Global Investing

The euro zone just avoided recession in the first quarter of 2012 but the region’s debt crisis sapped the life out of the French and Italian economies and widened a split with paymaster Germany.

Click here for an interactive map showing which European Union countries are in recession.

The technology sector has been leading the way in the S&P 500 in performance terms so far this year with energy stocks at the bottom of the list. Since the start of this quarter financials have seen the largest reverse in performance.

The yield on 10-year  U.S. Treasuries, fell to their lowest levels since early October today, breaking decisively below 1.80 percent. That compares to the dividend yield on the S&P 500 of 2.28%.

The European Central Bank kept its government bond-buy programme in hibernation for the ninth week in a row last week. The ECB may come under pressure to act as  yields on Spanish 10-year government bonds rose further above 6% today.

Output at factories in the euro zone unexpectedly fell in March, the latest in a series of disappointing numbers signalling that the bloc’s recession may not be as mild as policymakers hope. On an annual basis, factory output dived 2.2 percent in March, the fourth consecutive monthly slide, Eurostat said, and only Germany, Slovenia and Slovakia were able to post growth in the month.

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.”

One thing investors in China thought they could rely on was a steady, if unelected, hand.

Now Chongqing’s political head Bo Xilai has fallen, and in pretty spectacular fashion too. His wife has been accused of murdering a British businessman and his brother had to step down from the board of Everbright Bank. There are rumours the handover of power in the Politburo scheduled for this autumn, when seven out of nine of Chinese leaders are going to retire, could be delayed as the intrigue unfolds.

So what does this mean for investing in the Middle Kingdom? Xi Jinping is tipped for the top, and presuming he makes it to the transition unscathed, one of his tasks will be continuing the internationalisation of the renminbi. 

Who would have thought it. As fears over the euro zone’s fate, Chinese economic growth and Middle Eastern politics drive investors toward safe-haven U.S. and German bonds, some have apparently been going the other way.  According to JPMorgan, bonds from so-called frontier economies such as Pakistan, Belarus and Jordan (usually considered high-risk assets) have performed exceptionally well, doing far better in fact than their peers from mainstream emerging markets.  The following graphic from JPM which runs the NEXGEM sub-index of frontier debt, shows that returns on many of these bonds are running well into the double digits.

NEXGEM returns of 8.4 percent  are on par with the S&P 500, writes JPMorgan and outstrip all other emerging bond categories. Clearly one reason is the lack of correlation with the mainstream asset classes, many of which have been selling off for weeks amid growth fears and in the run up to French and Greek elections.  Second, investors who tend to buy these bonds usually have a pretty high risk-tolerance anyway as they keep their eyes on the double-digit yields they offer.

So year-to-date returns on Ivory Coast’s defaulted debt are running at over 40 percent on hopes that the country will resume payments on its $2.3 billion bond after June. The underperformer is Belize whose bonds suffered from a default scare at the start of the year.

The Bundesbank is preparing to stomach higher German inflation than it likes, above the European Central Bank’s target level, because of the euro zone crisis, a source at the central bank said on Thursday.

Although the Bundesbank still wants stable prices across the euro zone, its latest comments show the bank recognises that upward pressure on German wage costs and property prices suggest its inflation is likely to rise above the bloc’s average.

As this chart shows, historically the Bundesbank was quick to react to any signs of inflation:

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

This chart shows the wide dispersion in equity market performance so far this year. In local currency terms Korea has a total return of nearly 12% and Germany over 10%, this compares to Italy at-6% and Spain at -16%.

In contrast to last year, this has driven average correlations between equity markets lower.

However, correlations may well pick up if markets move back into ‘risk-off’ mode. The chart below showing the weakness in the Citigroup G10 economic surprise indicator seems to be pointing towards further weakness in bonds relative to equities.

Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?

The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful – just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone’s doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.

(Poland’s central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.

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.