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from Global Investing:

Research Radar: Greek gloom

Greek gloom dominates the start of the week as new elections there look inevitable and talk of Greek euro exit, or a Grexit" as common market parlance now has it, mounts. All risk assets and securities hinged on global growth have been hit, with China's weekend reserve ratio easing doing little to offset gloomy data from world's second biggest economy at the end of last week. World stocks are down heavily and emerging markets are underperforming; the euro has fallen to near 4-month lows below $1.29; safe haven core government debt is bid as euro peripheral debt yields in Italy and Spain push higher; and global growth bellwethers such as crude oil and the Australian dollar are down - the latter below parity against the US dollar for the first time in 5 months.

Financial research reports on Monday and over the weekend were just as gloomy, but plenty of interesting takes:

Bank of New York Mellon's Simon Derrick's view of the Greek political impasse concluded "there is at least an evens chance that the latter part of this summer will see what had officially been seen up until last November as an impossibility: a nation leaving the EUR."

RBS's Sanjay Mathur reckons that if there is another hung parliament after new Greek elections, implying no significant voter return to the pro-bailout parties, then euro risk soars.  "This means, on another hung parliament, that Greek government IOUs could trade as proxy currency as early as July." If that does not galvanize sufficient parties into accepting Trioka bailout demands at that point, he said that then exit looms. "Opening up the Pandora's box of exit means deposit risk across the periphery. The future of the euro would then be dictated by the subsequent policy response."

Barclays Sree Kochugovindan talks of a three phase possible deterioration of the euro crisis -- one, where solvency concerns and asset market fright are contained to Europe and mostly the fixed income markets of the periphery countries concerned; two, solvency concerns hit the core such as France and Belgium with asset market contagion widening before a series of major policy responses; and three, no major policy response or ECB SMP/LTRO, which leads to Greek default and even exit and global market shock akin to September 2008. "Given the immense cost of a crisis triggered by a Greek exit, we are not expecting the current situation to deteriorate into Phase 2. However, the risks are elevated and with the prospect of second round Greek elections in a few weeks, market jitters are likely to continue."

Deutsche Bank's global markets note also focuses on rising risks from Greece and also on the May 31 Irish referendum on the EU fiscal pact. Apart from outlining obvious risks to the Greek financing from a political vacuum, one conclusion Deutsche comes to is that a new EU growth pact may happen sooner than many had figured. "The new situation in Athens forces EU leaders to find common ground faster than we thought." Another conclusion was that Ireland may consider postponing its referendum, given the risk that a "no" vote may disastrously cut off its access to new EU funds and also given a possible delay in German parliamentary votes on the fiscal deal to June. "Ireland might do well to think about postponing the 31 May referendum." It called Spain's sweeping banking reform plan "making progress" but a 15 bln euro government recapitalisaation of the banks "too timid".

HSBC's Karen Ward and Simon Wells warn about the long-term impact of continuous quantitative easing by central banks, saying the political relationship between central banks and governments rather than inflationary consequences may be the biggest concern. "The heyday of independent central banking could be drawing to a close."

from Global Investing:

South African bond rush

It's been a great year so far for South African bonds. But can it get better?

Ever since Citi announced on April 16 that South African government bonds would join its World Government Bond Index (WGBI),  almost 20 billion rand (over $2.5 billion ) in foreign cash has flooded to the local debt markets in Johannesburg, bringing year-to-date inflows to over 37 billion rand. Last year's total was 48 billion. Michael Grobler, bond analyst at Johannesburg-based brokerage Afrifocus Securities predicts total 2012 inflows at over 60 billion rand, surpassing the previous 56 billion rand record set in 2o1o:

The assumption..is based on the fact that South Africa will have a much larger and diversified investor base following inclusion in the WGBI expanding beyond the EM debt asset class

Currently South African bonds are restricted to emerging local bond indices. The most-widely used, JPMorgan's GBI-EM, has less than $200 billion benchmarked to it and South Africa's weighting is 10 percent. But the WGBI is a different matter altogether -- around $2 trillion is estimated to track this index which currently includes just 22 countries, only three of them emerging markets.  An expected 0.44 percent weighting for South Africa implies inflows of  $5-$9 billion, analysts estimate.

Some of that cash has already come. How much more could roll in this year? Optimists point to Mexico -- foreign ownership of the local debt market there rose to 31 percent from 24 percent over 2010, the year the country joined the WGBI, with $11 billion flowing in. But the picture in South Africa is in fact not that rosy. Inflows will undoubtedly pick up, benefiting both bonds and the rand but many reckon positioning in South African bonds is already pretty crowded --  about a third of the market is in foreign hands already, analysts at Morgan Stanley reckon. Worse, the country faces a possible credit ratings downgrade this year (all three rating agencies have cut its ratings outlook to negative in recent months).

