Global Investing

Time for a slice of vol?

As the global markets consensus shifts toward a “basically bullish, but enough for now” stance — at least before Fed chief Bernanke on Monday was read as rekindling Fed easing hopes — more than a few investment strategists are examining the cost and wisdom of hedging against it all going pear-shaped again. At least two of the main equity hedges, core government bonds and volatility indices, have certainly got cheaper during the first quarter. But volatility (where Wall St’s Vix index has hit its lowest since before the credit crisis blew up in 2007!) looks to many to be the most attractive option. Triple-A bond yields, on the other hand, are also higher but have already backed off recent highs and bond prices remain in the stratosphere historically.  And so if Bernanke was slightly “overinterpreted” on Monday — and even optimistic houses such as Barclays reckon the U.S. economy, inflation and risk appetite would have to weaken markedly from here to trigger “QE3″ while further monetary stimuli in the run-up to November’s U.S. election will be politically controversial at least — then there are plenty of investors who may seek some market protection.

Societe Generale’s asset allocation team, for one, highlights the equity volatility hedge instead of bonds for those fearful of a correction to the 20% Wall St equity gains since November.

A remarkable string of positive economic surprises has boosted risky assets and driven macro expectations higher but has also created material scope for disappointment from now on. We recommend hedging risky asset exposure (Equity, Credit and Commodities) by adding Equity Volatility to portfolios.

 

Market exhaustion?

It’s curious to see so many asset managers reaffirm their faith in a bullish 2012 for world markets just as a buzzing first quarter comes to a close on Friday with hefty gains in equities and risk assets.  Whether or not there is a mechanical review of portfolios at quarter end, it’s certainly a reasonable time for review. The euro zone crisis has of course eased, the ECB has pumped the banks full of cash and the U.S. recovery continues.  So, no impending disaster then (unless you subscribe to the increasingly-prevalent hard-landing fears in China). But after 11+ percent gains in world equities in just three months on the back of all this information, you have to wonder where the “new news” is going to come from here. The surprise factor looks over and we’re highly unlikely to get 10%+ gains in global stocks every quarter this year.  So, is it time for tired markets to sober up for a while or maybe even reconsider the risk of reversal again? Strategists at JPMorgan Asset Management, at least, reckon the economic news has just lost its oomph.

There are broad signs of exhaustion in markets, which is coinciding with a softening in the data, suggesting that in the short term the moderation in the “risk on” environment may continue.

JPMAM cite the rollover in the Citigroup economic surprises indices, shown below, and also say their own propietary Risk Measurement index — a 39-factor model built on data from money markets, equities, economic data, commodities etc — is flagging more caution.

Hungary’s plan to get some cash in the bank

Hungary says it might borrow money from global bond markets before it lands a long-awaited aid deal with the International Monetary Fund. That pretty much seems to suggest Budapest has given up hope of getting the IMF cash any time soon. Given the fund has already said it won’t visit Hungary in April, that view would seem correct.

There is some logic to the plan.

Hungary desperately needs the cash — it must  find over 4 billion euros just to repay external debt this year.

It is also an attractive time to sell debt.  Appetite for emerging market debt remains strong. Emerging bond yield premiums over U.S. Treasuries have contracted sharply this year and stand near seven-month lows. Moreover, U.S. Treasury yields may rise, potentially making debt issuance more costly in coming months.

Russia’s new Eurobond: what’s the fair price?

Russia’s upcoming dollar bond, the first in two years, should fly off the shelves. It’s good timing — elections are past, the world economy seems to be recovering and crucially for Russia, oil prices are over $125 a barrel.  And the rise in core yields has massively tightened emerging markets’ yield premium to  U.S. Treasuries, offering an attractive window to raise cash.  Russia’s spread premium over Treasuries hit the narrowest levels in 7 months recently and despite some widening this week it is still some 75 basis points below end-2011 levels.

Initial indications from the ongoing roadshow are for a two-tranche bond with 10- and 20-year maturities, possibly raising a total of $3.5 billion.

