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Pioneer Funds Annual Report 2012
Annual Commentary on the Financial Markets (continued)
Equity Markets
Europe
Since June 2012, we have gradually been adding to our European equity exposure despite widespread concerns over a euro break-up, as we
believed that those pessimistic forecasts were reflected in some valuations. While the worst-case scenario has been averted, we share the
prevailing view that the European economy will stay in recession for most of 2013. However, we believe that European equity valuations
remain cheap and consistent with these downbeat macroeconomic forecasts. According to our estimates, the cyclically-adjusted price/earnings
ratio in Europe is far below the long-term average and near its historical minimum.
A fair assessment of European stockmarkets has to take into account that companies listed on European exchanges sell most of their goods
outside of Europe and tend to follow the global economic cycle. The cheapest companies were in the Financial sector, whose liquidity shortage
was eased by the European Central Bank’s support, with a beneficial impact on stock prices. However, long-term earnings estimates may
improve very slowly as long as the credit crunch continues in recession-hit countries of the euro area. Higher capital ratios imposed by
domestic and international regulators are also looming, although some investors may be comfortable with the additional constraints posed by
the new requirements, notably on loan selection.
United States
Concerns about a recessionary fiscal cliff seemed to be only mildly reflected in US stockmarket action, when the broad S&P 500 index
wrapped up a double-digit gain in 2012, led by the most cyclical (economy-sensitive) sector groups. Even the VIX index of implied volatility
appeared to be on the rise when compared with recent low values, but was about half as much as in the summer of 2011, when the standoff
over fiscal policies pushed the S&P 500 down by 12% in under a month. The Financials index turned out to be the best performer among the
10 economic sectors in the S&P 500 and this sector group has long been one of the most vulnerable following the continued volatility
surrounding the US economy. The Federal Reserve’s (Fed) overly loose monetary policy has helped greatly, though on a more fundamental
basis the flow of economic data has also somewhat improved, thanks to upbeat data from the Housing sector.
The risk of resurgent inflation did not appear to be anticipated by equity investors (though not so among inflation-linked bondholders). This
stance was especially good news for banks, which were able to exploit a positive carry by borrowing money at the short end of the yield curve
and lending to companies and households. This margin would be largely untapped if demand for loans remained weak, but these have steadily
recovered from the recession especially for the most solid lenders.
The housing market has also benefitted from quantitative easing. It took some time for falling mortgage rates to leave a mark, but home sales
and prices stepped up the pace of recovery in 2012. Going forward, international trends may be crucial for other cyclical sectors. Exporters of
basic materials and resources are unlikely to generate past earnings growth, whereas makers of consumer goods may benefit from strong and
increased sales especially of discretionary items.
Asia and Emerging Equities
Emerging market countries and sectors have delivered quite different results throughout the year.
Country-wise, at the end of 2012, Chinese stocks were supported by the growing perception of a soft-landing scenario. We believe that the
trough of the earnings cycle has been reached and expect corporate profits to start improving in 2013, as GDP growth may have bottomed out
at 7% year-on-year in 2012. Chinese blue-chip stocks (mostly listed in Hong Kong) have largely beaten world market averages in late 2012,
but we believe that despite the latest rally Chinese stocks are still undervalued compared to broad emerging market averages, notably in the
key Banking sector which has long been under pressure amid investors’ disappointment over a too-slow monetary easing. Chinese consumer
stocks may also get steady support from a possible change in China’s growth model from investment-led to a consumer-led one.
Other major emerging markets had less room to grow amid fewer available economic policy tools. Throughout 2012, Brazil’s central bank has
cut its benchmark rates in half to a record low in an effort to revive GDP growth, but structural factors such as low labour productivity and
still-excessive regulations were a hindrance. A weaker real may benefit exporters, but most of them belong to resource-related sectors which
are likely to suffer from China’s change in growth model. Russia is another resource-driven economy, but it appeared to have some more room
for growth in domestic household spending to offset.
Indian stocks have been broadly supported, although fundamental reasons for concern still persist amid a narrow breathing space for economic
stimulus: on the monetary side, the central bank’s willingness to let interest rates fall further and relax the inflation target to revive a flagging
economy recently met with some criticism and provided more uncertainties than comfort.
However, we believe that emerging-market equities, as a whole, remain the best long-term investment opportunity.
Currencies: The search for competitive currencies becomes broad-based
Major currencies experienced relatively modest swings in 2012. In our view, volatility is unlikely to pick up again in 2013 as monetary
policies carried out in developed countries after the latest great recession tended to resemble each other.
Until late into 2012, the US dollar’s trade-weighted index declined and fell to historical lows despite the sovereign-debt crisis and the ensuing
recession in the euro area. The Federal Reserve’s stance has often had a lot of influence on financial markets, and policies (like QE) boosting
money supply could weaken the dollar, but when the ECB resorted to its own liquidity-enhancing tools to contain the damage of the debt
crisis. The ECB and the Fed were committed to doing whatever it took to fulfil their respective goals (saving the euro and moving the US
economy to a faster track). Both currencies did not appear to be supported by a strong commitment to fighting inflation. As a central bank
policy goal, consumer price stability looks like a legacy of the past and some investors may not appreciate such a radical change of priorities in
favour of economic growth. The US dollar’s cheap valuation as a hedge against tensions over the euro sovereign-debt crisis partially offset the
Fed’s overly loose stance.
8 Pioneer Funds - Annual Report