Kieran Curtis, a fund manager at Aviva Investors upped his holdings of South African local bonds after the WGBI news but is reluctant to go overweight,  betting the market will benefit less than Mexico did two years ago. He cites two reasons -- first South Africa's budget deficit has been creeping higher and it follows that debt issuance will too. Second, the external backdrop is less supportive today than two years ago when the Fed was in full money-printing mode:

I wouldnt say I detect a very strong commitment in South Africa to restoring the budget to balance and those debt numbers can rise quickly when you have a 5-6 percent deficit. Also Mexico's inclusion came at a time when U.S. Treasury yields were falling fairly quickly but now, with Treasury yields rising we may not get the same support for South Africa.

from Global Investing:

Big Fish, Small Pond?

It's the scenario that Bank of England economist Andrew Haldane last year termed the Big Fish Small Pond problem -- the prospect of rising global investor allocations swamping the relatively small emerging markets asset class.

But as of now, the picture is better described as a Small Fish in a Big Pond, Morgan Stanley says in a recent study, because emerging markets still receive a tiny share of asset allocations from the giant investment funds in the developed world.

These currently stand at under 10% of diversified portfolios from G4 countries even though emerging markets make up almost a fifth of the market capitalisation of world equity and debt capital markets.  In the case of Japan, just 4% of cross-border investments are in emerging markets, MS estimates.

But change is on its way. MS surveys show most classes of global institutional investors intend to boost allocations to emerging markets, including the more conservative investor groups -- Japan's $1.3 trillion government pension insurance fund, for instance, plans to start buying emerging equities later this year.  MS analysts calculate allocations to emerging markets could rise 3.5% over the next five years.

That may not sound like much until one realises the true scale of the global pool of investable institutional assets and compares them with current market cap values in developing countries . These assets currently exceed $212 trillion, meaning a 3.5 % allocation increase will bring over $2 trillion into emerging markets. That's over half the capitalisation of EM equity market, more than 80% of bond markets and a third of the combined market cap of both sectors.

Take a look at some more numbers:

-- Based on current market values, a 1% increase in allocation to EM by pension and insurance funds represents a $524 billion flow to EM assets.

from Breakingviews:

Temasek’s triple personality bodes well for returns

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Temasek is turning into a financial chimera. Where that mythical beast was part lion, goat and serpent, the Singaporean fund combines aspects of a hedge fund, private equity house and investment bank. That combination sounds good for returns, though it might not sit well with Temasek’s political ties.

First, consider Temasek’s recent opportunistic actions. It sold $2.5 billion of shares in two China banks on May 3, just weeks after buying $2.3 billion of shares in another. Temasek reportedly flipped China Construction Bank shares for 20 percent more than it paid last November - which in turn was 20 percent below where the shares were trading when it sold in the previous July.

The fund has also shown a taste for private-equity style financial engineering. Temasek is kingmaker in a proposed $7.2 billion takeover of Indonesia’s Bank Danamon by Singaporean bank DBS, which would leave the fund with 40 percent of the combined group. Last year’s exchangeable bond, convertible into part of Temasek’s 18 percent stake in Standard Chartered, reflected more cleverness than necessity.

Finally, there are shades of an investment bank. Temasek has hired big-hitting bankers like UBS finance director John Cryan, whose influence may explain the change of gear. So too may its investment-bank-like pay, which leans heavily on performance. Temasek even claws back past bonuses when the fund fails to meet its internal hurdle rate, as happened in 2010.

This combination could be just what’s needed. Temasek’s return to the finance ministry, its sole shareholder, was below 5 percent in 2010, its last reported period - compared with a 20-year average of 15 percent. Without healthy returns, it’s hard to justify the $155 billion fund’s existence. Singapore already has a bigger sovereign piggy bank in the form of foreign reserve fund GIC.

from Global Investing:

Research Radar: “State lite”?

The FOMC's relatively anodyne conclusions left world markets with little new to chew on Thursday, with some poor European banking results for Q1 probably get more attention.  Broadly, world stocks were a touch higher while the dollar and US Treasury yields were slightly lower. European bank stocks fell 2% and dragged down European indices. Euro sovereign yields were slightly higher, with markets eyeing Friday's Italian bond auction. Volatility gauges were a touch lower and crude oil prices nudged up.

