Global Investing

Far from the rules of the dusty old investment almanac, it’s up, up and away in May after all. And judging by the latest batch of economic data, markets may well have had good reason to look beyond the global economic ‘soft patch’ – with US employment, Chinese trade and even German and British industry data all coming in with positive surprises since last Friday. Is QE gaining traction at last?

Well, it’s still hard to tell yet in the real economy that continues to disappont overall. But what’s certain is that monetary easing is contagious and not about to stop in the foreseeable future – whether there’s signs of a growth stabilisation or not. With the Fed, BoJ and BoE still on full throttle and the ECB cutting interest rates again last week, monetary easing is fanning out across the emerging markets too. South Korea was the latest to surprise with a rate cut on Thursday, in part to keep a lid on its won currency after Japan’s effective maxi devaluation over the past six months. But Poland too cut rates on Wednesday. And emerging markets, which slipped into the red for the year in February, have at last moved back into the black – even if still far behind year-to-date gains in developed market equities of about 16%!

Not only have we got new records on Wall St and fresh multi-year highs in Europe and Japan, there’s little sign that either this weekend’s meeting in London of G7 finance chiefs or next weekend’s G20 sherpas gathering in Moscow will want to signal a shift  in the monetary stance. If anything, they may codify the recent tilt toward easier austerity deadlines in Europe and elsewhere. But inevitably talk of unintended consequences of QE and bubbles will build again now as both equity and debt markets race ahead , even if the truth is that asset managers have been remarkably defensive so far this year in asset, sector and geographical choices …  one can only guess at what might happen if they did actually start to get aggressive! Perhaps the next pause will have to come from the Fed thinking aloud again about the longevity of its QE programme — so best watch those thought bubbles!

Next week’s big data and events:

G7 finance ministers and central bank governors meet in London Sat

EBRD meeting in Istanbul Sat

Pakistan general elections Sat

Bulgaria parliamentary elections Sun

China April Industrial output/retail sales Mon

France/Italy bond auctions Mon

Euro group meeting Mon

US April retail sales Mon

Indonesia rate decision Tues

EZ March industrial production Tues

German May ZEW sentiment Tues

ECOFIN meeting Tues

UK 5-yr gilt/Japan 30-yr JGB/Dutch DSL auctions Tues

EZ/DE/FR/IT flash Q1 GDP Weds

UK April jobless Weds

Iceland rate decision Weds

Greek PM Samaras in China Weds

Japan Q1 GDP Thurs

UK 30-yr gilt/Japan 5-yr JGB auction/German 2-yr auction Thurs

Spain’s Rajoy meets with unions on pension reforms Thurs

Draghi speech Milan Thurs

US/EZ April CPI Thurs

US April housing starts/permits, May Philly Fed index Thurs

Turkish rate decision Thurs

Turkey’s Erdogan in Washington Thurs

G20 sherpas meeting in St Petersburg Sat/Sun

Figuring out what was driving pretty violent market moves this week was trickier than usual – and that says something about how much the herd has scattered this year, with ‘risk on-risk off’ correlations having weakened sharply. Just as everyone puzzled over a potential “wall of money” from Japan after the BOJ’s aggressive reflation efforts, the bottom seemed to fall out of gold, energy and broader commodity markets – dragging both equity markets and, unusually, peripheral euro zone bond yields lower in the process.  As dangerous as it may be to seek an overriding narrative these days, you could possibly tie all up these moves under the BOJ banner – something along these lines: the threat of a further yen losses pushes an already pumped-up US dollar ever higher across the board and undermines dollar-denominated  commodities, which have already been hampered by what looks like yet another lull in global demand. Developed market equities, whose Q1 surge had been reined in by several weeks of disappointing economic data and an iffy start to the Q1 earnings season, were then hit further by a lunge in heavy cap mining and energy stocks. The commodities hit may also help explain the persistent underperformance of emerging markets this year. What’s more the lift to Italian and Spanish government bonds comes partly from an assumption any Japanese money exit will seek U.S. and European government bonds and relatively higher-yielding euro government paper may be favoured by some over the paltry returns in the core ‘safe havens’ of Treasuries or bunds. The confidence to reach for yield has clearly risen over the past six months as wider systemic fears have receded – something underlined in dramatic style this week by a huge lunge in gold,  now lost almost 20 percent in the year to date.

