Global Investing

Weekly Radar: Glass still half-full?

ECB,BOE,RBA MEETINGS/ US-CHINA DEC TRADE DATA/CHINESE INFLATION/EU BUDGET SUMMIT/EUROPEAN EARNINGS/BUND AUCTION/SERVICES PMIS

Wednesday’s global markets were a pretty good illustration of the nature of new year rally. The largest economy in the world reported a shock contraction of activity in the final quarter of 2012 despite widespread expectations of 1%+ gain and this month’s bulled-up stock market barely blinked. Ok, the following FOMC decision and Friday’s latest US employment report probably helped keep a lid on things and there was plenty of good reason to be sceptical of the headline U.S. GDP number. Reasons for the big miss were hooked variously on an unexpectedly large drop in government defence spending, a widening of the trade gap (even though we don’t get December numbers til next week), a drawdown in inventories, fiscal cliff angst and “Sandy”. Final consumer demand looked fineand we know from the jobs numbers (and the January ADP report earlier) that the labour market remains relatively firm while housing continues to recovery. The inventory drop could presage a cranking up assembly lines into the new year given the “fiscal cliff” was dodged on Jan 1 and trade account distortions due to East Coast storms may unwind too. So, not only are we likely to see upward revisions to this advance data cut, there may well be significant “payback” in Q1 data and favourable base effects could now flatter 2013 numbers overall.

Yet as logical as any or all of those arguments may be,  the reaction to the shocker also tells you a lot about the prevalent “glass half full” view in the market right now and reveals how the flood of new money that’s been flowing to equity this year has not been doing so on the basis on one quarter of economic data. An awful lot of the investor flow to date is either simply correcting extremely defensive portfolios toward more “normal” times or reinvesting with a 3-5 year view in mind at least. There’s a similar story at play in Europe. Money has come back from the bunkers and there’s been a lock-step improvement in the “big picture” risks – we are no longer factoring in default risk into the major bond markets  at least and many are now happy to play the ebb and flow of economics and politics and market pricing within more reasonable parameters. There are no shortage of ghosts and ghouls still in the euro cupboard – dogged recession, bank legacy debt issue, Cyprus, Italian elections etc – but that all still seems more like more manageable country risk for many funds and a far cry from where we were over the past two years of potential systemic implosion. Never rule out a fresh lurch and the perceived lack of market crisis itself may take the pressure off Brussels and other EU capitals to keeping pushing hard to resolve the outstanding conundrums. But it would take an awful lot now to completely reverse the recent stabilisation, not least given the ECB has yet to fire a bullet of its new OMT intervention toolkit.

And so a hugely impressive January for risk assets comes to a close today. For the record, global stocks have clocked up almost  5% – the best month in 12, even if still shy of last Janauary’s 5.7% gain. Wall St stocks, where total returns indices hit record highs last September, are now within reach of new price records after a 5.7% gain this month. Although January is typically an the best month of the year for stocks, this year’s gain is more than three times the average January gain of since 1928 and there have been record new investor flows in excess of $55 billion. If only for health reasons alone, February will not be as effervescent and the final days of this month already see some cooling of prices and firming of volatility indices.  There may well be some pullback if any of the peristent euro zone or US political rows gain more attention  — but few assume this shift will evaporate as easily as it has done in recent years.

DATA/EVENTS TO WATCH NEXT WEEK

Europe Q4 earnings Mon: Julius Baer

Spain PM Rajoy meets Germany’s Merkel in Berlin Mon

RBA rate decision Tues

Europe Q4 earnings Tues: UBS, BP, BG

Global Feb services PMIs Tues

EZ Dec retail sales Tues

France’s Hollande speech to European Parliament Tues

Europe Q4 earnings Weds: GlaxoSK, ArcelorMittal, Svenska Handelsbanken, Volvo

German 5-yr government debt auction Weds

Poland/Iceland rate decisions Weds

US Q4 earnings Weds: Marathon/Time Warner

Europe Q4 earnings Thurs: Vodafone, Credit Suisse, Daimler, Danske, Telecom Italia

Who’s driving the equity rally?

Does the money match the story?

Perhaps the biggest investment theme of the year so far has been the extent to which long-term investors may now slowly migrate back to under-owned and under-priced equities from super-expensive safe haven bunkers such as ‘core’ government bonds, yen, Swiss francs etc to which they herded at each new gale of the 5-year-old credit storm.

Indeed, some go further and say asset allocation mixes of the big institutional pension and insurance funds are – for a variety of regulatory and demographic reasons – now at such historical extremes in favour of bonds that they may now need rethinking in what some dub The Great Rotation.

All this has played into a new year whoosh in equity and other risk markets, as ebbing tail risks from the euro zone, US budget and China combine with signs of a decent cyclical turn in the world economy into 2013. Wall St’s S&P500, for example, has climbed 5.5% in January so far and closed above 1500 for the first time in more than five years last week following its longest winning streak (8-days) in eight years.

