"Cocos" has become the user-friendly name for a new type of hybrid bond created to help UK bank Lloyds raise money from investors to break away from a government insurance scheme for bad loans.

This nickname seems to have caught on in financial circles as it is much snappier than the bonds' official title: Enhanced Capital Notes.

The name Cocos seems to have derived from "contingent convertible," which describes one characteristic of these bonds - they convert to equity in certain circumstances.

Coco was famously the first name of French fashion designer Chanel. She was not known for her understanding of the credit markets but she did know a thing or two about fashion and the value of tradition over new-fangledness.

One senior capital markets banker pointed out these comments she made:

"Innovation! One cannot be forever innovating. I want to create classics."

Some bankers hope Cocos can become credit market classics, but admit that the jury is still out.

Dubai returns to the fixed-income sphere for the first time in more than a year after raising about $2 billion from dirham and dollar-denominated Islamic bonds.

Confidence in the emirate had run aground earlier this year as investors bet on Dubai's state-linked entities not being able refinance debt. So far, this year it has met all its obligations and with the fresh issue booking about $6.5 billion from regional and international investors, Dubai's doomsday scenario appears to be vanishing. 

With much of the United Arab Emirates' oil coming from the largest of the emirates Abu Dhabi, investors have flocked to the capital this year as appetite for good emerging market debt revives. The spread between Abui Dhabi and Dubai widened at its peak to over 500 basis points in February, but Dubai government efforts to restore confidence -- kickstarted by the UAE central bank buying $10 billion of its bonds -- has helped spreads narrow to about 200 basis points.

Dubai still has a long way go. The next test will be property developer Nakheel resolving its $3.5 billion Islamic bond maturing on Dec. 14 and then a raft of debts in 2010.....but as Harold Wilson once said, "A week's long time in politics."  

Could it be that equity and bond investors are living in the best of all worlds at the moment?

Tim Bond, head of global asset allocation at Barclays Capital, has hinted that they might be. He says that history shows current conditions to be the best for both assets.

 Since 1925, we find that in those years in which GDP was above trend and inflation below trend, U.S. equities have delivered an average 10.6 percent real return, with 20-year Treasuries delivering a 5.2 percent real return. 

But this is not the number one scenario for either.

This is the second best return regime of the business cycle, beaten only by those periods in which both growth and inflation are below trend, the condition that has applied so far
this year.

Specifically, the findings were as follows:

         Real annual returns, 1925-2008, U.S. assets
                                       Real annual returns Pct
                                                                             Equities Bonds Tbills

                Low GDP, Low CPI                                   11.4    10.1    2.8
                High GDP, Low CPI                                  10.6     5.2     1.3
                High GDP, High CPI                                  8.2     -1.2    -0.9           
                Low GDP, High CPI                                  -1.9     -5.0    -1.7

      The highs and lows are calculated based on trends over time with Bond estimating that current U.S. trend growth is about 2.3 percent and trend inflation 2.3 percent.

Reuters polls project the U.S. economy to contract by 2.6 percent annualised this year and to grow 2.2 percent in 2010. Inflation is seen at -0.5 percent and 1.8 percent, respectively.

The stock market's penchant for emotional reactions that remind one of a roomful of two-year olds can never be underestimated. Major world central banks are pulling back on their efforts to provide liquidity to the financial system, and the U.S. equity market has flipped out, with stocks falling sharply after the news.Volatility has spiked as well, even though the banks' move is largely administrative, with demand for certain borrowing programs already diminished. Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ notes that "demand for dollar liquidity at banks offshore is sharply reduced now that the crisis has blown through. The amount of dollar borrowing in offshore centers is down sharply."

But equity markets aren't so easily swayed by reason. The move in stocks follows a similar sell-off late Wednesday, after the Federal Reserve's statement, which intimated that it would start to reduce the tools that it has employed in keeping things afloat. Joe Saluzzi of Themis Trading pegged the reaction as a predictable one from the notoriously self-interested stock market, saying that "now all the money printing crack addicts who are waiting for more of it are not getting their money printing and they are going to throw a hissy fit."

Housing sales fall, despite lower rates.

And this is with only the most gradual of responses from the Fed. Lou Crandall of Wrightson ICAP points out that the Fed, with the tweak to their statement Wednesday and today's action, is signaling its intention to shift away from life-support efforts, even though it is nowhere near raising interest rates.

The uneasiness becomes clearer when considering the day's poor housing figures. Sales of existing homes fell 2.7 percent in August, and some speculate that the eventual removal of a first-time home-buyers credit by November (only homes that have closed qualify) will cause a reduction in demand, similar to the way the cash-for-clunkers program provided a temporary lift in auto sales.

No one data point can be taken as a full assessment of the economic environment, but major sectors of the economy are running with training wheels. What happens when they're finally removed?

The old lore about the best way to cure a hangover is with a few more nips of whatever it was you were imbibing the previous evening, commonly known as "hair of the dog."