While all that logic may be plausible, there have been dozens of other reasons floating around for the seemingly erratic twists and turns of the week.

The only truth so far is that everyone is still just guessing about the likely extent of a Japanese outflow and confidence about global growth has received another setback.

US Q1 EARNINGS START/DUBLIN EURO GROUP MEETING/US T-SECRETARY LEW IN BERLIN-PARIS/US-FRANCE-ITALY GOVT BOND AUCTIONS/FRANCE NATL ASSEMBLY VOTES ON LABOUR REFORM/VENEZUELA ELECTIONS

World markets have started the second quarter in an oddly indecisive mood given that Q1 turned out to be yet another bumper start to the year, looking to extend record stock market highs on Wall St but lacking the juice of new information to make a decisive break while Europe splutters and emerging markets and commodities head south. Two important pieces of the U.S. jigsaw will likely emerge over the coming week  with this Friday’s US employment report and the start of the Q1 corporate earnings season next week.

But there’s clearly been a more general rethink further afield among global investors given the breakdown in cross-asset and cross-border correlations – meaning it’s no longer enough to just get Wall St right and adjust your global risk button accordingly. It looks much harder work to get regional or asset allocations and positioning right. As Wall St flirts with new highs and US and Japanese equity funds continue draw hefty inflows, there’s been a pullback from all things Europe surrounding the Cyprus saga and parallel growth disappointments across the region and EPFR data last week showed redemptions from euro stock, bond and money funds continued.

The Year of the Snake is considered one of the less auspicious in the 12-year Chinese zodiac cycle. And 2013 is the year of the Black Water Snake, which comes around once every 60 years and is seen as the least fortuitous. How China’s stock markets turn out after years of poor performance remains to be seen but the snake is providing banks and asset managers with plenty of food for thought. Many of them have been gazing into the crystal ball to see what 2013 may hold for Chinese markets.

Fidelity Worldwide investments highlights the ‘Snakes and Ladders’ that could influence Chinese equities this year. (They have a great accompanying illustration)

Fidelity’s Raymond Ma reckons  there are six ‘R’s’ that could act as ‘ladders’ to buoy Chinese equity markets this year: recovery, reverse, reform, reflation, re-rating and rally. Under snakes he names inflation, a continued depreciation of the Japanese yen, excessive corporate debt/equity issuance,  a prolonged euro zone crisis and an earlier-than-expected end to quantitative easing in the United States.

As we wrote here last week, Russian bond markets are bracing for a flood of foreign capital. But there appears to be a surprising lack of interest in Russian equities.

Russia’s stock market trades on average at 5 times forward earnings, less than half the valuation for broader emerging markets. That’s cheaper than unstable countries such as Pakistan or those in dire economic straits such as Greece. But here’s the rub. Look within the market and here are some of the most expensive companies in emerging markets — mostly consumer-facing names. Retailers such as Dixy and Magnit and internet provider Yandex trade at up to 25 times forward earnings. These compare to some of the turbo-charged valuations in typically expensive markets such as India.

A recent note from Russia’s Sberbank has some interesting numbers on Russia’s consumer potential. Sberbank tracks a hypothetical Russian middle class family, the Ivanovs, to see how consumer confidence is shaping up (According to SB their data are broader in scope than the government’s official consumer confidence survey).

Russian debt finally became Euroclearable today.

What that means is foreign investors buying Russian domestic rouble bonds will be able to process them through Belgian clearing house Euroclear, which transfers securities from the seller’s securities account to the securities account of the buyer, while transferring cash from the account of the buyer to the account of the seller. Euroclear’s links with correspondent banks in more than 40 countries means buying Russian bonds suddenly becomes easier.And safer too in theory because the title to the security receives asset protection under Belgian law. That should bring a massive torrent of cash into the OFZs, as Russian rouble government bonds are known.

