will persist into next year, but said that the rate of decline in home construction should slow as the inventory of unsold new homes is gradually worked down.

On Global Stage - By Jay Dubashi

Globalisation has turned the world upside down. We expected foreign companies to make a beeline to India and snap up every Indian firm in sight at giveaway prices. After all, foreign companies had all the cash in the world while Indian companies were going cheap.

But that is not what happened. Fifteen years after liberalisation, it is the Indian companies that are buying foreign firms now. Every day, you read about Indian companies, which, until a few years ago, were unknown outside the country, swallowing up foreign companies, many considerably bigger than themselves, as easily as sharks swallow small fish.

What is surprising is that many, like Corus Steel, gave in without a fight and seem positively relieved that they become part of Indian business groups like the Tatas. Ratan Tata now heads Corus, the first Indian to do so. I have a feeling that after the deal goes through, the company will drop the name Corus and will be known as Tata Steel, which is what it actually is anyway.

This is only the beginning. Much bigger things are in store for the future. If Tata Steel, which until recently, made less than four million tonnes of steel a year, can buy a British steel giant that makes four times as much steel, what is to prevent firm like Infosys Technologies, making a bid for IBM in, say, 10 years time and getting away with it? Or, for that matter, ONGC buying up Shell or BP (British Petroleum), both of which are not doing too well!

In fact, I won't be surprised if Tata Motors, a highly successful company, decides to make a bid for Ford Motors or General Motors, which have been ailing for some time and may be only too glad to jump on the Tata or some other Indian bandwagon, as Corus Steel did last month or Arcelor did (on the Mittal wagon) a few month ago.

Globalisation was not expected to do all this. It was supposed to bring in badly-needed foreign investment and give a spurt to the Indian economy. It has certainly given a spurt to the economy and also brought in foreign investment, but Indian companies are investing more outside than foreign companies inside the country, and this has messed up all the calculations. Instead of the world globalising India, it is India that is globalising the world.

I wonder whether we realise what is happening. The government certainly doesn't nor the so-called economics experts who think they know all about globalisation. Globalisation is not a one-way process. When capital starts flowing, it does so in all directions, from the west to the east and from the north to the south. But it also flows from the east to the west and from the south to the north. For investment is like water and when you open up the sluices, it flows everywhere and floods all the canals.

The fact is that you cannot keep India or Indians down. Liberalisation has released their energies, which were bottled up all these years by politicians who know no better. They made all kinds of excuses --- as the communists are doing now --- to keep us down and they did succeed. But now that the gates are up and the waters are flooding the countryside, there is little that the politicians can do. Corus and Arcelor are only the beginning. The world is an oyster and it is ours for the taking.

Indian shares seen trading sideways

Indian shares are likely to trade sideways on Thursday as investors pause after a run to record highs, with leads from other Asian markets subdued ahead of key U.S. data.

But the downside for an index that has hit all-time highs on four successive days should be limited by strong foreign fund flows that have topped $7.7 billion this year.

That has helped the key index <.BSESN> gain 15 percent since the start of September and more than 43 percent so far this year, making it the best performer in Asia-Pacific.

"We are seeing investors turn more cautious at these levels, picking specific stocks and more mid-caps," said Ketan Shah at Prabhudas Lilladher brokerage.

"But there is enough liquidity in the market to keep up the momentum, barring big profit sales."

The 30-share BSE index closed 0.33 percent higher at 13,469.37 points on Wednesday, a record close, after it scaled a record high of 13,506.08 in intra-day trade.

STOCKS TO WATCH

* Hindustan Zinc Ltd. , after it lowered zinc prices by 5.4 percent from Thursday. For details, double-click on [ID:nBOM11742].

* Zandu Pharmaceutical Works Ltd. , ahead of its board meeting to consider an issue of bonus shares.

* Power generation and air conditioning equipment maker Thermax Ltd. , after its net profit rose 39 percent for Sept. quarter from a year ago. For details, double-click on [ID:nBMB002177].

* State-run National Aluminium Co. Ltd. , after it finalised a one-year sale of 240,000 tonnes of alumina. For details, double-click on [ID:nBMA000255].

* BSEL Infrastructure Realty Ltd. , after a top official of the company said its net profit to double and revenue rising 50 percent in 2006/07. For details, double-click on [ID:nBOM215244].

