The Federal Reserve's plans to raise interest rates further have been dealt a lethal blow by the downbeat stock markets and some bad data points, said Xavier Smith, investment director and fund manager at Centre Asset Management, in an interview with Real Money.
The minutes from the Fed's December meeting, when it raised interest rates for the first time in nearly a decade, are out on Wednesday and many in the markets fear that the Fed will continue on its monetary tightening path.
But the ISM manufacturing PMI index for December fell to 48.2 from 48.6 in November, below expectations of 49 in a Reuters poll of 80 economists.
"That signals that the economy is contracting. That shows that manufacturing in the U.S. is slowing. We would see that as a materially negative data point," said Smith, who is responsible for the firm's Global Select Equity strategy. Another piece of negative data is construction spending, which fell in November for the first time in one and a half years.
"Our biggest worry is looking at some of the slowing data points coming out of the U.S. economy, combined with high [stock market] valuations," he said.
December's Fed interest rate rise of a quarter of a percentage point is "probably the last hike we've seen for a while," Smith said. "I feel that the Fed is very sensitive to equity market moves, to sentiment. It's all kind of pointing in a negative direction."
And the market rout may be far from over. Smith believes there is more scope for downward moves in developed stock markets because, while emerging markets' price earnings ratio is at a five-year low, developed markets still trade on PEs that are at five-year highs.
"You look at these extremes and think: someone's wrong. Either emerging markets are too cheap, or developed markets are wrong and we should be cautious. I think developed markets will go down. I think the move is down, it's not up."
This does not necessarily mean emerging markets have bottomed, although Smith said the Chinese H-shares market -- Chinese companies' shares listed in Hong Kong and trading in Hong Kong dollars -- looks oversold. One positive he mentions about China is the fact that corporate margins have increased, which means Chinese companies are having some success in terms of cutting costs and are helped by the low prices of raw materials.
With so many analysts expressing doubts about the official GDP figures out of China, Smith is watching non-performing loans reported by Chinese banks and power consumption figures to gauge the health of the economy. If non-performing loans fall and power consumption increases, this could be a sign that the economy has bottomed and industrial activity is picking up.
But even at these levels, Smith said there are investment opportunities in the region; he picks companies that have an attractive model that does not depend on the economic cycle. One such firm is Chinese videogame-software maker NetEase (NTES), and another is Hong Kong-based Techtronic Industries (TTNDY), which owns tool makers whose products are sold on a replacement basis, therefore there is more predictability for its revenue stream.
"The best place to be is in corporates that are not geared to the business cycle. Health care companies, staples, utilities -- I think these are the places to be in right now. We're looking for firms that have the best operating momentum: rising margins, rising return on capital," he said.
Some analysts believe this could turn out to be the year of the eurozone stock markets because of the European Central Bank's monetary easing, but Smith does not believe the ECB will "lift all boats."
"I think it will be beneficial for European companies that benefit from a low euro. As the euro goes down, it means their cost base is going down." In the eurozone, Smith likes the auto sector -- he has been buying Volkswagen (VLKAY) after it plunged following the emissions scandal and mentions Daimler (DDAIF) among his favorites -- and the aerospace sector, with Airbus (EADSY) also set to benefit from the weaker euro.
But despite the ECB's asset purchases and rising economic activity in some countries -- Italy's manufacturing PMI was at a 57-month high in December -- he does not believe that Europe will enjoy a spectacular recovery.
"China is weak, Asia is weak, the U.S. is slowing. How will Europe be able to outrun that? Loose monetary policy is helpful, but what you really need is strong demand. Fiscal stimulus would be helpful across regions," Smith said.
