Global Investing

With a week to go in January, global stock markets are up 3.8 percent – gently nudging higher after the new year burst and with a continued evaporation of volatility gauges toward new 5-year lows. That’s all warranted by a reappraisal of the global economy as well as murmurs about longer-term strategic shifts back to under-owned and cheaper equities. But, as ever, you can never draw a straight line. If we were to get this sort of move every month this year, then total returns for the year on the MCSI global index would be 50 percent – not impossible I guess, but highly unlikely. So, at some stage the market will pause, hestitate or even take a step back. Is now the time just three weeks into the year?

Well lots of the much-feared headwinds have not materialized. The looming US budget ceiling showdown keeps getting put back – it’s now May by the way, even if another mini-cliff of sorts is due in March — but you get can-kicking picture here already. The US earnings season looks fairly benign so far, even given the outsize reaction to Apple after hours on Wednesday. European sovereign funding worries have proven wide of the mark to date too as money floods to Spain and even Portugal again. And Chinese data confirms a decent cyclical rebound there at least from Q3′s trough. All seems like pretty smooth sailing – aside perhaps from the UK’s slightly perplexing decision to add rather than ease uncertainty about its economic future. So what can go wrong? Well there’s still an event calendar to keep an eye on – next month’s Italian elections for example. But even that’s stretching it as a major bogeyman the likely outcome.

In truth, the biggest hurdle is most likely to be the hoary old problem of over-inflated expectations. Just look at the US economic surprise index – it’s tipped into negative territory for the first time since late last summer. Yet incoming US data has not been that bad this year. What the index tells you more about has been the rising expectations. (The converse, incidentally, is true of the euro zone where you could say the gloom’s been overdone.) Yet without the fuel of positive “surprises” we’re depending more on a structural story to buoy equity and that is a multi-year, glacial shift rather than necessarily a 2013 yarn. The start of the earnings season too is also interesting with regard to expectations. With little over 10 percent of the S&P500 reported by last Friday, the numbers showed 58% had beaten the street. That’s not bad at first glance but a good bit lower than the 65% average of the past four quarters. On the other hand, it’s been top-line corporate revenues that have supposedly been terrifying everyone and it’s a different picture there. Of the 10% of firms out to date, 65 percent have reported Q4 revenues ahead of forecasts – far ahead of the 50% average of the past four quarters. Early days, but that’s relatively positive on the underlying economy at least.

And the Apple story is yet another case in point. Even though its shares fell about 10% in after-hours trade on anything from a slight revenue miss, future guidance and market-share concerns — it says more about the scale of expectations built into this one, if spectacular, corporate story. Look at the actual numbers  and you see in absolute terms, its supposedly worrying iPhone shipments were still up 29% over the year to a new record and iPhone sales in greater China more than doubled. A tough crowd to please now, clearly, but again telling us more about expectations that underlying activity. For what it’s worth, Apple’s bottom-line earnings beat the street. 

And finally, the other big – structural rather than cyclical – story in play over the past 10 days has been the unwind of the euro safe-haven plays – hardly surprising given that now two of the three bailout countries (Ireland and Portugal) are back in the private markets again default-free and the one-time big worry (Spain) is drowning in foreign creditors all of a sudden. Bund, Treasury and Gilt yields of course have all been pushing higher, even though QE limits that move. But perhaps the biggest manifestation of the safe-haven exit has been the 3% Swiss franc retreat – who said the SNB couldn’t hold the line? Sterling’s slide too is as much to do with this as it is related to Cameron’s EU sideswipe. Watch out for others too – Nordic markets perhaps? London property? Gold is still higher on the year, but that just underlines the fact it was always more an inflation-hedge rather than haven from systemic shocks.       

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…

Investors keen to wade deeper into the euro zone’s quieter waters  will have 765 billion euros,  or just over $1  trillion, worth of fresh government bonds offered to them this year, nearly 8 percent less than in 2012,  Deutsche Bank writes in a report.

With the debt crisis quieting down, euro zone assets are among the top 2013 picks for many leading investors, with the likes of Societe Generale and AXA Investment Managers advising to head for the periphery with Spanish and Italian sovereign debt.

Deutsche Bank writes in its Eurozone 2013 supply outlook report, based on the bloc’s ten biggest bond issuers:

The new year starts with a markets ‘whoosh’, thanks to some form of detente in DC — though this one was already motoring in 2012. The New Year’s Eve rally was the biggest final day gain in the S&P500 since 1974, for what it’s worth.  And for investment almanac obsessives, Wednesday’s 2%+ gains are a good start to so-called “five-day-rule”, where net gains in the S&P500 over the first five trading days of the year have led to a positive year for equity year overall on 87 percent of 62 years since 1950.

So do we have a fiscal green light stateside for global investors? Or does it just lead us all to another precipice in two months time? Well, markets seem to have voted loudly for the former so far. And to the extent that at least some bi-partisan progress reduces the risk of policy accident and renewed recession, then that’s justified. And Wall St’s relief went global and viral, with eurostocks up almost 3% and emerging markets up over 2% on Wednesday. Even the febrile bond markets sat up and took notice, with core US and German yields jumping higher while riskier Italian and Spanish yields skidded to their lowest in several months.