Following is a selection of some of the day's interesting research snippets:

- Deutsche Bank's emerging markets strategists John Paul Smith and Mehmet Beceren said they retain their negative bias toward global emerging market equities both in absolute and relative terms, highlighting Argentina's expropriation of YPF from Repsol as another negative. "We anticipate that so-called state capitalism will continue to be a negative driver, as it has been since mid-2010, since the poor economic backdrop makes the corporate sector a tempting target for governments wishing to boost their popularity or find additional resources to add to the relatively low levels of social protection across most emerging economies." They added that they remain overweight "state lite" emerging markets such as Taiwan, Mexico and Turkey and underweight Russia, China, Brazil and South Korea.

- Morgan Stanley's James Lord thinks the rally in Hungary's markets following Tuesday's decision by the EU to reopen negotiations on financial assistance is justified but much may now be in the price. He said MS would prefer to wait for some pullback before looking for more bullish trades.  On a relative basis, Hungary 5-year CDS is now 60bp wider than Spain's and MS said that while this gap could close much further  it was hard to see how Hungary CDS rates could trade below Spain.  "Indeed, if Spain goes into serious financial trouble, it could represent a systemic risk for all Europe, and funding stress would likely increase substantially. Given the strong dependence of Hungary towards the EU, it would be difficult to argue for Hungary to trade through Spain on any sustained basis."

- Ashmore Investment Management's Jerome Booth restates his bullish case for emerging markets with 10 points that conclude with the line:  "the best way to lose money without really trying is not to invest in emerging markets." His points include warnings about equating past volatility with risk, passive investing (where he points out that only 12% of emerging debt is represented by available indices) and seeing emerging currency volatility against the dollar as an emerging problem rather than a U.S. one ("It is the dollar which is volatile".)

- Legal & General Investment Managers' Ben Bennett argues that central bank money printing will be needed for some time as banks' bad loans are still way too high for them to be "in a position to drive the money printing presses once again". Explaining QE as a nationalisation of money printing presses normally operated by the commercial banks, he says the success of either form of money creation can only be judged by the productive nature of use to which that money is put. The pre-crisis lending into the property bubble was negative case in point, and the relative success of QE lending to the banks will be even more complex to judge.  "The investment lesson to be learnt is not to follow the money, but to analyse the usefulness of what it is being spent on."

from Global Investing:

Research Radar: Very 20th century

Wednesday's market commentaries are loaded with the buzz around another technical UK recession in Q1 (the first time Britain has suffered what many see as a 'double-dip' since the 1970s); guessing about Wednesday's FOMC outcome; and the European Commission letting Hungary off the hook about its controversial constitutional changes. In aggregate, and probably due to the looming FOMC,  markets are fairly stable - world equities, including euro stocks, emerging markets and even Britain's FTSE are all higher. The US dollar, Treasuries,  volatility gauges, gold and even peripheral euro government bond yields are all down a bit.

Following is a selection of some of Wednesday's interesting research ideas:

- Barclays' Barry Knapp reckons US and world equities face a dilemma from the endless distortion to multiples and risk premia from monetary intervention and QE that is artifically lowering the risk-free rate akin to the "financial repression" of the 1950s -- no one is sure now if equity is cheap or bonds just very expensive. He concludes that best thing for equities in the medium to long term is to avoid further QE but the problem is that stocks will almost certainly suffer in the short run if the Fed takes QE3 off the table. What's more, Wednesday's FOMC could be problem for markets initally if the Fed frets about the growth outlook, but a worsening of the economy might bring QE3 sooner than similar bouts in 2010 and 2011.

- ING's James Knightley says UK GDP numbers mask business survey improvements and better March data and expects the economy to return to growth in Q2 as well as upward revisions to Q1. Flagging up improving business sentiment in the April CBI survey, he says the Bank of England is unlikely to do more QE and reckons any post-GDP rally in gilts or fall in sterling should be short-lived.

- However, Citi's Michael Saunders is far gloomier in flagging " the worst recession/recovery cycle opf the last 100 years" and dismisses suggestions that the persistent weakness of the economy since 2008 can be blamed on things like quarterly construction swings. "We expect the economy will continue to underperform, given the headwinds from fiscal drag, high household debts, the EMU crisis and poor credit availability. A less-tight fiscal policy probably would not help significantly, given the likelihood that fiscal slippage would trigger market pressure. A lower pound would help, but the key policy lever is QE and we continue to expect extra QE."

