The Great Switchback and the ERP?
The risk of a whiplash-inducing switchback from core AAA bonds to equity and risk — now that euro/banking systemic fears have eased and a global economic stabilisation seems to be underway — is suddenly top of most investors’ agendas. Last week’s surge in U.S. Treasury, German bund and British gilt yields as global stocks caught a fresh updraft saw U.S. equity outperform bonds by almost 5 percent, according to Societe Generale. While not historically shocking in itself, SG reckons the cumulative weight of several weeks of this may well be having its impact on asset managers as the Q1 comes to an end.
Coming on the back on several weeks of equity outperformance, those remaining overweight bonds will be finding life particularly uncomfortable right now.
The question for most strategists is whether this is start of a wholesale rebasing of portfolios that could see dramatic asset allocation shifts over the coming quarters.
Deutsche Bank equity strategists said they reckon 10-year U.S. Treasury yields could “easily” rise another 45bp to 2.70% over the remainder of the year if expectations for policy rates remain unchanged. Its “ready reckoner” suggests such a rise in bond yields would take 3% off equities, all else being equal. However, they stress that if this is in tandem with rising growth expectations, the negative impact on equity could be more than offset.
But Goldman Sachs Asset Management Chairman Jim O’Neill told clients at the weekend that his long-standing bullish view on equities remains rooted in the extremely high global Equity Risk Premium — which measures the global trend growth rate (a proxy for long-term earnings growth) plus dividend yields minus real government bond yields. O’Neill said that despite a slowdown in the big emerging markets this year, most investors did not take account of the fact that the long-term global trend growth rate was still rising and was now about 4.2%. Real bond yields, meantime, were extraordinarily depressed by a host of policy actions and systemic fears.
Until both the consensus forecast of world GDP growth moves above 4.2 pct, and real bond yields rise a lot, then the ERP offers equity investors a great return. Simple, eh?
Three snapshots for Monday
China’s trade balance plunged $31.5 billion into the red in February as imports swamped exports. It followed reports on Friday that inflation cooled in February while retail sales and industrial output fell below forecast, all pointing to a gradual cooling.
Investors ploughed more money into hedge funds over the past month as performance has picked up after last year’s losses.
Three snapshots for Friday
The U.S. economy probably created 210,000 jobs last month, according to a Reuters survey. If the forecasts are accurate, the government’s jobs report on Friday would mark the first time since early 2011 that payrolls have grown by more than 200,000 for three months in a row. Refresh chart
China’s annual consumer inflation slowed sharply to a 20-month low in February, and factory output and retail sales also cooled more than forecast, giving policymakers ample room to further loosen monetary policy to support flagging growth.
January in the rearview mirror
As January 2012 drifts into the rearview mirror as a bumper month for world markets, one way to capture the year so far is in pictures – thanks to Scott Barber and our graphics team.
The driving force behind the market surge was clearly the latest liquidity/monetary stimuli from the world’s central banks.
The ECB’s near half trillion euros of 3-year loans has stabilised Europe’s ailing banks by flooding them with cheap cash for much lower quality collateral. In the process, it’s also opened up critical funding windows for the banks and allowed some reinvestment of the ECB loans into cash-strapped euro zone goverments. That in turn has seen most euro government borrowing rates fall. It’s also allowed other corporates to come to the capital markets and JP Morgan estimates that euro zone corporate bond sales in January totalled 46 billion euros, the same last year and split equally between financials and non-financials..
Sparring with Central Banks
Just one look at the whoosh higher in global markets in January and you’d be forgiven smug faith in the hoary old market adage of “Don’t fight the Fed” — or to update the phrase less pithily for the modern, globalised marketplace: “Don’t fight the world’s central banks”. (or “Don’t Battle the Banks”, maybe?)
In tandem with this month’s Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that’s a lot of additional central bank support behind the market rebound. So is betting against this firepower a mug’s game? Well, some investors caution against the chance that the Banks are firing duds.
According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What’s more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.
Can Eastern Europe “sweat” it?
Interesting to see that Poland wants to squeeze out more income from its state-owned enterprise (SOE) sector in the face of slowing economic growth and financing pressures.
Warsaw wants to double next year’s dividends from stakes in firms ranging from copper mines to utility providers to banks.
