Global Investing

Credit rules, ok?

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.

The performance of high-yield, or “junk” bonds, has been even better. From a spread of 2,193 basis points in December, the BoA-ML global high-yield index now registers 773.

And what now? Investors still like the asset class, but there is evidence that the degree of passion may be cooling.

“Normal” volatility to help rally?

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)

Know when to hold ‘em

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.

Are investors building for a fall?

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:

Befriending a trend

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”.

Big Five

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).

Something to show off

Top Chinese officials were busy showing off warships and submarines to celebrate the 60-year anniversary of their navy today, but they have something to boast about when it comes to their economy too.  It is, after all,  the world’s third largest.

China’s economy grew 6.1 percent in the first quarter, lower than expected but still far outpacing its G20 peers, many of which are stuck in recession.

Goldman Sachs has just upgraded its forecast for China, expecting 8.3% growth in 2009 (up from 6%) and 10.9% (from 9%).

The end of the end?

While nobody would be rash enough to predict the end of the economic downturn, there are certainly increasingly loud murmurs that the bottom of the stock market fall may have come.

Battered share prices have become so cheap that the pound signs are beginning to light up in the eyes of investors as they pile back in, and it’s smallcaps that are really shining. You only have to look at the numbers, companies like biotech firm Alizyme doubling at the end of last week and engineer White Young Green tripling.

What has happened of course is that as buyers come back to the market, they are finding a shortage of sellers, pushing up prices. Because the hardest hit shares are the ones that will bounce the hardest, it is the higher risk smaller end of the market that is seeing prices increase most steeply.

Big Five

Five things to think about this week:

EARNINGS DELUGE
– A heavy U.S. earnings week looms and the European reporting calendar is picking up. While more banks and financials will be reporting (e.g. Bank of America, Bank of New York Mellon, Credit Suisse and a trading update due from Barclays), results will start flowing from a wider range of sectors in both the U.S. and Europe (ranging from Apple and IBM to Glaxo SmithKline, Du Pont, Coca Cola). Health of the broader economy on display.

MACRO SIGNALS
– The more mixed signals that earnings send, the more investors are likely to look to macro and other indicators as a cross-check of whether the stock market rebound is sustainable and whether the economy is anywhere near an inflexion point. Flash PMIs and Ifo for April will give an early indication of how economic activity was faring as Q2 got underway. Trade data from Japan is also due for release.

FISCAL HELP
 – The UK budget on April 22 is expected to issue grim forecasts and extend a helping hand to some sectors, such as autos. The fiscal presentation will keep the spotlight on the limited room for budgetary manoeuvre in Britain and elsewhere with past bailouts and support measures leaving tough decisions to be made on public spending, taxes, etc.

Bear market rally/Bull market beginning?

Another month and another Reuters asset allocation poll. This time saw investors in United States, Europe and Japan lifting their equity holdings and cutting back slightly on bonds.  Fits with what has been happening on global financial markets, where MSCI’s main world stock index is heading for its best month in at least six years.

So the big question is what happens now. Is this a bear market bounce that will soon dissipate?  Or is it the start of something bullish that will last?