Global Investing

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.

Deutsche Bank equity strategists said they reckon 10-year U.S. Treasury yields could “easily” rise another 45bp to 2.70% over the remainder of the year if expectations for policy rates remain unchanged. Its “ready reckoner” suggests such a rise in bond yields would take 3% off equities, all else being equal. However, they stress that if this is in tandem with rising growth expectations, the negative impact on equity could be more than offset.

But Goldman Sachs Asset Management Chairman Jim O’Neill told clients at the weekend that his long-standing bullish view on equities remains rooted in the extremely high global Equity Risk Premium — which measures the global trend growth rate (a proxy for long-term earnings growth) plus dividend yields minus real government bond yields.  O’Neill said that despite a slowdown in the big emerging markets this year, most investors did not take account of the fact that the long-term global trend growth rate was still rising and was now about 4.2%. Real bond yields, meantime, were extraordinarily depressed by a host of policy actions and systemic fears.

Central banks and the next bubble (3)

Expectations are running high ahead of next week’s LTRO 2.0 (expected take-up is somewhat smaller than the first time and the previous estimate though, with Reuters poll predicting banks to grab c492 bln euros).

The ECB’s three-year loan operation, along with the BOJ’s unexpected easing, BoE’s QE and commitment from the Fed to keep rates on hold until at least end-2014 may constitute competitive monetary easing, Goldman Sachs argues.

As the moves to ease have been rolled out, we increasingly encounter the argument that such ‘competitive’ (non-coordinated) monetary expansions by developed market central banks are at best ineffective and at worst a zero-sum game at the global level—and perhaps a precursor of something worse, such as a slide towards protectionism.