FACTORS TO WATCH * Indian bonds seen pausing ahead of auctions [IN/] * Indian rupee may edge higher on yen strength [INR/] * FOREX-Yen jumps on report China c.bank buying currency [FRX/] * Oil rises on U.S. stock fall, OPEC cut talk [O/R] * GLOBAL MARKETS-Stocks subdued ahead of data, yen jumps

[MARKETS/AS] * STOCKS NEWS ASIA-Tokyo firms on dividend hopes, Australia slips

Firm global indices may lift sentiment

Overall buoyancy in the international markets coupled with rising FII inflows in the current month and strong fundamentals may help the market edge higher. All the Asian indices are marginally up in morning trades which may help the domestic indices commence on a firm note. On the market technicals, the Nifty could test higher levels around 3857 while on the downside it has a support at 3830-3810 range. The Sensex has a likely support at 13330 and may face resistance at 13500.

US indices rallied sharply for the second consecutive session on Tuesday with the Dow Jones adding 86 points to close at 12218, this been the 15th record close since the beginning of October, while the Nasdaq advanced by 24 points to close at 2431.

Barring few all the Indian ADRs had a firm outing on the US bourses. Rediff was the major gainer and rose over 5% followed by Wipro which up by 4%, Infosys, Patni Computer and HDFC Bank gained over 2% each. However amongst the losers VSNL shed over 2% followed by ICICI Bank which was down by 1%. Tata Motors and Dr Reddys ended with marginally losses.

Crude oil prices in the US market slipped on Tuesday, with the Nymex Light Crude oil for December delivery falling by 30 cents to close at $58.28 a barrel and the London Brent crude declining by 66 cents at $59.05 per barrel. In the commodity space, the Comex gold for December series lost 50 cents to settle at $625.30 a troy ounce.

On Nov 13 2006, FIIs were net buyers of stocks to the tune of Rs778.20 crore (purchases worth Rs1927.70 crore and sales of Rs1149.50 crore) while domestic mutual funds were net buyers of stocks to the tune of Rs52.10 crore (purchases worth Rs549.28 crore and sales of Rs497.27 crore).

Global - Asian stocks, yen up after Japan growth data

Japan stocks led Asian markets higher on Tuesday after data showed the world's second-biggest economy growing faster than expected, while oil prices steadied below $59 a barrel after another fall.

The growth figures boosted the yen and sent Japanese bond yields sharply higher as investors priced in an increased risk that the Bank of Japan will raise interest rates in the next few months.

Gold traded near $623 an ounce, maintaining a steady position just below last week's two-month high around $636.

Japan's economy expanded 0.5 percent in the September quarter for an annualised growth rate of 2.0 percent, double market expectations, providing some relief after weaker-than-expected machinery order data last week.

"From these figures, we can say that the underlying trend of the economy remains bullish," said Takeshi Minami, chief economist at Norinchukin Research Institute.

By the end of the morning session, Tokyo's Nikkei average <.N225> had climbed 1.69 percent, picking up after two straight sessions of declines when investors were worrying that economic growth was faltering.

TECHS FIND FAVOUR

Among early Japanese gainers were domestic plays such as banks and property shares.

Number-two banking group Mizuho Financial Group <8411.t> jumped nearly 4 percent, while property firm Mitsubishi Estate Co. Ltd. <8802.t> gained 3.6 percent.

Spurred by positive broker comments for technology sector bellwether Intel Corp. , shares such as chip-tester maker Advantest Corp. <6857.t> of Japan and memory chip maker Samsung Electronics <005930.ks> of South Korea gained ground.

Advantest rose 3.45 percent, while Samsung Electronics, which on Monday forecast very strong demand for computer memory chips in the first quarter of 2007, added 1.41 percent.

Australia's Macquarie Bank climbed 1.41 percent after the investment bank beat forecasts with a 51 percent rise in first-half profit.

The MSCI index of Asian stocks outside Japan <.MSCIAPJ> advanced 0.59 percent by 0227 GMT, nearing a six-month high of 369.65 set a week ago.

South Korea's key KOSPI <.KS11> rose as much as 0.65 percent to a session peak of 1,405.79 -- its highest intraday level since May 16.

