Global Investing

There is no question that the losses on stock markets at the moment are primarily the result of the Greek crisis. A downgrade of a euro zone country’s sovereign debt to junk is enough to make all but insane mainstream investors take a large step away from risk.

But could it also be that the Greek crisis has come at a time when big investors were looking for an excuse to cool down the equity rally? MSCI’s all-country world stock index hit a peak on April 15 that was not only higher than anything seen this year, but also last year as well.  Up about 85 percent from its March 2009 lows, in fact.

Partly as a result, there were some signs emerging that suggested a correction would soon be in the works.

– Morgan Stanley noted that one of the indexes it follows had been up at least 50 percent year-on-year eight times in March. History showed that on 77 percent of such occasions that equity markets had subsequently fallen 4 percent.

– Bank of America Merrill Lynch’s April fund manager survey saw cash holdings had dropped to 3.5 percent of assets.  On four out of five occasions that that has happened before, BofA said, equities declined by 7 percent in the following 4-5 weeks.

The crisis of confidence in Greece's fiscal health has dented U.S. equities, though not enough to compromise a budding American economic recovery. Even a significant slowdown in European growth prospects might have limited immediate impact on the United States. However, that benign backdrop could vanish, economists at Morgan Stanley say, if the Greek situation were to turn in to an outright credit crisis.  They call it the "contagion tail risk":

While the retreat in risky assets in the past few weeks is not yet a headwind for growth, it is hardly a plus.  If the crisis spills over into broader risk aversion and a drying up of liquidity — the functional equivalent of the US subprime crisis — the consequences could be more dire.

JP Morgan, for its part, notes that it's not just Greece investors need to worry about.

Anyone wondering what ghoul is most haunting investors at the moment could see it clearly on Tuesday — it is the exit strategy from the past few years’ central bank liquidity-fest.

Germany came out with a quite positive business sentiment indicator, relief was still there that Greece had managed to sell some debt a day before, and Britain formally left recession – albeit in a limp kind of way.

But what was the main global market mover? It was China implementing a previously announced clampdown on lending.

It was down, down, down in 2008 and up, up , up in 2009. So what will 2010 bring?

Equities may be the poster child for this year’s market recovery, but corporate bonds have been the runaway outperformer.

As the graphic below shows, corporate debt was less volatile and moer profitable over the past nearly three years of crisis and recovery — even “junk” bonds.

This year’s performance for corporate bonds has been stunning. In December last year, the spread between global large cap company debt and U.S. Treasuries was 155 basis points, according to Bank of America Merrill Lynch. It has now narrowed to around 52 basis points.

As the graphic above shows, volatility in U.S. stocks has re-entered what could be called normal territory after soaring higher during the financial crisis. The blue band is plus or minus one standard deviation around the 1990 to 2007 avverage.

There may be an implication for equities beyond the obvious sign that things are calming down. Lower volatility is a buy signal in many trading models.

(Reuters graphic by Scott Barber)

If you had bought emerging market stocks exactly at the top of the bubble and sold them exactly at the bottom of the crash, you would have suffered a lot of pain (and probably shouldn’t be in the investment business in the first place).  The loss would have been 67 percent of your principal.

Most people won’t have lost that much, of course, depending on when they bought and sold. But even if an investor did buy exactly at the top, as long as they held on their losses by now would have been pared back considerably. 

The graphic above, created by Scott Barber, shows how much of the crash has been clawed back. The full column represents the maximum loss; the green shows the amount recovered. In points terms, 50 percent of the emerging markets crash losses have been recouped.

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:

Trend is your friend.

This is an old cliche every market player knows, but Jack Ablin, chief investment officer of U.S.-based Harris Private Bank, argues against befriending all trends blindly.

In his new book, he says: “One must recognise the point at which that trend is old and about to shift gears, alter direction, or simply vanish altogether… It’s the new, new thing that grabs their attention.”

Harris Private Bank’s analysis shows that relying on the signals sent by the 200-day moving average — a technical strategists’ favourite arsenal in gauging momentum — would have fared better than just following the advice to “buy and hold”.

Five things to think about this week:

VALUATIONS
- The MSCI world stocks index has rebounded 37 percent since March, the VIX fear gauge has hit its lowest level since September 2008, and positive earnings surprises in Europe are marginally outstripping negative ones. But there are serious questions over the equity market’s ability to sustain its rise.

MACRO SIGNALS
- Trade data from the U.S., Canada and the UK, all out in this week, will be combed for signs of any recovery in global commerce. Also due are flash GDP data from the euro zone, industry output for the U.S., France, Italy, the euro zone and the UK, and Japan machinery orders.  
  
QUANTITATIVE EASING
- The ECB has finally shown willingness to deploy unconventional easing measures but it’s hard to judge the success of such steps. Narrowing credit spreads, stock markets’ bounce and gains in emerging market assets all show efforts to restore confidence in the financial system are having an effect. But if getting and keeping bond yields down is the yardstick for success, it’s unfortunate that 10-year UK and U.S. government bond yields are back up to levels seen before the announcement of quantitative easing in those countries. And diminishing returns on further balance sheet expansion raise questions over how much more money central banks can print before inflation fears start to preoccupy policymakers and markets.
  
COMMODITIES
- Confusion over the reasons for the commodities rally has reduced the usefulness of commodities prices as indicators of the industrial outlook. An apparent economic recovery in China has helped to boost the CRB commodities index by 21 percent from February’s lows. But how much does the rise reflect a change in supply/demand for commodities, and how much is it simply due to idle money flooding back to unstable markets? Similarly, why has spot gold remained strong above $900 as jitters over the financial system decrease? Gold could be reflecting expectations that recovering economies will boost physical demand for the metal, but it may also be responding to fears of currency debasement after central banks’ radical monetary easing.

EMERGING MARKETS 
- Rising commodity prices and an easing dollar have offered a perfect environment to re-enter emerging markets. The coming week’s  EBRD meeting will focus attention on central and eastern Europe and how it is coping with a nasty period of refinancing (albeit less dire than the IMF initially estimated).