Author: Mike Dolan

Central banks may be regaining some two-way control over global markets that had started to behave like a one-way bet. After flagging some unease earlier this month that frothy markets were assuming endless QE, the Fed and others look to be responding with at least some frank reality checks even if little new in the substance of their message. In truth, there may be no real change in the likely timing of QE’s end, or even the beginning of its end, but the size of the stock and bond market pullbacks on Wednesday and Thursday shows how sensitive they now are to the ebb and flow of central bank guidance on that score.  Although the 7% drop in Japan’s stock market looks alarming – Fed chief Bernanke actually played it fairly straight, signalling no imminent change and putting any possible wind down over the “next few meetings” still heavily conditional on a much lower jobless rate and higher inflation rate. The control he gains from here is an ability to nuance that message either way if either the data disappoints or markets get out of hand.

The central banks are clearly treading a fine line between getting traction in the real economy and not blowing new financial bubbles. The decider may be inflation and on that score central banks have a lot of leeway right now – global inflation is still evaporating and, as measured by JPM, fell in April to just 2.0% – its lowest in 3-1/2 years.  That said, CPI was also very well behaved in the run-up to 2007 credit crisis – it was asset prices and not consumer inflation that caused the problem. So – expect to hear plenty more cat-and-mouse on this from the central banks over the coming weeks/months.

For investors, periodic pullbacks from here are justified and likely sensible. But it’s still hard to argue against a wholesale change of behaviour – which is merely to assume central banks will prevent further growth shocks but will take some time to transform persistently sluggish growth into anything like a sustained inflation-fueling expansion . As a result, funds will likely steer clear of “safe” havens of cash, gold, Swiss franc and yen despite this bounce and continue their migration to income everywhere, with a bias to relative growth stories within that and an exchange rate tilt according to the likely sequencing of QE exit– all of which points to the U.S. dollar if not its stock markets. And for many that may just mean repariation or staying at home –the US is still the homebase for two thirds of the world’s institutional funds, or some $55 trillion of savings.

And the dollar move is just starting to play out big in emerging markets, where emerging market currencies are on the back foot everywhere from Turkey to South Africa, South Korea and others. The reaction so far as been to lift local stock markets on potential exporter relief but a big question moving ahead is to what extent persistent exchange rate weakness will start to deter or even reverse foreign investment flows.

Next week is a busy if mixed bag – a heavy G7 data slate, with Japan a focus; rate decisions in Brazil, Thailand, Hungary and Canada, US Treasury and JGB debt auctions, EU flash inflation and jobless reports, and China’s Premier visiting Germany.

GLOBAL DATA/EVENTS TO WATCH

China Premier Li Keqiang meets German Chancellor Merkel in Berlin Sat

Africa Union summit in Addis Ababa Sat

Equatorial Guinea parliamentary elections Sun

BoJ’s Kuroda speaks in Tokyo Sun

Israel rate decision Mon

Japan 20-yr JGB auction Tues

French May consumer confidence Tues

Hungary rate decision Tues

French/German labour ministers meet in Paris Tues

US May consumer confidence/March house prices Tues

US 2-yr Treasury auction Tues

BoJ’s Kuroda speaks in Tokyo Weds

Japan April retail sales Weds

German May jobless/CPI Weds

Italy May biz confidence Weds

EZ April credit/M3 Weds

Brazil/Thai rate decisions Weds

Canada rate decision Weds

US 5-yr note auction Weds

IMF annual report on Japan Thurs

Japan 2-yr JGB auction Thurs

Swiss Q1 GDP Thurs

Italy govt bond auction Thurs

EZ May biz/consumer sentiment Thurs

EU summit in Brussels Thurs

US 7-yr Treasury auction Thurs

US Q1 GDP revision Thurs

Japan April jobless/production, May Yokyo CPI Fri

EZ flash May inflation/April jobless Fri

Italy April jobless, French April consumer spending Fri

UK April consumer credit/mortgage Fri

US May Chicago PMI, April personal spending/income/PCE Fri

Canada Q1 GDP Fri

China May manufacturing PMI Sat

ECB chief Mario Draghi returns to London next week almost 10 months on from his seminal “whatever it takes” speech to the global financial community in The City  – a speech that not only drew a line under the euro financial crisis by flagging the ECB’s sovereign debt backstop OMT but one that framed the determination of the G4 central banks at large to reflate their economies via extraordinary monetary easing. Since then we’ve seen the Fed effectively commit to buying an addition trillion dollars of bonds this year to get the U.S. jobless rate down toward 6.5%, followed by the ‘shock-and-awe’ tactics of the new Japanese government and Bank of Japan to end decades.