So is all that New Year euphoria premature given we will likely be back in  the political trenches again next month?  Maybe, but there’s good reason to retain last year’s optimism for a number of basic reasons. As seasoned euro crisis watchers know well, the world doesn’t end at self-imposed deadlines. The worst that tends to happen is they are extended and there is even a chance of – Shock! Horror! – a compromise. Never rule out a disastrous policy accident completely, but it’s wise not to make it a central scenario either. In short, markets seem to be getting a bit smarter at parsing politics. Tactical volatility or headline-based trading wasn’t terribly lucrative last year, where are fundamental and value based investing fared better.  And the big issue about the cliff is that the wrangling has sidelined a lot of corporate planning and investment due to the uncertainties about new tax codes as much as any specific measures. While there’s still some considerable fog around that, a little of the horizon can now be seen and political winds seem less daunting than they once did. If even a little of that pent up business spending does start to come through, it will arrive the slipstream of a decent cyclical upswing.  China is moving in tandem meantime. The euro zone remains stuck in a funk but will also likely be stabilised at least by U.S. and Chinese  over the coming months. Global factory activity expanded again in December for the first time since May.

Hungary’s outlook upgrade to stable from positive by Fitch was greeted with incredulity by many analysts. Benoit Anne at Societe Generale wonders if the decision had anything to do with the Mayan prophecy that proclaiming the end of the world on Dec. 21:

What is the last crazy thing you would do on the last day of the world? Well, the guys at Fitch could not find anything better to do than upgrading Hungary’s rating outlook to stable. Now, that really makes me scared.

A bit brutal maybe but the point Anne wants to make is valid — nothing fundamental has changed in Hungary — its GDP growth and debt numbers are looking as dire as before and the central bank is still subject to political interference.

Adversity is a great leveller. Just look at the way sovereign credit ratings in the developed and emerging world have been converging ever since the credit crisis erupted five years ago. JPMorgan  has crunched a few numbers.

Few were surprised last week by S&P’s decision to cut the outlook on Britain’s AAA rating to negative. That gold-plated rating is becoming increasingly rare — according to JP Morgan, just 15 percent of global GDP now rates AAA with a stable outlook — a whopping comedown from 50 percent in 2007. Only 13 developed economies are now rated AAA, compared to 21 before the crisis. And only one, Australia, now has a higher rating (AAA) than in 2007 — 16 of its peers have suffered a total of 129 downgrades in this period.  With 20 rich countries on negative outlook, more downgrades are likely.

Emerging sovereigns, on the other hand, have enjoyed 189 upgrades (43 percent of these were moves into investment grade). That has caused what JPM dubs “a traffic jam”  in the triple B ratings area, with 20 percent of world GDP now rated at this level, compared to 8 percent in 2009.

Is there room only for the biggest, most aggressively-marketed funds in crisis-hit Europe?

Europe’s ten best-selling funds have attracted nearly a third of net sales across bonds, equity and mixed assets so far this year, as the grey bars show in the following chart from Thomson Reuters’ fund research firm Lipper.

TEN MOST SUCCESSFUL FUNDS’ NET SALES AS A PROPORTION OF ALL SALES

The numbers — which exclude ETFs — are even more staggering if looking at at the concentration of sales into groups/companies, rather than at fund level.

JP Morgan has an interesting take on the stupendous recent rally in the credit default swaps (CDS) of countries such as Poland and Hungary which are considered emerging markets, yet are members of the European Union. Analysts at the bank link the moves to the EU’s upcoming ban on “naked” sovereign CDS trades — trade in CDS by investors who don’t have ownership of the underlying government debt. The ban which comes into effect on Nov. 1, was brought in during 2010 after EU politicians alleged that hedge funds short-selling Greek CDS had exacerbated the crisis.

JP Morgan notes that the sovereign CDS of a group of emerging EU members (Bulgaria, Croatia, Hungary, Lithuania, Poland and Romania) have tightened 100 basis points since the start of September, while a basket of emerging peers including Brazil, Indonesia and Turkey saw CDS tighten just 39 bps. See the graphic below:

Spread tightening was of a similar magnitude in both groups before this period, JPM says (the implication being that traders have been selling some of their “naked” CDS holdings in these markets ahead of the ban):

British investors are warming up to European equities, with the highest level of positive or rather positive views of the troubled bloc’s stocks in a year, an online survey by Baring Asset Management shows:

The biggest rise in sentiment was seen towards European equities, with over half (53%) of respondents saying they were now either ‘quite’ or ‘very’ favourable, up from 42% in the last survey and the most favourable they have been towards the European equity sector for a year.

UK investors remain more positive on stocks from emerging markets, the United States and Asia ex-Japan, but with ratings down from the previous poll three months ago, and UK equities are also viewed more favourably. The poll answered by just over 100 respondents between Aug 22-Sept 19 shows the euro zone crisis is still considered the biggest global economic challenge.

The Olympic medals have all been handed out and the athletes are on their way home.  Which countries surpassed expectations and which ones did worse than expected? And did this have anything to do with the state of their economies?

An extensive Goldman Sachs report entitled Olympics and Economics  (a regular feature before each Olympic Games) predicted before the Games kicked off that the United States would top the tally with 36 gold medals. It also said the top 10 would include five G7 countries (the United States, Great Britain, France, Germany and Italy), two BRICs (China and Russia), one of the developing countries it dubs Next-11  (South Korea), and one additional developed and emerging market. These would be Australia and Ukraine, it said.

Close enough, except that Hungary took the place of Ukraine as the emerging economy in the Top 10 and the United States actually took 46 gold medals — more than Goldman had predicted.