Saxo Bank's Jakobsen sees potential in European small-caps and African stocks

AS a trader and keen observer of the markets, Steen Jakobsen has gained a reputation for his unorthodox and contrarian approach to making money. He has had a multi-faceted career in finance, handling sales, trading and research across different markets separated by geography and asset class. Now, as chief investment officer and chief economist at Saxo Bank, the Dane is continuing to think out of the box when it comes to making big calls about where the markets are headed and where to put one's money.

Jakobsen's call for a peak in global equity markets in early November has been prescient as investors returned to worrying over the looming "fiscal cliff" after the balance of power between the White House and Congress was left virtually unchanged in the wake of the US elections. He has also made a series of predictions that have come good in the currency markets, in which Saxo has a strong online presence and a global community of traders that use the bank's platform for executing trades. Recent forecasts that have panned out include this year's strength in Scandinavian currencies and a weaker South African rand on account of the country's political and central bank policies.

Jakobsen also visits 15 countries a year to meet clients and understand the secular forces driving markets. He spoke with The Edge Singapore during a visit to the city-state last month, proffering non-consensus and thought-provoking opinions about the markets and the best places in which to put one's money to work. The following are excerpts of the interview.

What are the investment implications for us as the US economy approaches its 'fiscal cliff'? How should investors play it as a trading/investment opportunity?

What people first need to know in investment terms about the fiscal cliff is that every 1% drag on the US economy equates to about 100 points on the Standard & Poor's Index. The market expects the compromise now to be about a minus 1.5% drag on GDP, so you can argue very quickly that it is 150 S&P points off the index from a bottom-up analysis.

On the other side of the equation, there is a stabilised housing market. You also have very easy monetary conditions and huge investments into shale gas. So, when these three things are combined, you can argue it will create 1% of positive GDP growth. So, the net price after accounting for everything will be 50 to 60 points off the S&P Index for the fiscal cliff.

The S&P is trading around 1,400 now and I think it will be almost unchanged in about a year's time — my call is for the S&P to be around 1,350. I think 2013 will be a year of transition, as a lot of things need to come right for the market to go up and the outlook is based on continued earnings growth and easy monetary policy. And the attraction of easy monetary policy is just not there anymore. The impact of loose monetary policy stopped working on the real economy two years ago, and it no longer has a net impact on asset prices.

Besides trying very hard to resolve the year-end fiscal impasse, what else is on President Barack Obama's agenda?

Few people realise that the president doesn't actually have a lot of say on domestic policy, but he does have a very strong voice and action on foreign policy. So, his second term will be a lot about foreign policy. In terms of the domestic agenda, what people have to realise is that the US business cycle is almost 100% independent of the US president. It doesn't matter for investors what Obama wants to do, as he's essentially a lame duck president, but that's a good thing because the less macroeconomic policies that anyone can do, the better. Macro policies are over-valued as a cyclical support tool; we have had maximum intervention in macro policies over the last five years and no one has got anywhere with them.

But the US still has some things going for it, and one of them is energy. They are producing electricity at 10-year low prices in terms of using natural gas, whereas most of Asia and Europe continues to use very expensive coal and crude oil. So, the US is going to have a competitive advantage for at least the next five years until the rest of the world adjusts to the same process that the Americans have.

What does it all mean, then, for US assets such as stocks, bonds and the US dollar in the long run?

I am extremely bullish on the US dollar because I think it is turning around cyclically, as the US has ready access to credit and is still the largest capital market in the world. It will out-compete other currencies in the coming period. In terms of fixed income, 2013 will be a turning point, as the US was the first to go into crisis and it will be the first to come out of it. Most of that improvement in the underlying economics will be based on cheap energy and a re-shoring of jobs back to the US. This will initially be energy-intensive processing jobs like aluminium production. Ultimately, it will be things like high-impact electronics and automation-based manufacturing that can be done just as well by robots or machinery in the US as they are in China.

US stocks will also be in a transition year because, if I am right about a shift to tighter US monetary policy in 2013, the early part of that cycle will be slightly negative for stocks. Thus, I have an unchanged to a slightly negative outlook for stocks. They will still outperform Asia and Europe; so, in terms of allocation, that's definitely where I want to be relative to other regions.