"This could be the beginning of an early 'Santa Claus' rally," said Cho Seong-joon, an analyst at Meritz Securities. "Japan's economy was stronger than expected, and that was a nice surprise."

FIRM YEN

Backed by a stronger-than-expected economy, the yen rallied against the dollar and the euro.

The dollar bought 117.67 yen in Asia, down from levels above 118 yen in New York, while the euro fetched 150.78 yen , down from more than 151 yen earlier.

Analysts said the strong growth data has kept alive the chance of a second interest rate increase this year, although most market players are still betting on a move early next year.

The yield on the Japanese 10-year bond jumped to 1.715 percent, rebounding from a six-week low of 1.655 percent on Monday.

Benchmark U.S. crude rose 13 cents to $58.71 a barrel, finding a steadier footing after falling on Monday and Friday as mild U.S. weather kept a lid on demand for heating oil and on concerns about rising inventories in consuming nations.

The contract had been trading above $61 on Thursday.

Doubts that OPEC would deliver on its agreed crude production cut also weighed on oil prices.

"There are growing concerns about the lack of OPEC compliance," said Bill O'Grady, analyst at A.G. Edwards. "If OPEC isn't cutting back as much as it says it is, it will be hard for prices to stay afloat."

Offtopic - Zecco offers zero commission trading

Zecco offers zero commission stock trading - just that you have to put up with Google Ads on their site. Interesting

Is Google Going for YouTube?

The search giant is said to have offered $1.6 billion for one of the Web's most popular social networking sites

The blogosphere is abuzz with speculation that Google (GOOG) is bidding $1.6 billion for YouTube. Neither company is discussing possible talks, as is typical with acquisition deals. But it wouldn't be surprising if Google was interested in the user-generated video sharing site. After all, YouTube is one of the Internet's most popular social networking destinations, with roughly 20 million unique visitors a month.

What online player reliant upon advertising wouldn't be interested in that kind of traffic? In fact, rumors also abound that Yahoo! (YHOO), Viacom (VIA), and even Time Warner's (TWX) AOL explored acquiring the startup, though each company declined to comment about possible past negotiations.

What's surprising is that Google, the king of do-it-yourself Web projects, would bid so aggressively to acquire a company without a proven method of making money. YouTube has been vocal about not running ads before its videos. It has been far less clear about how it will monetize its massive audience.

Todd Dagres, a general partner at Boston venture-capital firm Spark Capital, says such a bid would be a bit out of character for Google, but ultimately makes sense. "I'm a little surprised because it goes against their philosophy and personality to pay this much for an acquisition, but I think they view this as an imperative to get into user-generated video," says Dagres.

CORE COMPETITION. There are several reasons Google sees social networking as key to its continued success. For one, user-generated video sites combine two online arenas advertisers aggressively want to enter. The advertising dollars U.S. social networking sites collect is expected to grow from $280 million this year to $1.9 billion in 2010, according to estimates by research firm eMarketer. By 2009, the firm estimates that online video advertising will balloon to $1.5 billion (see BusinessWeek.com, 8/23/06, "Online Video: Tasty Takeover Targets?").

Second, though Google is clearly the dominant search player, it's still facing increased competition for its core search users from Yahoo, Microsoft's MSN (MSFT), and others (see BusinessWeek.com, 10/05/06, "A Gaggle of Google Wannabes"). Social networking sites have the added ability of generating user loyalty and increasing the barriers to switching to other Internet portals or platforms.

Despite controlling more than 51% of the search market, Google could lose some of its search share if it doesn't proactively move into the social media space, says Forrester Research's Josh Bernoff. "Google is at risk right now of someone coming up with a better search utility and luring users away," says Bernoff. "If your friends are all on MySpace, you have to be on MySpace. If your friends are all on YouTube, you have to be on YouTube. These sites have the power of human relationships, which is much more sticky than just having a good utility."

BUY RATHER THAN BUILD? To date, Google's homegrown efforts to enter the social media market have been relatively lackluster. Google's video site, for example, ranks a distant fifth in the online video space—behind Yahoo Video, News Corp.'s (NWS) MySpace, YouTube, and MSN Video, according to an August, 2006, comScore report. YouTube's market share in the video space is four times that of Google's, according to September data from Hitwise.