But market bullishness notwithstanding, investors say Moscow should resist temptation to price the bond too high, a mistake it made during its last foray into global capital markets in April 2010. Fund managers have unpleasant memories of that deal, recalling that Russia unexpectedly tightened the yield offered by 25-28 bps, making the bond an expensive one for investors who had already placed bids. The bond price fell sharply once trading kicked off and yields across the Russian curve rose around 25-30 basis points. Jeremy Brewin, a fund manager at Aviva said:

The Great Switchback and the ERP?

The risk of a whiplash-inducing switchback from core AAA bonds to equity and risk — now that euro/banking systemic fears have eased and a global economic stabilisation seems to be underway — is suddenly top of most investors’ agendas.  Last week’s surge in U.S. Treasury, German bund and British gilt yields as global stocks caught a fresh updraft saw U.S. equity outperform bonds by almost 5 percent, according to Societe Generale. While not historically shocking in itself, SG reckons the cumulative weight of several weeks of this may well be having its impact on asset managers as the Q1 comes to an end.

Coming on the back on several weeks of equity outperformance, those remaining overweight bonds will be finding life particularly uncomfortable right now.

The question for most strategists is whether this is start of a wholesale rebasing of portfolios that could see dramatic asset allocation shifts over the coming quarters.

Retreat of Tail-Risk Trinity

Until this week at least, one of the big puzzles of the year for many investors was squaring a 10-15% surge in equity indices with little or no movement in rock-bottom U.S., German and UK government bond yields. To the extent that both markets reflect expectations for future economic activity, then one of them looks wrong. The pessimists, emboldened by the superior predictive powers of the bond market over recent decades, claim the persistence of super low U.S. Treasury, German bund and British gilt yields reveals a deep and pervasive pessimism about global growth for many years to come. Those preferring the sunny side up reckon super-low yields are merely a function of central bank bond buying and money printing — and if those policies are indeed successful in reflating economies, then equity bulls will be proved correct in time. A market rethink on the chances for another bout of U.S. Federal Reserve bond-buying after upbeat Fed statements and buoyant U.S. economic numbers over the past week also nods to the latter argument.

But as we approach the final fortnight of the first quarter,  more seems to be going on. Much of the whoosh of Q1 so far has merely been a reversal of the renewed systemic fears that emerged in the second half of last year. In fact, gains in world equity indices of circa 13% are an exact reversal of the net losses suffered between last June and the end of 2011.  And if those gains are justified, then much of the extreme “tail risks” that scared the horses back then must have been put to rest too, no? Well, the two mains tail risks — a euro zone breakup or collapse and a lapse of the U.S. economy into another recesssion or depression — do look to have been been put to bed for now at least. The ECB’s mega 3-year cash floods in December and February and the “orderly” Greek debt default and restructuring last week have certainly eased the euro strain. The remarkable stabilisation of U.S. labour markets, factory activity, household credit and even retail sales has also silenced the double-dippers there for now too.

The net result seems to have been this week’s synchronised retreat in three of the main “catastrophe hedges” — gold, AAA-government bonds and equity volatility indices — and this move could well mark a critical juncture. Gold is down 8% since its 2012 peak on Leap Day,  10-year U.S., UK and German government bond yields are up 25/30 basis points since Monday alone, and equity volatility gauges such as Wall St’s ViX have dropped to levels not seen since before the whole credit crisis exploded in the summer of 2007.  If extreme systemic fears are genuinely abating and the prevalence of even marginal positioning like this in investment portfolios is being unwound, then there may well be some seismic flows ahead that could add another leg to the equity rally.  The U.S. bias in all this is obvious with the rise of the dollar exchange rate index to its highest since January. That has its own investment ramifications — not least in emerging markets. But the questions for many will remain. Is the coast really clear? Are elections over the coming weeks in France and Greece and an Irish referendum on the euro fiscal pact just sideshows? Is the global economy sufficiently repaired to bet on renewed growth from here and will corporate earnings follow suit? Has bank and household deleveraging across the western world halted? Are the oil price surge and geopolitical risks in the Middle East no longer a concern? And if you’ve made 10-15% already this year, are you going to go double or quits?  The chances are there will not be 10-15% equity gains in every quarter this year.