Weekly Radar: Cliff dodging and Euro recessions

Most everything got swept up in the US election over the past week but, for all the last minute nail biting  and psephology, it was pretty much the result most people had been expecting all year. So, is there anything really to read into the market noise around the event? The rule of thumb in the runup was a pretty crude — Obama good for bonds (Fed friendly, cliff brinkmanship, growth risk) and Romney good for stocks (tax cuts, friend to capital/wealth, a cliff dodger thanks to GOP House backing and hence pro growth). And so it played out Wednesday. But in truth, it’s been fairly marginal so far. Stocks were down about 2 pct yesteray, but they’d been up 1 pct on election day for no obvious reason at all. But can anyone truly be surprised by an outcome they’d supposedly been betting on all along. (Just look at Intrade favouring Obama all the way through the runup). Maybe it’s all just risk hedging at the margins. What’s more, like all crude rules of thumb, they’re not always 100 pct accurate anyway.  Many overseas investors just could not fathom a coherent Romney economic plan anyway apart from radical political surgery on the government budget that many saw as ambiguous for growth and social stability anyhow.  Domestic investors may more understandably wring their hands about hits on dividend and income taxes, but it wasn’t clear to everyone outside that that a Romney plan was automatically going to lift national growth over time anyhow.

That said, it was striking on Wednesday that even though global funds were mostly relieved the Fed won’t now be shackled after 2014, nearly everyone still expects the fiscal cliff to be resolved by compromise. Whether that’s wishful thinking or the smartest guess remains to be seen. But, just like in Europe, it means they are at the very least going to have endure a barrage of political noise in headlines and endless scaremongering before any deal is ultimately forthcoming. Some say the nature of the GOP defeat, even with an incumbent saddled with an 8 pct unemployment rate, will force enough moderate Republicans to seek distance from Tea Party and seek compromise. But others point out that post-Sandy relief  spending may also bring the dreaded debt ceiling issue forward sooner than expected now too. All in all, the overwhelming consensus still betting on an eventual cliff dodge may be the most worrying aspect of market positioning and may be the best explanation the slightly outsize and sudden stock market reaction.

It also presupposes markets are trading solely on U.S. issues when the other world worries remain.

Fears of collateral drought questioned

Have fears of global shortage of high-grade collateral been exaggerated?

As the world braces for several more years of painful deleveraging from the pre-2007 credit excesses, one big fear has been that a shrinking pool of top-rated or AAA assets — due varioulsy to sovereign credit rating downgrades, deteriorating mortgage quality, Basel III banking regulations, central bank reserve accumulation and central clearing of OTC derivatives — has exaggerated the ongoing credit crunch. Along with interbank mistrust, the resulting shortage of high-quality collateral available to be pledged and re-pledged between banks and asset managers,  it has been argued, meant the overall amount of credit being generating in the system has been shrinking,  pushing up the cost and lowering the availability of borrowing in the real economy. Quantitative easing and bond buying by the world’s major central banks, some economists warned, was only exaggerating that shortage by removing the highest quality collateral from the banking system.

But economists at JPMorgan cast doubt on this. The bank claims that the universe of AAA/AA bonds is actually growing by around $1trillion per year.  While central bank reserve managers absorb the lion’s share of this in banking hard currency reserves,  JPM reckon they still take less than half of the total created and, even then, some of that top-rated debt does re-enter the system as some central bank reserve managers engage in securities lending.

Citing a recent speech by ECB Executive Board member Benoit Coere dismissing ideas of a collateral shortage in the euro zone, JPM said ECB action in primary covered bond markets and in accepting lower-rated and foreign currency collateral had helped. It added that the average amount of eligible collateral available for Eurosystem liquidity operations was 14.3 trillion euros in the second quarter of 2012 — with 2.5 trillion euros of that put forward as collateral by euro zone banks to be used in the ECB’s repo operations of 1.3 trillion.  Critically, the majority of that 2.5 trillion posted at the ECB was either illiquid collateral such as bank loans or collateral associated with peripheral issuers and thus unlikely eligible for use in private repo markets anyway, they added. This process of absorbing low quality collateral in order to free up higher-quality assets for private use has been an approach of both the ECB and Bank of England.

Wages wag the tail of the DAX

This week, Germany celebrated its Tag der deutschen Einheit (Day of German Unity) marking twenty-two years since the wall was torn down between East and West.

Back in the present, Frankfurt’s main share index, the DAX, has outperformed all of its European peers this year and in dollar terms has outshone almost every other global equity index. Re-unification has been painful, fostering social tensions and still huge disparities between east and west, but some analysts argue that it is precisely those disparities, not least in wages, which have underpinned the primacy of German stocks today.