- Standard Chartered reckons it's time to book profits on a short EUR/GBP position, as the market looks primed for a correction. "An unexpectedly weak UK GDP report for Q1 has tempered expectations the economy will outperform"

- Societe Generale's cross-asset team says it remains bullish on crude oil prices due to supply and capacity worries and geopolitical concerns and it targets $135 per barrel for Q3 -- a price they say is not priced into futures markets. They say portfolios should be hedged for the possibility that 20-year-high oil/equity correlations will drop sharply and there several ways to gain exposure to rising crude -- Brent Sept call option spreads, US 5-year inflation-protected TIPS, long global oil services stocks, long Russia's rouble and Mexico's peso and short Thailand's baht and Korea's won. Seperately, SG's Dylan Grice worries about Australia -- "What do you call a credit bubble built on a commodity bull market built on a much bigger Chinese credit bubble? Leveraged leverage? A CDO squared? No, it's Australia."

from Global Investing:

Research Radar: Beyond Hollande and Holland…

Markets have been dominated this week so far by the fallout from Sunday's French presidential election, where Socialist Francois Hollande now looks set to beat incumbent conservative Nicolas Sarkozy in the May 6 runoff , and the collapse of the ruling Dutch coalition on Monday.  Public anxiety about budgetary austerity in Europe was further reinforced by news on Monday of a deepening of the euro zone private sector contraction in April. That said, euro equity, bond and currency prices have stabilised relatively quickly even if implied volatility has increased as investors brace for another month or so of political heat in the single currency bloc. The French runoff is now on the same day as the Greek elections and May 31 sees Ireland going to the polls to vote on the EU's new fiscal compact.  Wall St's volatility gauge, the ViX, is back up toward 20% -- better reflecting longer term averages -- and relatively risky assets such as emerging market equities remain on the back foot. The euro political heat and slightly slower Q2 world growth pulse will likely keep markets subdued and jittery until mid year at least. At that point, another cyclical upswing in world manufacturing together with the passing of the EBA's euro bank recapitalisation deadline as well as the introduction of the new European Stability Mechanism may well encourage investors to return at better levels.

Following are some interesting tips from Tuesday's bank and investment fund research notes:

- JPM economists reckon finding the reason behind the backup in US weekly initial jobless claims over the past couple of weeks is key to assessing whether a sub-par March payrolls report is repeated in April. It says it's possible the claims jump move is a seasonal factor as unadjusted claims are closely tracking 2007's pattern and Easter holidays fell on the same dates in both years. If 2007 was repeated, there would be a sizeable late April drop in claims and JPM looks for some of that on Thursday with a 14,000 forecast drop. (Reuters poll consensus is for a 11,000 drop)

- Following the surprise news last week that dovish Bank of England policy maker Adam Posen is no longer voting for more UK money printing, Barclays FX team said it's turning more positive on the UK economy and also says sticky inflation may mean the Bank of England's current monetary stance may be too accommodative. As a result, it lowered its euro/sterling 3-month forecast to 0.79 from 0.84. However, it cautioned about being short euro/sterling until after Wednesday's Q1 UK GDP report, which it said could come in weaker than expected due to temporary factors. (Reuters poll consensus is for a 0.1% rise Q/Q)

- As everyone watches the FOMC outcome on Wednesday, Bank of New York Mellon's Simon Derrick highlights widespread expectations of further Bank of Japan easing and asset purchases on Friday. He reckons the economic arguments for more easing in Japan may be sound but it's worth considering whether BoJ governor Masaaki Shirakawa may want to start facing down heavy political pressure for endless BoJ easing.

- Rabobank's emerging markets team flag their concern about Poland's zloty, which has been one of the best performing currencies of the year so far. They say the zloty is a high "Eurozone beta" play, seen in the correlation of the eur/pln rate with composite euro periphery sovereign CDS spreads, and as a result will suffer if euro tensions rise further over the next month or two.

from Global Investing:

Hair of the dog? Citi says more LTROs in store

Just as global markets nurse a hangover from their Q1 binge on cheap ECB lending -- a circa 1 trillion euro flood of 1%, 3-year loans to euro zone banks in December and February (anodynely dubbed a Long-Term Refinancing Operation) -- there's every chance they may get, or at least need, a proverbial hair of the dog.

At least that's what Citi chief economist Willem Buiter and team think despite regular insistence from ECB top brass that the recent two-legged LTRO was likely a one off.

Even though Citi late Wednesday nudged up its world growth forecast for a third month running, in keeping with Tuesday's IMF's upgrade , it remains significantly more bearish on headline numbers and sees PPP-weighted global growth this  year and next at 3.1% and 3.5% compared with the Fund's call of 3.5% and 4.1%.

But its euro zone calls are gloomiest of all. First off, it sees two consecutive years of economic contraction of the bloc as a whole -- a 1.0% shrinkage this year followed by 0.2% drop in 2013. Against this dire backdrop, it expects  Spain to be forced to seek Troika (EU, IMF and ECB) support later this year that will be focussed on recapitalizing and restructuring its ailing banks and it also expects both Portugal and Ireland to need second bailouts from the same source.