Slipping up on oil and Greece?

Thursday’s crude oil price surge to its highest in almost 4 years (apparently due to a subsequently denied report from Iran of a Saudi pipeline explosion…phew!)  illustrates just how anxious and dangerous the energy market has become for world markets yet again this year and HSBC on Friday spotlighted its threat to the global economy and asset prices in a note entitled  “Oil is the new Greece”. The point of the neat headline hook was a simple one:

With Greece disappearing, at least temporarily, from the headlines, investors have quickly found a new source of anxiety thanks to the recent surge in oil prices

Just like many investors and strategists over the past month, HSBC rounded up its various assessments of the impact and fallout from higher oil prices, stressing the biggest risk comes from supply disruptions related to the Iran nuclear standoff and that any major political upheaval in the region would threaten significant crude spikes. “Think $150 or even $200 a barrel,” it said. It reckoned the impact on world growth, and hence the broader risk horizon depended on the extent of this supply disruption and the durability and scale of the price rise.  Worried equity investors should consider hedging their portfolios by overweighting the energy sector. Obvious winners in currency world would be the Norwegian crown, Malaysian ringitt, Brazil’s real and Russia’s rouble, the bank’s strategists said. The most vulernable units are India’s rupee, Mexican and Philippines pesos and Turkey’s lira.

Turkey gearing up for rate cuts but not today

Could the Turkish central bank surprise markets again today?

Given its track record, few will dare to place firm bets on the outcome of today’s meeting but the general reckoning for now is that the bank will keep borrowing and lending rates steady and signal no immediate change to its weekly repo rate of 5.75 percent. With year-on-year inflation in the double digits, logic would dictate there is no scope for an easier monetary policy.

But there are reasons to believe the Turkish central bank, whose mindset is essentially dovish, is letting its thoughts stray towards rate cuts. Consider the following:

a) Governor Erdem Basci has already said he does not see the need for further policy tightening  b)The lira has strengthened  9 percent this year against the dollar and is back at levels last seen in early September, thanks to almost one billion dollars in foreign flows to the Turkish stock market and well-subscribed bond issues. And crucially c) Global factors are supportive (developed central banks are continuing to pump liquidity and a bailout  has finally been agreed for Greece) .

Discovering the pleasure of dividends in Russia

American financier J.D. Rockefeller said watching dividends rolling in was the only thing that gave him pleasure. But it is a pleasure which until now has largely bypassed shareholders in most big Russian companies. That might be about to change.

Russian firms,  especially the big commodity producers, are generally seen as poor dividend payers. So dividend yields, the ratio of dividends to the share price,  have been unattractive.

On a trailing 5-year period, the average dividend yield in Russia was 1.8 percent compared to 2.5 percent for emerging markets, notes Soren Beck-Petersen, investment director for emerging markets at HSBC Global Asset Management. That absence of positive cash flow from companies is one reason why Russia has always traded so cheap relative to other emerging markets, he says.

Emerging Markets: the love story

It is Valentine’s day and emerging markets are certainly feeling the love. Bank of America/Merrill Lynch‘s monthly investor survey shows a ‘stunning’ rise in allocations to emerging markets in February. Forty-four percent of  asset allocators are now overweight emerging market equities this month, up from 20 percent in January — the second biggest monthly jump in the past 12 years. Emerging markets are once again investors’ favourite asset class.

Looking ahead, 36 percent of respondents said they would like to overweight emerging markets more than any other region, with investors saying they would underweight all other regions, including the United States. Meanwhile investor faith in China has rebounded  with only 2 percent of investors believing the Chinese economy will weaken over the next year, down from 23 percent in January. China also regained its crown of most favoured emerging market in February.

Last year, the main EM index plummeted more than 20 percent as emerging assets fell from favour. So what is the reason for this renewed passion in 2012?