Fellow euro zone aspirant Lithuania has also embarked on reforms aimed at increasing dividends sixfold from what UBS has dubbed “the forgotten side of the government balance sheet”. It wants to emulate countries such as Sweden and Singapore where such companies are managed at arm’s length from the state and run along strict corporate standards to consistently grow profits.
Hungary and the euro zone blame game
More tough talk from Hungarian officials on the ‘unjustified’ weakness of the country’s currency, which has dropped 11 percent against the euro this year to all-time lows.
This time, it’s central banker Ferenc Gerhardt arguing that the weakness of the forint is out of sync with economic fundamentals and blaming it on the debt turmoil in the euro zone.
Perhaps he should look a little closer to home.
Phew! Emerging from euro fog
Holding your breath for instant and comprehensive European Union policies solutions has never been terribly wise. And, as the past three months of summit-ology around the euro sovereign debt crisis attests, you’d be just a little blue in the face waiting for the ‘big bazooka’. And, no doubt, there will still be elements of this latest plan knocking around a year or more from now. Yet, the history of euro decision making also shows that Europe tends to deliver some sort of solution eventually and it typically has the firepower if not the automatic will to prevent systemic collapse. And here’s where most global investors stand following the “framework” euro stabilisation agreement reached late on Wednesday. It had the basic ingredients, even if the precise recipe still needs to be nailed down. The headline, box-ticking numbers — a 50% Greek debt writedown, agreement to leverage the euro rescue fund to more than a trillion euros and provisions for bank recapitalisation of more than 100 billion euros — were broadly what was called for, if not the “shock and awe” some demanded. Financial markets, who had fretted about the “tail risk” of a dysfunctional euro zone meltdown by yearend, have breathed a sigh of relief and equity and risk markets rose on Thursday. European bank stocks gained almost 6%, world equity indices and euro climbed to their highest in almost two months in an audible “Phew!”.
Credit Suisse economists gave a qualified but positive spin to the deal in a note to clients this morning:
It would be clearly premature to declare the euro crisis as fully resolved. Nevertheless, it is our impression that EU leaders have made significant progress on all fronts. This suggests that the rebound in risk assets that has been underway in recent days may well continue for some time.
Is end-game approaching for Turkey’s policy experiment?
In less than two months, Turkey will mark the first anniversary of the start of an unusual monetary policy experiment, and it may well do so by calling it off. The experiment hinged on cutting interest rates while raising banks’ reserve ratio requirements, and as recently as August, the central bank was hoping it would be able to slow a local credit boom a bit but still protect exports by keeping the currency cheap. Instead, an investor exodus from emerging markets has put the lira to the sword, fuelling at one point a 20 percent collapse in its value against the dollar. That has forced the central bank to roll back some of the reserve ratio hikes and last week it jacked up overnight lending rates in an attempt to boost the currency. It has also sold vast quantities of dollars and is promising to unveil more measures on Wednesday.
But what the market really wants to see is an increase in Turkey’s main interest rate. ”Not sure that ‘measures’ short of rate hikes will help,” RBS analyst Tim Ash writes.
Given Turkey’s massive current account deficit of almost 10 percent of GDP, an interest rate of 5.75 percent will provide little protection to the lira if emerging markets come under serious pressure again. Even if the lira stabilises at current levels, an inflation spike to double-digits looks inevitable. Meanwhile the central bank’s hard currency reserves are vanishing at an alarming rate — just last week it spent $2.7 billion. That’s a lot given Turkish reserves are just $86 billion, or four months of imports. Current central bank policy is ”an open door to reserve depletion,” Societe Generale strategist Guillaume Salomon says, noting that despite the massive dollar sales, the lira is not far off record lows hit earlier this month.
Avoid financial meltdown – use a thesaurus
So it’s not just investors who are guilty of moving in a herd-like fashion.
Financial journalists use the same verbs and nouns with greater frequency as stock markets overheat but display more variety in their phraseology after the bubble bursts, a study by Irish computer scientists has shown.
Trawling through nearly 18,000 on-line news articles that mention the Dow Jones, FTSE and Nikkei stock indices between 2006 and 2010, Aaron Gerow of Trinity College Dublin and Mark Keane of University College Dublin found that the language used by the writers had become more similar in the run-up to the global financial crisis.