And with that sort of pressure from deleveraging, austerity, sovereign debt stress and recession , the ECB will have to bring out yet another punchbowl, it reckons.

We expect that renewed EMU strains will prompt the ECB to launch at least one more multi-year LTRO and continue to pencil in one or two more rate cuts by end-2013.

Yet, just like the euphoric effects of both the binge and "morning after" drink, the problem with LTRO is that it risks causing more problems than it solves by tying the banks of weak peripheral euro states ever closer to their ailing sovereigns.

from Global Investing:

No hard landing for Chinese real estate

The desperate days when Chinese property developers offered free cars as an inducement to homebuyers look to be over.

Sales and earnings figures indicate some of the gloom is lifting as developers have enjoyed a second straight month of rising sales. Vanke, China's biggest developer by sales, said last week that March sales had risen 24 percent year on year, while  2011 profits rose 30 percent. Another firm, China Overseas Land, posted a 21.5 percent profit rise last year.

The mood is reflected in stock prices. While the Shanghai shares index has risen less than 5  percent this year,  a sub-index of Chinese property companies has risen 13 percent. Shares in Vanke and COL are up 13 percent and 22 percent respectively. A Reuters poll of fund  managers showed that investors had upped their weighting for property stocks to 10.9 percent at the end of March, the highest level in two years.

The share rally has continued even though the government has dashed hopes it will soon wind down its two-year campaign  to bring down property prices.  It has also bucked a broad housing market slowdown (home prices fell for the fifth straight month in February) amid signs that Chinese authorities are unlikely to provide the economy with any further stimulus. Analysts at Citi said in a recent note:

Developers' comfort under current tightening (policy) and confidence in a stable outlook suggests the toughest time for China's property sector is over.

For a long time, the country's real estate market -- and the possibility of a crash there -- has generated fear in the minds of China-watchers. That danger is by no means over -- economic growth is cooling but inflation remains high. Companies too have warned that tough times still lie ahead.

But many such as Karine Hirn, Shanghai-based chief representative of asset manager East Capital, have never believed in an outright property sector collapse. China has an 80 percent home ownership rate and 25 million people work in construction, she points out. Real estate accounts for 13 percent of China's GDP. So it is unlikely the government would ever have risked a property price crash. Hirn also points out that while sales in cities like Beijing and Shanghai are indeed slowing sharply,the market remains robust in Tier-3 cities -- home to over half of China's urban population.

from Global Investing:

Japanization of euro zone bonds?

Fear of many years of stagnation in the major western economies has everyone fretting about a repeat of  the "lost decades" that Japan suffered after its banking and real estate bubble burst in the early 1990s. Indeed HSBC economists were recently keen to point out that U.S. per capita growth over the noughties was already actually weaker than either of Japan's lost decades.

But in a detailed presentation on the impact of two years of soveriegn debt crisis on euro zone government bond holdings, Barclays  economist Laurent Fransolet asks whether that market too is turning into the Japanese government bond market -- where years of slow growth, zero interest rates, current account surpluses and captive local buyers have depressed borrowing rates for years and turned JGBs into an increasingly domestic market dominated by local banks, pension funds and insurers. Non-residents hold less than 10 percent of JGBs, compared to more than 50 percent for the EGB as a whole, and Japanese banks hold up to 35 percent of their own government bond market.

But is the euro government market heading in that direction after successive crises have seen foreign investors flee many of the peripheral markets of Greece, Portugal, Ireland and even Italy and Spain? Fransolet argues that the seniority of substantial European Central Bank holdings built up in the interim (now about 15 percent of each of the five peripheral markets) may be one reason why these foreign investors will be wary of returning. Meantime, euro zone banks, who have traditionally held a high 20-25 percentage point share of euro government markets, withdrew sharply late last year amid balance sheet repair pressures but have  rebuilt holdings again sharply in early 2012 after the ECB's liquidity injections -- particularly in Italy and Spain.

In answer to the longer-term question of whether euro bonds will turn into a more insular market dominated less by interest rate signals than liquidity, regulatory and balance sheet issues, Fransolet is equivocal. On one level they are still very different -- state-sector holdings of euro debt are still far from Japan's, the euro market has clearly fragmented and net new issuance of euro debt is also still way below Japan.

However, the trend is clearly toward a more domestically driven market in the periphery of euro bloc in particular and local banks are becoming bigger players.  And, crucially, although foreign investors may not return en masse soon, their impact on those markets via futures and CDS markets and index weightings may still be high.