There are other crucial factors of course. Germany’s high-value and high cost exports such as BMW cars are in high demand in countries such as China and India, all the more because of the weak euro.  And despite the outperformance, the market seems to price German stocks as bargains — they currently trade around 10 times forward earnings compared to over 12 times for the world index. According to fund managers at Baring Asset Management:

What would a benign dictator do with the euro?

The idea of a “benign dictator” may well be an oxymoron but as a thought exercise it goes a way to explaining why giant global fund manager Blackrock thinks the chances of a euro zone collapse remains less than 20 percent.  When push comes to shove, in other words, Europe can sort this mess out. Speaking at an event showcasing the latest investment outlook from Blackrock Investment Institute, the strategy hub of the investment firm with a staggering $3.7 trillion of assets under management,  Richard Urwin said the problem in trying to second-guess the outcome of the euro crisis was the extent to which domestic political priorities were working against a resolution of the three-year old crisis.

“The thing is if you could imagine a benign dictator, then the problems are all solvable and could be fixed in a matter of weeks,” said Urwin, who is Head of Investments at Blackrock’s Fiduciary Mandate Investment Team.  Playing with the idea, Urwin said parts of a workable plan may involve debt rescheduling or restructuring for the existing bailout countries Greece, Portugal and Ireland; a buildup of a sufficiently large liquidity fund to help the larger countries such as Spain and Italy; a euro banking union with deposit guarantees and single supervisor to ring-fence and close insolvent banks that will never function properly; the creation of a central finance ministry and the issuance of jointly-guaranteed euro bonds etc etc.

Urwin’s point of course was not to advocate a dictator for the euro zone — although he acknowledged the euro was not exactly a child of European electorates to begin with–  rather that euro members have the ability if not the willingness yet to solve the crisis and that global investors looking for signposts in the saga needed to watch closely the runes of political cooperation and leadership instead of the economics and debt dynamics alone.  Where exactly that turns is hard to guess, but but it may well be that the process that has to wait until the German elections next year, he added.

Next Week: Big Black Cloud

Following are notes from our weekly editorial planning meeting:

Not unlike this year’s British “summer”, the gloom is now all pervasive. Not panicky mind, just gloomy. And there is a significant difference where markets are concerned at least. The former involves surprise and being wrongfooted — but latter has been slow realisation that what were once extreme views on the depth of the credit swamp are fast becoming consensus thinking. The conclusion for many now is that we’re probably stuck in this mire for several more years – anywhere between 5 and 20 years, depending on your favoured doom-monger. Yet, the other thing is that markets also probably positioned in large part for that perma-funk — be it negative yields on core government debt or euro zone equities now with half the p/e ratios of US counterparts. In short, the herd has already  hunkered down and finds it hard to see any horizon. Those who can will resort to short-term tactical plays based on second-guessing government and central bank policy responses (there will likely be more QE or related actions stateside eventually despite hesitancy in the FOMC minutes  and Fed chief Bernanke will likely give a glimpse of that thinking in his congressional testimony next week); or hoping to surf mini econ cycles aided by things like cheaper energy; or hoping to spot one off corporate success stories like a new Apple or somesuch.

So has all hope been snuffed out? The reason for the relapse mid-year depression is only partly related to the political minefield frustrating a resolution of the euro crisis – in some ways, things there look more encouraging policywise than they did two months ago. It stems as much from a realization of just how broken the banks credit creation system remains – a system that had hinged heavily on extensive collateral chains that have now largely been broken or shortened and starved of acceptable high-quality collateral. Curiously, QE – by removing even more of the top quality collateral – may even be exaggerating the problem. Some even say the extreme shortage of this quality “collateral” may require more, not less, government debt in the US and UK and would also benefit from a pooling of euro debt  – but everyone knows how easy all that’s going to be politically.

Despite all this, global markets have remained fairly stable over the past week – in part due to policy hopes underpinning risk markets and in part because there’s not many places left to hide without losing money in “safe-haven” bunkers. World equities are down about 2 percent over the past week,  but still up more than 6 percent from early June. Risk measured by volatility indicesis a smidgen higher too. Oil has firmed back toward $100pb, disappointing everyone apart from oil exporters. Spanish and Italian 10-yr yields are a touch higher. And at least part of the caution everywhere is ae vigil ahead of Chinese Q2 GDP data on Friday – numbers that now almost rival the U.S.  monthly payrolls in global market impact.

Next Week: Managed expectations

Here’s a view of next week from our team’s weekly news planner:

Not unlike England’s performance at the Euro 2012 football tourament, EU summit expectations have been successfully lowered in advance by all concerned and  so it will be hard to disappoint as a result!