Are things under control in the eurozone?

For Europe, 2012 has been about removing tail risks but, in the process, the systemic risks have risen. The reason for this is that the Italian and Spanish banks have more government bonds than before the crisis. The only buyers of bonds in those countries are essentially pension funds and banks within the same system, so systemic risks have increased and the tail risks are down.

There is also an 80% chance that Greece will leave the euro next year in a managed process — not in a negative way, but it will be a sabbatical from the euro. Since August, the core economies of Europe have also been in trouble — Germany, Denmark, Sweden, Netherlands are all seeing very slow growth and collapsing export volumes. That has changed the dynamics of Europe, so 2013 will also be a transition year for Europe. This year has been all about the European Central Bank doing the dirty work for the politicians, so 2013 needs to be about the politicians being made accountable for what they want the EU to be. The markets seem to be moving more on political risks than fundamentals these days, so in that respect, it could turn out to be either a good year or a bad year, but it will be a volatile year for the markets.

So, what should investors with the risk appetite buy in the major asset classes in Europe?

What I like most are small-cap European stocks because, if your premise is that global growth will be meagre with a lot of political uncertainty, what you want to expose yourself to is companies with a laser-beam focus on their market niches, that are managed either by families or with a high degree of CEO ownership, as this segment will be very interesting. That is also where there are less credit flows and companies have the most capital needs, so you can pick up relatively cheap stocks that trade at a discount that focus on export markets and niches.

What I also like for Europe next year is to have a few peripheral plays because people tend to forget that, despite the negative outlook for Spain, Greece and Italy, there are still companies there that are extremely profitable. Generally speaking, Europe is cheaper than the US in valuation but with a higher political tail risk. What you should do in terms of a tactical approach to Europe is to find the stocks you want to buy, and buy them when Europe is under severe pressure. And if I am right about the mandate for change from the microeconomic level in Europe, there could be a V-shaped recovery at the end of 2013.

But where European fixed-income is concerned, I will be decreasing my exposure to the high-yield and sovereign markets through 2013, as it has become over-valued. I will be switching progressively into equities in the small-cap and peripheral markets.

How do you feel about emerging markets, especially Asia?

Asia is often wrongly treated as one region and one investment theme. For instance, I do not see China as a good investment story for the next three to four years because they are working on a business model that has not changed since the late 1970s. For China, two things are important: increasing economic competition and decreasing the level of corruption so as to get private consumption up. If these two things happen, it will be extremely positive for Asia but even more positive for China. But the reality is that the new leadership in China will probably need the first four or five years to figure out what they want to do, before any real changes come. So, China is on a path to a slowdown, but it won't be a crash landing, although a hard landing could happen. That could leave the rest of Asia exposed.

Policymakers in Asia also have challenges to grapple with. Inflation remains an issue, plus the fact that many housing markets in the region are overheating. There is a need from a growth perspective to lower interest rates, but doing that will make the housing bubble bigger. Asia is in a period of transition as well because, having had great success with its current growth model, it now needs to reinvent that model by moving away from an over-reliance on big business and government involvement in the economy towards an SME [small and medium-size enterprise]-driven model. Take, for example, an economy like Germany's — more than 65% of all jobs and GDP growth have come from SMEs. And since 2002, 85% of all jobs in Europe have been created by SMEs. Asia will have to do the same.

What are the hotspots for investing in Asia and other emerging markets?

I am underweight in most emerging markets, including Asia. These markets have become expensive in valuation terms. Besides, most of the gains in these markets have come from currency revaluations in the past. As most currencies in this region need to weaken on a relative basis over the next one to two years, you may gain on the equities but lose on the currencies, which is the opposite of what has happened over the last 10 years.

Having said that, if you really want to be in emerging markets, then you should be in Africa, where you can buy companies at price-to-earnings multiples of two to five times. These economies don't need a lot of investment to take off and, once they get going, by doing the necessary reforms and creating the infrastructure to facilitate their resource economies, they can grow massively. So, in an environment in which global growth is down, I would rather be in areas that still have potential. Africa is one of those areas.

This story first appeared in The Edge Singapore weekly edition of Dec 3-9, 2012.


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