In a wide-ranging note entitled “License to Clear” sent yesterday, Barclays reckons previous predictions of some $20 billion in inflows from overseas to OFZ could be understated — it now estimates that $25 to $40 billion could flow into Russian OFZs during 2013-2o14. Around $9 billion already came last year ahead of the actual move, Barclays analysts say, but more conservative asset managers will have waited for the Euroclear signal before actually committing cash.

Foreigners’  increased interest will have several consequences.  Their share of Russian local bond markets, currently only 14 percent, should go up. The inflows are also likely to significantly drive down yields, cutting borrowing costs for the sovereign, and ultimately corporates. Already, falling OFZ yields have been driving local bank investment out of that market and into corporate bonds (Barclays estimates their share of the OFZ market has dropped more than 15 percentage points since early-2011).  And the increased foreign inflows should act as a catalyst for rouble appreciation.

Global markets have found themselves at an interesting juncture of underlying new year bullishness stalled by trepidation over several short-term headwinds (US debt debate, Q4 earnings, Italian elections etc etc) – the net result has been stalemate, something which has sunk volatility gauges even further. Not only did this week’s Merrill funds survey show investors overweight bank stocks for the first time since 2007, it also showed demand for protection against a sharp equity market drops over the next 3 months at lowest since at least 2008. The latter certainly tallies with the ever-ebbing VIX at its lowest since June 2007. Though some will of course now argue this is “cheap” – it’s a bit like comparing the cost of umbrellas even though you don’t think it’s going to rain.

Anyway, the year’s big investment theme – the prospect of a “Great Rotation” back into equity from bonds worldwide – has now even captured the sceptical eye of one of the market’s most persistent bears. SocGen’s Albert Edwards still assumes we’ll see carnage on biblical proportions first — of course — but even he says long-term investors with 10-year views would be mad not to pick up some of the best valuations in Europe and Japan they will likely ever see. “Unambiguously cheap” was his term – and that’s saying something from the forecaster of the New Ice Age.

For others, the very fact that Edwards has turned even mildly positive may be reason enough to get nervy! When the last bear turns bullish, and all that…

One of the very few positives for the world economy over the second quarter — or at least for the majority of the world that imports oil — has been an almost $40 per barrel plunge in the spot price of Brent crude. As the euro zone crisis, yet another soft patch stateside and a worryingly steep slowdown in the BRICs all combined to pull the demand rug from under the energy markets, the traditional stabilising effects of oil returned to the fray. So much so that by the last week in June, the annual drop in oil prices was a whopping 20%. Apart from putting more money in household and business purses by directly lowering fuel bills and eventually the cost of products with high energy inputs, the drop in oil prices should have a significant impact on headline consumer inflation rates that are already falling well below danger rates seen last year. And for central banks around the world desperate to ease monetary policy and print money again to offset the ravages of deleveraging banks, this is a major relief and will amount to a green light for many — not least the European Central Bank which is now widely expected to cut interest rates again this Thursday.

Of course, disinflation and not deflation is what everyone wants. The latter would disastrous for still highly indebted western economies and would further reinforce comparisons with Japan’s 20 year funk. But on the assumption “Helicopter” Ben Bernanke at the U.S. Federal Reserve and his G20 counterparts are still as committed to fighting deflation at all costs, we can assume more easing is the pipeline — certainly if oil prices continue to oblige.  Latest data for May from the OECD give a good aggregate view across major economies. Annual inflation in the OECD area slowed to 2.1% in the year to May 2012, compared with 2.5% in the year to April 2012 – the lowest rate since January 2011. While this was heavily influenced by oil and food price drops, core prices also dipped below 2% to 1.9% in May.

JP Morgan economists Joseph Lupton and David Hensley, meantime, say their measure of global inflation is set to move below their global central bank target of 2.6% (which they aggregate across 26 countries)  for the first time since September 2010.

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. 

For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind.  These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms —  from property rights to entrepreneurship – and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.

So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom.  Brazil is sixth from bottom while South Africa ranks two places higher.

At the other end of the spectrum is tiny Singapore. Its EFI score is double that of Russia and between 2002-2008 it attracted FDI equivalent to 50 percent of its economy. Russia in contrast saw negative net FDI (outflows exceeded inflows)