Archive for May, 2013
Markets received a pleasant surprise this week when Q1 GDP growth for Japan came in higher than expected – 0.9% on the quarter versus an average forecast of 0.7%. Growth surprises have been mixed this quarter: GDP for the US was weaker than forecast (2.5% annualised vs. expectations of 3.0%), and before that the Chinese figure disappointed too (7.7% on the year to Q1 as against a forecast 8.0%). On the other hand, the number for the UK – +0.3% – was above a consensus expectation of +0.1% and allayed fears of a “triple dip recession”.
The differences between expected and observed outcomes for growth data have not been large, but their direction has had a material effect on markets. When quarterly data for the end of 2012 began coming through it was taken badly, with the US, Japan, eurozone and UK all falling behind forecast levels. Oil and industrial metals markets have yet to regain the February peaks they left so far behind as a result of this, and while the major developed-world markets merely paused for breath, emerging markets were knocked back and only began to recover last month.
So well done the Japanese and their not-so-new programme of Abenomics.
The market reaction to these growth numbers, however – powerful as it is – only partially captures the fundamental message of the data. Of course it is material if economic growth across the world as a whole is falling short of what is expected, with all the implications for demand, trade, earnings and so on that this entails. That is what was feared this February. The data out over the last few weeks, though, reminds us that the recovery from the Great Recession is, in aggregate, an ongoing reality – albeit a patchy and unsatisfactory one. And it is that patchiness which ought also to be of interest to markets over time.
Look again at the numbers. The differences between the forecasts and out-turns for growth rates in the various economies are pretty small. Certainly they pale in comparison to, say, the difference in growth rates between China and the US, or the US and the UK, or Asia and the rest of the world. Some of these larger differences are structural, and therefore somewhat predictable – and way more so than the precise quarterly outcomes for the individual economies themselves. And yet they are often, seemingly, ignored.
Much of this is down to confidence. Though emerging economies are growing and are forecast to grow more quickly than their developed counterparts across the geographic regions of the world, their markets, generally speaking, have lagged materially over the year to date. Investors still prefer to avoid owning a bank 100% of whose earnings derive from a fast-growing economy if they can own a confectioner which derives 10% of its earnings from selling sweets in the same place. Such is the way of things, for now.
Ultimately it is confidence that will change the picture. The historic p/e ratio of the Shanghai Composite index has averaged 22x over the past ten years. It now stands at a little over 12x, where it has been stuck for the last two. On the eve of the Great Recession it peaked just shy of 48x. To say that Chinese equity has fallen out of favour would be to make an enormous understatement. And at some point, global markets will get bored with investing via confectionery.
Furthermore, as the year progresses some signs of key threats to confidence have continued to recede. This month, ten year Greek debt stabilised below 10% for the first time since the sovereign crisis broke in 2010. Buy the 2% 2023 now and it will yield you less than 8% to maturity. The equivalent bonds for Spain and Portugal will still yield a little over 4% and 5% respectively. The economic cataclysm faced by these and other countries continues but the systemic threat from bond markets that caused so much of the trouble has lessened.
It is as always impossible to say what will happen next. But confidence can be a powerful asset: just ask the Japanese.
What an interesting year it is turning out to be.
This afternoon, stronger-than-expected employment data from the US surprised markets, driving equities to new record highs and causing bonds to sell off …
… But not all bonds. Government yields in Spain, Portugal, Italy and Greece have reached new lows for the year. 10-year Italian debt looks set to spend its first week below 4% since November 2010 – and this when a new prime minister has just announced he’s sick of austerity and wants to take some tax hikes off the table.
Safe haven bonds have held their ground well, the equity rally has seen huge regional variation and gold has made up a considerable amount of the ground it lost in its massive downward splurge last month. But we have been seeing real signs of a return to confidence – in some cases, even, a return to reason – in financial markets that have been challenged by serious events and which in recent years might have been expected to have reversed as a result.
We have spoken before about a “tug of war” between the US and Europe. If the US recovery keeps its pace and we see a return to growth on the other side of the Atlantic too, then the focus of this game will change.
There has been a lot of comment about a supposed “Great Rotation” from bonds to equities this year, and use of the phrase “risk on” whenever there are signs of this. The fact is though that this rotation / risk revaluation has been highly selective. European equity has lagged, as have the major emerging markets (three of the four “BRICs” are down YTD, with the exception of India, where the Nifty 50 has sputtered all of 0.7% higher). And even with this afternoon’s moves, benchmark bond yields in the US, the UK, Germany and Japan remain lower than where they ended 2012.
A sustained return of market confidence and a continued absence of macroeconomic catastrophe should see more of a “rotation” in appetite for risk than we have had so far: not just bonds-into-equities, but “safe” equities into markets, sectors and strategies which are still feared; spread compression in credit markets that is mirrored to a greater extent by drifts downward in over-bought government bonds … There are those who regret having missed what they see as a surprising rally in risk, but in fact this has been sufficiently limited for plenty of opportunities to remain should momentum build, broadening the spectrum of risk revaluation and making price behaviour elsewhere more consistent with what we have seen on the stock exchanges of New York, London and Tokyo.
It is true that this has been a frustrating, difficult and indeed hair-raising recovery. Market confidence could still quite easily come unstuck. But it is surely an equal truism that by the time everyone has regained their confidence, lost their fear of setbacks and decided to buy, risk markets really will be overpriced.
This is likely to take some time. And in a few months, of course, it might well look with hindsight that we should have all sold in May and gone away. Otherwise there are still opportunities out there – for now.