And as Draghi returns 10 months on, there’s little doubt that he and his U.S. and Japanese peers have succeeded in convincing financial investors of central bank doggedness at least. Don’t fight the Fed and all that – or more pertinently, Don’t fight the Fed/BoJ/ECB/BoE/SNB etc… G4 stock markets are surging ever higher through the Spring of 2013 even as global economic data bumbles along disappointingly through its by now annual ‘soft patch’.  Looking at the number tallies, total returns for Spanish and Greek equities and euro zone bank stocks are up between 40 and 50% since Draghi’s showstopper last July . Italian, French and German equities and Spanish and Irish 10-year government bonds have all returned about 30% or more. And you can add 7% on to all that if you happened to be a Boston-based investor due to a windfall from the net jump in the euro/dollar exchange rate. What’s more all of those have outperformed the 25% gains in Wall St’s S&P 500 since then, even though the latter is powering to uncharted record highs. And of course all pale in comparison with the eye-popping 75% rise in Japan’s Nikkei 225 in just six months!! Gold, metals and oil are all net losers and this is significant in a money-printing story where no one seems to see higher inflation anymore.

But with both Fed and BoJ pushes getting some traction on underlying growth and the euro zone economy registering it’s 6th straight quarter of contraction in the first three months of 2013, maybe Draghi’s big task now is to convince people the ECB will do whatever it takes to support the 17-nation economy too and not only the single currency per se. Last year’s pledge may have been a necessary start to stabilise things but it has not yet been sufficient to solve the economic problems bequethed by the credit crisis.

Coincidence or not, Draghi speech on Thursday is flanked by keynotes from his monetary allies. Fed chief Bernanke  speaks on Saturday and then to testifies to the congressional Joint Economic Committee on Wednesday, BoJ head Kuroda holds a press conference after the bank’s policymaking meeting ends on Thursday and outgoing BoE governor King speaks Friday. G20 sherpas meet in Russia this weekend, while EU leaders meet in Brussels on Wednesday. The big economic data set-piece of the week will be critical flash global PMI readings for May – is business finally pulling out of the early year funk or is confidence still evaporating?

 

Main economic events and data releases for next week:

G20 sherpas meeting in St Petersburg Sat/Sun

Fed’s Bernanke speech on long-run economic prospects Sat

Italy March Industry orders Mon

Irish PM Kenny in Boston Mon

Japan 40-yr JGB auction Tues

UK April inflation Tues

Japan April trade Weds

BOJ news conference after latest policy meeting Weds

BoE minutes Weds

EU summit Weds

German 10-yr bund auction Weds

US April existing home sales Weds

Fed’s Bernanke testifies to Joint Economic Committee of Congress Weds

FOMC minutes Weds

Global May flash PMIs Thurs

Spain govt bond auction Thurs

UK April retail sales/Q1 GDP revision Thurs

ECB’s Draghi speaks in London Thurs

EZ May consumer confidence Thurs

US April new homes sales/March house prices Thurs

SAfrica rate decision  Thurs

German May Ifo sentiment Fri

French May business climate Fri

Italy May consumer confidence Fri

US April durable goods orders Fri

BoE’s King speaks in Helsinki Fri

Far from the rules of the dusty old investment almanac, it’s up, up and away in May after all. And judging by the latest batch of economic data, markets may well have had good reason to look beyond the global economic ‘soft patch’ – with US employment, Chinese trade and even German and British industry data all coming in with positive surprises since last Friday. Is QE gaining traction at last?

Well, it’s still hard to tell yet in the real economy that continues to disappont overall. But what’s certain is that monetary easing is contagious and not about to stop in the foreseeable future – whether there’s signs of a growth stabilisation or not. With the Fed, BoJ and BoE still on full throttle and the ECB cutting interest rates again last week, monetary easing is fanning out across the emerging markets too. South Korea was the latest to surprise with a rate cut on Thursday, in part to keep a lid on its won currency after Japan’s effective maxi devaluation over the past six months. But Poland too cut rates on Wednesday. And emerging markets, which slipped into the red for the year in February, have at last moved back into the black – even if still far behind year-to-date gains in developed market equities of about 16%!

