Global Investing

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.

Elsewhere, we’re still waiting more details on China’s leadership handover and monthly economic data dump this week. But Europe hasn’t disappointed the gloomsters with another round of GDP downgrades and industrial unrest to darken the winter skies some more. EZ Q3 GDPs are out there next week and there’s still plenty to chew on surrounding knife-edge Greek austerity votes – not to mention rolling Spain saga, EU budget spat and Italy and French debt auctions next week.

Overall, global stocks are down just over one percent this week  – slowly chipping away at the year’s double-digit gains with little over a month to go in 2012 and as Treasuries rally again. Vol is up a bit, oil is down, euro debt yields and gold are slightly higher. Given the news headline backdrop over the coming weeks, it wouldn’t be surprising to see the year’s favourite trades unwind further into yearend. Of course, any  sign that the cliff’s been avoided would clear the decks for 2013 and the underlying investor is still broadly bullish. So, some murky times ahead perhaps.

Research Radar: Very 20th century

Wednesday’s market commentaries are loaded with the buzz around another technical UK recession in Q1 (the first time Britain has suffered what many see as a ‘double-dip’ since the 1970s); guessing about Wednesday’s FOMC outcome; and the European Commission letting Hungary off the hook about its controversial constitutional changes. In aggregate, and probably due to the looming FOMC,  markets are fairly stable – world equities, including euro stocks, emerging markets and even Britain’s FTSE are all higher. The US dollar, Treasuries,  volatility gauges, gold and even peripheral euro government bond yields are all down a bit.

Following is a selection of some of Wednesday’s interesting research ideas:

- Barclays’ Barry Knapp reckons US and world equities face a dilemma from the endless distortion to multiples and risk premia from monetary intervention and QE that is artifically lowering the risk-free rate akin to the “financial repression” of the 1950s — no one is sure now if equity is cheap or bonds just very expensive. He concludes that best thing for equities in the medium to long term is to avoid further QE but the problem is that stocks will almost certainly suffer in the short run if the Fed takes QE3 off the table. What’s more, Wednesday’s FOMC could be problem for markets initally if the Fed frets about the growth outlook, but a worsening of the economy might bring QE3 sooner than similar bouts in 2010 and 2011.

Two months rally + long markets = correction?

The debate in global financial markets is whether the new year’s rally is either just pausing or coming to an end.

Many say the rally so far has been driven by only thin volumes (for more on volumes read this story) and thin volume rallies tend to outlive high volume stampedes.

The market certainly seems to be getting very long — which itself suggests that the market was due for a correction one way or another.

Calculating euro breakup shocks

Euro breakup risks, although subsiding, are still high on investor minds.

Almost one in two fund managers surveyed by Bank of America Merrill Lynch last month said they expect a euro zone country to leave the monetary union.

Technology services company SunGard, which has modelled different euro breakup scenarios, says the departure of Greece and Portugal will lead to a 15 percent rise in the euro against the dollar, a 20 percent fall in euro zone yields, a 15 percent fall in euro zone equities and a 20 percent increase in credit spreads.

Below are other findings:

    If all PIIGS left the euro, the single currency would rise 25% and regional equities would fall 20%. U.S. stocks would drop 15 percent. European banking stocks would fall by 25% and ITRAXX Financials credit spreads would increase by 100%, which would imply losses of up to 20% in high-grade corporate debt. VIX would be over 50. A total collapse scenario would see European equities down 40%, U.S. and global equities down 30%, euro yields down 75% and ITRAXX Europe and ITRAXX Financials credit spreads up 150% and 200%respectively. Oil would fall across the scenarios, ranging from 5% from a Greece departure through to a 50% decline from a complete breakup. Sterling would strengthen against the Euro by between 5-25% across the scenarios.

The results seek to model the impact of each scenario over three months, looking eight weeks before and six weeks after the shock to form a balanced picture.