The gnawing realization in markets is that the really game-changing steps by Germany on some form of debt pooling now look unlikely before next year’s general election there and so investors may have to hang on tight to what can get done in the meantime if the system is to hold together. Yet for all the understandable policy scepticism, there are a lot of big changes on the table — from banking union, more flexible budget-cutting programs, infrastructure growth pushes, a roadmap at least to euro bonds and a euro finance ministry and the launch of the ESM next month (barring a last-minute torpedo from the German constitutional court at least).  It may be a little too easy to dismiss all that is happening just because there’s not going to be a grand instant fix ready for Monday. The ESM alone should have powerful stabilization powers for markets at least. What’s more, Merkel says ”over my dead body” to Euro bonds in one breath, and then “when conditions are right” in another. Assuming she’s referring to her political body, then even these may not be a million miles away.

But the saga has become as much about politics and personalities now as percentages and public opinion, and so you always have to factor in the chance of a major bust-up or row. Broad agreement itself, as a result, may be a relief for a bit come next week — at least until Thursday’s next Spanish debt auction!

Next week: Half time…

QE, some version of it or even the thought of it, seems to have raised all boats yet again — for a bit at least. You’d not really guess it from all the brinkmanship, crisis management and apocalyptic debates of the past month, but June has so far turned out to be a fairly upbeat month – weirdly. World equities are up more than 6 percent since June, lead by a 20 percent jump in European bank stocks and even a 20 percent jump in depressed Greek stocks. The Spanish may found themselves at the centre of the euro debt storm now, but even 10-year Spanish debt yields have returned to June 1 levels after briefly toying with record highs above 7%  in and around its own bank bailout and the Greek election. And the likes of Italian and Irish borrowing rates are actually down this month.  Ok, all that’s after a lousy May that blew up most of the LTRO-inspired first-quarter market gains. But, on a broad global level at least, stocks are still in the black for the year so far. It was certainly “sell in May” yet again this year, but it’s open question whether you stay away til St Ledgers day in September, as the hoary old adage would have it.

On the euro story, the Greeks didn’t go for the nuclear option last weekend at least and it looks like there are some serious proposals on the EU summit table for next week – talk of banking union, EFSF/ESM bond buying programmes, euro bills if not bonds, EIB infrastructure/project bonds to try and catalyse some growth,  and reasonable flexibility from Berlin and others on bailout austerity demands. The Fed has announced that it will twist again like it did last summer, by extending the Treasury yield curve programme by more than a quarter of a trillion dollars, and there are still hopes of it at least raising the prospect of more direct QE. The BoE is already chomping at that bit, as well as lending direct to SMEs, and most investors expect some further easing from the ECB in the weeks and months ahead.

Of course all that could disappoint once more and expectations are getting pumped up again as per June market performance numbers. The EU summit won’t deliver on everything, but there is some realization at least that they need to talk turkey on ways to prevent repeated rolling creditor strikes locking out governments out of the most basic of financing — only then have those very same creditors shun countries again when they agree to punishing fiscal adjustments. A credible growth plan helps a little but some pooling of debt looks unavoidable unless they seriously want to remain in perma-crisis for the rest of the year and probably many years to come. It may be a step too far before next year’s German elections, but surely even Berlin can now see that the bill gets ever higher the longer they wait.

Stumbling at every hurdle

Financial markets are odd sometimes. For weeks they have fretted about the outcome of the Greek election and its impact on the future of the euro zone as a whole. But today they appeared to dismiss the outcome despite a result that was about as positive as global investors fearful for euro zone stability could have hoped for.  So what gives?

The logic behind the weeks of trepidation was fairly simple and straightforward. After an inconclusive election on May 6, a second Greek poll on June 17 was due to give a definitive picture of whether Greeks wanted to stay in the euro and with all the budgetary conditions necessary to keep EU/IMF bailout funds in place.  If a victory for parties wanting to scrap the bailout agreement and austerity led to a halt of EU/IMF funds, the fear was that Greece would inevitably be forced out of the single currency bloc in time too. And if that unprecedented event happened, then a chain reaction would be hard to avoid.  If one country goes back to its domestic currency, despite all its debts being denominated in euros, investors would then find it impossible not to assume at least some element of euro exit risk for fellow-bailout recipients Portugal and Ireland and possibly even Spain and Italy, where doubts remain about their market access over time.

Extreme tail risk or not, this set the scene for the jittery markets that ensued during the Greek electoral hiatus of May 6- June 17. Athens stocks lost more than 17%;  Spanish 10-year government bonds lost more than 7% and the euro/dollar exchange rate was down almost 4%. etc. The fear of euro-wide contagion was so-great that the Spanish bank bailout in the interim had a little or no positive impact. And with the global economic growth picture weakening in tandem with, and partly because of, the euro mess, then prices reflecting world demand in general were hit hard by concerns that another shock to the European banking system could trigger a reversal of trillions of euros of European bank lending from around the globe. Crude oil dropped almost 14%, broad commodity prices and emerging market equities lost about 8%.