The extension of this rally in stocks and just about every other asset identified with risk feels like a hair-of-the-dog situation. Between 2003 and mid-2008, easy flow of capital facilitated revelry in stocks, emerging markets, real estate, bonds, and high-yielding currencies.

REUTERS/Brendan McDermid

When investors invariably lost interest in an asset class where valuations could no longer be denied, they flocked to another - witness $150-a-barrel oil, $1,000 gold prices, and crazy gyrations in wheat and soybeans, of all things.

Then the hangover came. Major stock indexes were cut in half. Oil went to $30 a barrel, and investors fled for cover in the dollar and the safety of Treasury bonds.

With U.S. Federal Reserve and other central banks cutting rates to nothing, money worked its way back into the markets, though.

And how: Bespoke Investment Group notes that the S&P's charge has lifted it to its highest level above its 200-day moving average since 1983, just six months after it hit its lowest point below that average since 1932 - something that's only happened three times. The Australian dollar is up 23 percent against the dollar this year.

Want more? China's SSE Composite has gained nearly 70% since hitting a low late last year. Options action has been massive in recent days as investors concentrate bets on momentum-oriented names. The party line on Wall Street is that markets are reconsidering their view of risk, but recent reports noting investment bankers' newfound interest in securitization of life insurance settlements (surely nothing can go wrong there).

The fear, of course, is this: that the eventual unwind of government stimulus, low interest rates, and protective efforts for large financial companies will reveal a shell, one where economic activity and market gains prove to be a mirage. With some investors still cautious - U.S. money market fund assets, while lower, are still high - it doesn't take much imagination to see that a few extra nips could bring on another nasty hangover. Until then, party on?

By Jason Benham

It’s the property face of the Gulf’s business and tourist hub and the developer of palm-shaped islands visible from space - so Dubai will simply not allow property firm Nakheel to default on its huge $3.5 billion Islamic bonds which mature in December.

Just think of the bad publicity it would bring to the region, and there’s already been plenty of that. Another kick in the teeth is certainly not what Dubai needs. Plenty of critics have joined the ‘bash Dubai” bandwagon and several more are set to join the ranks at some stage. 

But any default would mark a failure for Dubai World, the state-owned conglomerate, and a castrophe for Dubai’s government, which has ploughed billions of dollars over recent years into making Dubai what it is today.

That leaves two more options - repayment or restructuring.”I would lean towards the repayment scenario,” said Fahd Iqbal, GCC strategist at EFG-Hermes in Dubai.”It would send a better signal to the market, and ultimately, I don’t think Dubai’s government has serious financial restraints since it should have recourse to the federal government. Dubai wants to avoid bad publicity and Nakheel is one of the key cornerstones of the Dubai story.”

A restructuring is also a possibility but appears to come second to a repayment, with some bankers and analysts saying the window of opportunity to restructure is diminishing.

But even in the likelihood of a repayment, Dubai has not done itself any favours by failing to address a lack of information about what will happen, and that only leads to more speculation and uncertainty.

A lack of clarity and transparency in the emirate’s property sector continues to weigh on investors’ minds. And it’s not just Nakheel’s bonds that are cause for concern. The market remains hungry for news on the planned merger of Dubai’s Emaar Properties and three local firms; the restructuring of troubled mortgage lenders Amlak and Tamweel and more clarity on property ownership.

Until then, most prospective Dubai investors are happy to look, but won’t touch.

So who is right and who is wrong?The stock market has rallied by more than 50 percent in the last five months. But bond market yields currently hover around 3.4%, and while that's nowhere near close to the crisis-induced record low reached at the end of 2008, a graph of the 10-year note's yield shows that it remains lower than almost any point other than when prices spiked in the wake of the Lehman Brothers collapse.

Ten-year yields remain in a tight range.

Equity investors would rightly point to better housing data and stronger economic indicators as a sign that things are looking up. The bond market, meanwhile, continues to worry that the outlook remains grim. Yields have been bound in a range between 3.4% and 4% since late May, despite the dark warnings from those "bond vigilantes" that believe crushing U.S. debt will turn off our major foreign benefactors.

But a rally in both the bond and stock markets was a fixture of the financial scene for a number of years. Strong growth coupled with low inflation created the so-called Goldilocks scenario, where bond yields could rally, and stocks flourished in part due to lower borrowing costs.

Whether that can be repeated for any length of time remains to be seen. Stocks have rebounded from an awful several months but still remain about one-third below their peak. Yields are low, but 3.4% has been the floor, even with the inducement of the Federal Reserve buying Treasury securities.

The possibility exists that in coming years both stocks and bonds will deliver mediocre returns. Bonds have benefited from the intermittent breakouts of risk aversion that accompany bad economic reports or brief stock swoons. And it seems less likely that equities can keep running at this pace with the outlook for earnings - particularly profit growth - so unsettled.

Investors have been forced to contend with a severe pullback in consumer demand and the panic that overtook the banking sector in late 2008.

