Devil and the deep blue sea
Ok, it’s a big policy week and of course it could either way for markets. An awful lot of ECB and Fed easing expectations may well be in the price already, so some delivery would appear to be important especially now that ECB chief Mario Draghi has set everyone up for fireworks in Frankfurt.
But if it’s even possible to look beyond the meetings for a moment, it’s interesting to see how the other forces are stacked up.
Perhaps the least obvious market statistic as July draws to a close is that, with gains of more than 10 percent, Wall St equities have so far had their best year-to-date since 2003. Who would have thunk it in a summer of market doom and despair. Now that could be a blessing or a curse for those trying to parse the remainder of the year. Gloomy chartists and uber-bears such as SocGen’s Albert Edwards warn variously of either hyper-negative chart signals on the S&P500, such as the “Ultimate Death Cross”, or claims that the U.S. has already entered recession in the third quarter.
On the other hand, the economic data isn’t playing ball with doomsters, as can be seen in Thursday’s latest U.S. consumer and business confidence readings as well as the latest house price data. What’s more, the closely watched Citigroup Economic Surprise index, though still in negative territory, is turning higher again as a result amid some hopes for at least a midyear fillip in manufacturing worldwide. Of course surprises are only relative to expectations. But then sufficiently lowered expectations are no bad thing in a marketplace attempting to discount all available information. It’s true too of the ongoing U.S. earnings season, where there had been a sharp downgrade of forecasts in the weeks leading up the corporate reports. Thomson Reuters data shows that of the 303 firms in the S&P500 who have already reported Q2 earnings, some 66 percent are above analysts expectations — just shy of the average of of the past four quarters of 68 percent.
There is the hoary old argument that lukewarm economic signals will prevent the Fed from moving soon again on QE3, in part because the bar may be higher in an election year. But that just throws us back to the policy arena yet again and we promised to step aside from that for now!
The final piece of the puzzle is looking at alternatives to still apparently well-valued U.S. equities. With top-rated government bonds around the world the destination of choice for several quarters now, the yield implications have indeed been dramatic. Not only are up to half a dozen core euro zone Treasury bill yields now prefaced by a minus sign, even two-year German bonds now offer only negative yields. U.S. bill rates, meantime, have dipped again to their lowest levels since the 19th century, while 10-year German and U.S. Treasury bonds yields are less than 1.5 percent. At these rates, a backup in yields of less than 20 basis points could wipe out returns for the year. The risk in these markets is rising too despite their perception as havens.
Yet, that’s where global investors are getting sucked in. Today’s release of the Reuters Asset Allocation Poll for July showed the aggregate positions of some 49 investment funds worldwide showed global bond holdings at their highest since at least January 2010, with government bonds favoured over corporate credit.
However, of the 31 asset managers who responded to the question, almost 40 percent said their investment models would not allow them to hold negatively yielding government securities.
So, between the devil and the deep blue sea? Maybe policy is the decider after all…