Paul Keung, an analyst with CIBC World Markets, says Google can't build the kind of brand recognition YouTube has in the video space. "It's hard to replicate the brand and the audience," says Keung, "and YouTube has a great network at this point." Similarly, Forrester's Bernoff says building its own site is more difficult than buying. "They could build it, but it would take a long time and, at the end of it, they would have to start trying to suck the traffic away from YouTube," says Bernoff. "This is a way to gain momentum in a space where momentum is very important."

Furthermore, there is not a very good precedent for big online companies successfully growing their own user-generated content sites from the ground up. Yahoo's social networking sites have been significantly bolstered by recent acquisitions of startups such as del.icio.us and Flickr (see BusinessWeek.com, 10/2/06, "Yahoo's Strategy: Growth by Acquisition").

PAYING A PREMIUM. Perhaps more important, Google doesn't want another online player to grab YouTube. If YouTube added its traffic to Yahoo, for example, Yahoo could not only sell lucrative, targeted ads on YouTube's sites based on its audience numbers, but it could also get that audience's related search traffic. Google has showed willingness in the past to pay a premium for such traffic and the ability to serve ads to it. In August, it paid News Corp. $900 million for access to serve ads to the MySpace crowd (see BusinessWeek.com, 8/08/06, "Google Gets Back into MySpace").

But is YouTube really worth more than $1 billion? CIBC's Keung says that, providing Google continues to attract and target advertisers as it has in the past, $1.6 billion could be a bargain. "I can come up with numbers that make it an awesome deal, but it is all in the execution," says Keung. In an Oct. 6 note to investors, Keung writes that YouTube has the potential to generate $200 million to $300 million in ad revenues in 2007 alone at the going online advertising rates of between $20-$50 for cost-per-thousand impressions. It could make even more if it finds a way to monetize the traffic with new technology, Keung notes.

However, there are problems with YouTube that make it a risky purchase. Chief among these is the copyright issue. Because YouTube does not prescreen the videos uploaded to its site, copyrighted content sits on its pages until it is removed. YouTube has taken the position that, because it removes the content as soon as it is notified, it is operating according to the rules set out by the Digital Millennium Copyright Act. Yet, it was still sued in July for copyright infringement by an independent photographer (see BusinessWeek.com, 7/27/06, "Whose Video Is it Anyway?"). Universal Music Group is also upset about its content being uploaded to YouTube and is weighing whether to file a copyright infringement lawsuit against the company (see BusinessWeek.com, 9/18/06, "Sour Musical Notes on YouTube, MySpace").

COPYRIGHT ISSUES. Google's deep pockets would make lawsuits all the more likely. "YouTube can wait until somebody screams the content is offensive, but Google would have to clean it up a bit and be sure that copyrights are not being violated," says Spark's Dagres. Otherwise, "the damage could be up to a half a million dollars per issue."

In an e-mail to BusinessWeek, billionaire tech wunderkind and Dallas Mavericks owner Mark Cuban wrote that the copyright issues made YouTube an unattractive acquisition. "I don't think an acquisition would be smart until all the copyright issues are decided," wrote Cuban. "It would be reminiscent of BMG buying Napster."

In Napster's case, lawsuits all but crushed the peer-to-peer file-sharing company. However, Google has the money and expertise to ensure the same doesn't happen with YouTube. Jason Schultz, a staff attorney with the Electronic Frontier Foundation, says YouTube is no Napster.

"A lot of people have been trying to compare YouTube to the original Napster. But they are not exactly the same," he says. "The vast majority of content on [the old] Napster was straight-up content from major record labels. What you are seeing with YouTube is that, though originally there was a lot of content taken straight from movies and television, there is still a fair, and increasing, amount of user-generated content on there. YouTube can show that there is a significant percentage of people using it for legitimate purposes," says Schultz.

Google also has the funds and knowledge to remedy YouTube's copyright issues. There is filtering technology out there that can limit the upload of known copyrighted content. Guba, for example, uses such a filter. If the technology is out there, there's little reason why Google's skilled engineers couldn't acquire or build it. Google also has experience defending itself against copyright infringement suits. The company is currently in legal battles over its image search, book search, and policy of caching Web pages, notes Schultz.

YouTube's problems aside, the true question is not whether the site is worth $1.6 billion, but whether it's worth that much to Google. When you're valued at about $128 billion, what's a billion, says Dagres. "The company has Monopoly money."

Via Businessweek