Since March, stocks are up by nearly 50 percent and investors have shifted into riskier fixed-income assets as well, but whether these rallies continue will hinge on whether investors are drawn to those purchases, not whether they're forced into it because nothing else looks attractive.

That's how Mohamed El-Erian, chief executive at bond fund manager Pacific Investment Management Co., put it when speaking with Reuters Television earlier today. He noted that investors in longer-dated Treasuries were moving in that direction, in part because of the desire by authorities to move them away from short-dated risk.

"The question is not whether you can be pushed, but whether you can be pulled," he said. "What makes a rally sustainable is whether you can be pulled into more risk."

That may seem like a distinction without a difference, but the motivating factor is important to consider: When investors feel flush with liquidity and perceive opportunities for growth to be strong, they're more likely to hold investments in riskier assets, rather than fleeing swiftly to short-dated debt that poses little risk. The push-pull argument seems to allude to the phrase, "pushing on a string," in that there are certain things that cannot be pushed on.

With the prospects for growth muddy, many believe the stock market is due for a course correction after the post-panic run-up - and why Treasury auctions continue to draw strong demand.

El-Erian's colleague, Bill Gross, pointed out the knotty problem facing U.S. markets in his most recent commentary, saying that "but a modern capitalistic economy based on levered financing and asset appreciation cannot thrive if its ‘return on capital' or nominal GDP suffers such a significant shock."

And a shock it has suffered. Look no further than the news from Lowe's Monday, as the company cut back expansion plans due to weak demand.

The middle part of this decade made desire for investment - being pulled into growth opportunities - easy. Cash was flush, prices were going up, and few worried about leverage.

But the economy is in the midst of the painful, ongoing process of deleveraging, one that does not happen quickly. Economists at Goldman Sachs expect second-half growth to rise to about 3%, but then project early 2010 growth to decline to about 2%, and the square-root recovery (a long, drawn-out period of stagnation) appears likely.

With that in mind, there may be more pushing than pulling in coming months.

Reuters has taken its monthly snapshot of the investment choices of leading fund management houses across the world. At the end of July, the picture painted was one of investors embracing risk and shutting down their safest holdings.

Equity holdings as a percentage of a typical balanced portfolio were at their highest since the end of August last year, just a couple of weeks before Lehman Brothers collapsed. Here is what has been happening to equity holdings this year: 

At the same time, cash holdings have been cut back drastically. They are now at a level last seen in May 2007.  Here’s what that looks like:

Bonds offers a more mixed picture, but the latest month still shows a retreat that would be typical of roaring risk appetite:

Now the big question. Does all this add up to the start of a meaningful, long-term bull market? Or is it just overly optimistic exuberance?

By any standard the second quarter of 2009 was remarkable. Here are some numbers to chew over as the third quarter gets under way:   

— World stocks as measured by the MSCI All-Country World Index had their best quarter since the benchmark was first compiled in 1988.

    — The world index gained 21.2 percent for the second quarter. Its nearest “competitor” was the fourth quarter of 1998 when it rose 20.66 percent.

    — Much of the index’s gain this quarter came in the first two months. The index was essentially flat in June as investors began trading in a tight range.

    — Emerging markets were the main driver. MSCI’s sub-index for the sector gained 34.3 percent for the quarter, also a record high. Asian shares have been among the stars, with the MSCI Asia-Pacific ex-Japan index rising 33.7 percent. This was more than twice the gain on the U.S. Standard & Poor’s 500 index.

    — A big decliner was volatility. The Chicago Board Options Exchange Volatility Index, often called Wall Street’s fear gauge, fell below 30 percent at the end of the quarter to its lowest level since before the collapse of Lehman Brothers.

    — Over the quarter the VIX has lost 40.3 percent, reflecting growing confidence among investors that equities have ended the tumble of the past year or so.

    — One of the biggest percentage gainers was oil. New York crude gained around 42.2 percent on expected demand from a recovering world economy. Other commodities also made strong gains, with copper up 23.4 percent.

    — Hopes for a global recovery and rising concerns about future inflation — linked to the oil price surge and super-easy credit policy — pushed government bond yields and mortgage rates higher. Ten-year U.S. Treasury yields jumped 87 basis points over the quarter to 3.54 percent, having topped 4 percent at one point in early June. Ten-year euro zone government yields ended the quarter 39 basis points higher at 3.38 percent.

    — A growing appetite for higher-yields boosted demand for emerging market debt. Emerging sovereign debt spreads narrowed 212 basis over U.S Treasuries according to JPMorgan.

    — Investors ended the quarter clearly committed to future gains in higher-yielding assets. Reuters asset allocation polls for June showed cash reserves at a 23-month low, a sign that money was being put to work. EPFR Gobal data showed that about $130 billion has exited safe-haven money market funds in the year to date, but that is still less than a third of the $455 billion of cash that flocked to those funds in 2008 as a whole.

(Reuters photo: Gary Hershorn)