Currency traders: face a volatile 2011 as trade imbalances with China persist

After a difficult year in Ireland with significant uncertainties ahead, it is easy to ignore investment opportunities in other markets. The following piece outlines some of our predictions from an economic perspective and international investment opportunities that follow from these predictions.


From an economic perspective, we believe divergence will be a key theme for 2011. This divergence will be the difference in growth prospects between emerging markets and developed economies. Emerging markets such as China will grow at 8.5% in 2011 compared to an average of 2% in developed economies. Not only is this divergence evident in differentials in growth between emerging and development markets, it is also evident within certain regions within developed markets, in particular the eurozone, where growth within core member states is out-pacing the peripherals.


Due to the weaker-than-normal growth after the end of a recession in developed market economies, monetary policy will continue to remain accommodative, with even the ECB reversing its hawkish stance. In emerging market economies we expect interest rates to increase in 2011 as the authorities move to curb rising inflation and excessive increases in property prices.


Inflation will not be an issue for 2011, in our view, as the imbalances within economies are unwound, but bond markets will start to focus on the risk of higher inflation in the medium term. This will manifest itself in higher bond yields at the longer end of the curve, especially within the US and UK.


In Europe, the move higher in bund will be driven by the realisation Germany will have to support weaker member states in the euro, to save the project. Currencies will remain volatile and the rhetoric of imbalance between countries such as the trade surpluses enjoyed by China will continue to increase fears of trade wars.


We predict the euro will weaken against both the dollar and sterling during the year as the weaker growth profile and the lack of leadership in Europe will keep the euro weak. This will be a positive for Ireland in 2011, especially for the export sector.


This divergent economic performance is reflected in our core sector themes for 2011, with a focus on those sectors and stocks with emerging market exposure. This sector preference reads across into our preference for cyclical sector and stock exposures over defensive names.


The key sectors that will benefit from this divergent economic performance will be the mining and energy sectors, as industrial activity continues to expand and as energy consumption continues to increase.


Also dictating our sector and stock preferences is our outlook for currency markets with the anticipated weakness in the euro providing a favourable backdrop for European exporters, in particular the industrial exporters to the emerging market region.


Apart from the large European industrial export companies, US industrial groups will also benefit from growing emerging market demand. Accordingly, industrials is a sector that we believe will outperform strongly in 2011.


Another sector preference for 2011 is technology, particularly the chip manufacturers, where apart from a pick-up in developed market business spend, the sector will also benefit from emerging market demand.


Autos and auto components are also sectors that offer the dual potential of a recovery from the developed markets as well as for further growth in emerging markets. In the auto sector however, the higher-end manufacturers will outperform the mass-producers, given the former's greater pricing power.


We remain broadly positive on the pharmaceutical sector but we acknowledge that profit growth will be hindered by a lower pricing environment in developed markets due to austerity measures. We continue to favour those stocks in the sector with emerging market exposure where mid-teen margins will help off-set low-single-digit developed market margins.


In the defensive market sectors, we favour tobacco, food, and food retail, which all have emerging market exposure and in the case of food, and food retailing, have positive pricing power. The beverage sector however, faces significant challenges particularly in a price-sensitive market which will restrict the ability to pass on higher input costs.


Maintaining the strong emerging market growth theme, our favoured commodity for 2011 is copper while we also expect oil to move above the $100 a barrel level in 2011.


We do expect continuing improvement in corporate profitability during 2011, but outperformance will be from cyclical sectors with emerging market exposure. The stronger growth profile in these economies compared to developed economies will drive this outperformance. This view is what drives our investment calls for 2011 and our key sector picks for the coming year.


Oliver Gilvarry is head of research at Dolmen Securities