Not only have we got new records on Wall St and fresh multi-year highs in Europe and Japan, there’s little sign that either this weekend’s meeting in London of G7 finance chiefs or next weekend’s G20 sherpas gathering in Moscow will want to signal a shift  in the monetary stance. If anything, they may codify the recent tilt toward easier austerity deadlines in Europe and elsewhere. But inevitably talk of unintended consequences of QE and bubbles will build again now as both equity and debt markets race ahead , even if the truth is that asset managers have been remarkably defensive so far this year in asset, sector and geographical choices …  one can only guess at what might happen if they did actually start to get aggressive! Perhaps the next pause will have to come from the Fed thinking aloud again about the longevity of its QE programme — so best watch those thought bubbles!

 

Next week’s big data and events:

G7 finance ministers and central bank governors meet in London Sat

EBRD meeting in Istanbul Sat

Pakistan general elections Sat

Bulgaria parliamentary elections Sun

China April Industrial output/retail sales Mon

France/Italy bond auctions Mon

Euro group meeting Mon

US April retail sales Mon

Indonesia rate decision Tues

EZ March industrial production Tues

German May ZEW sentiment Tues

ECOFIN meeting Tues

UK 5-yr gilt/Japan 30-yr JGB/Dutch DSL auctions Tues

EZ/DE/FR/IT flash Q1 GDP Weds

UK April jobless Weds

Iceland rate decision Weds

Greek PM Samaras in China Weds

Japan Q1 GDP Thurs

UK 30-yr gilt/Japan 5-yr JGB auction/German 2-yr auction Thurs

Spain’s Rajoy meets with unions on pension reforms Thurs

Draghi speech Milan Thurs

US/EZ April CPI Thurs

US April housing starts/permits, May Philly Fed index Thurs

Turkish rate decision Thurs

Turkey’s Erdogan in Washington Thurs

G20 sherpas meeting in St Petersburg Sat/Sun

           

So, it’s May and time for the annual if temporary equity market selloff, right? Well, maybe – but only maybe.  A fresh weakening of the global economic pulse would certainly suggest so, but central banks have shown again they are not going to throw in the towel in the battle to reflate. The ECB’s interest rate cut today and last night’s insistence from the Fed that it’s as likely to step up money printing this year as wind it down are two cases in point. And we’re still awaiting the private investment flows from Japan following the BOJ’s latest aggressive easing there.

So where does that all leave us? A third of the way through 2013 and it’s been a good year so far for nearly all bulls – both western equity bulls and increasingly bond bulls too! Not only have developed world equities clocked up some 13 percent year-to-date (the S&P500 set yet another record high this week while Europe’s bluechips recorded a staggering 12^th consecutive monthly gain in April) , but virtually all bond markets from junk bonds to Treasuries, euro peripherals to emerging markets are now back in the black for the year as a whole. For the most eyebrow-raising evidence, look no further than last week’s debut sovereign bond from Rwanda at less than 7 percent for 10 years or even newly-junked Slovenia’s ability this week to plough ahead with a syndicated bond sale reported to already be in the region of four times oversubscribed. For many people, that parallel rise in equity and bonds smells of a bubble somewhere. But before you cry “QEEEEE!” , take a look at commodities — the bulls there have been taken a bath all year as data on final global demand hits yet another ‘soft patch’ over the past couple of months.

So is this just an idiosyncratic random walk of asset markets (itself no bad thing after years of stress-riven hyper correlation) or can we explain all three asset directions together? One way to think of it is in terms of global inflation. If QE-related inflation fears have been grossly exaggerated then pressure to remove monetary stimulus or wanes again and there may even be arguments – certainly in Europe – for more. This would intuitively explain the renewed dash for bonds and fixed income in general even in the face of the still-plausible, if long term, “Great Rotation” idea. You could argue the monetary free-for-all is buoying equities regardless of demand concerns. But why wouldn’t commodities gain on that basis too?

The answer likely lies in the desperate demand among big institutional investors for income in a low-growth, QE-buoyed world. The paltry income left in ‘safe’ bond markets becomes less unappealing if the inflation horizon is lower than we thought and from there the push for more yield fuels all bond markets. Similarly this year’s equities rally has been remarkable because it’s been led by income-like, blue chip defensive stocks with decent dividends that ape bond returns – and not by growth stocks or even emerging markets, which still remain in the red.

And if income is the only game in town and there’s no inflation scare, then the last place you want to be is income-less commodities.

So, what’s up next week? Tomorrow’s US payrolls report set the tone. But next week throws up a G7 meeting, heavy UK/European earnings sked, Chinese trade and inflation, BoE meeting and US/German bond auctions.

 

GLOBAL DATA/EVENTS TO WATCH

Malaysia general elections Sun

Europe Q1 earnings Mon: AXA, BCP, Natixis

EZ April services PMIs/March retail sales Mon

French debt auction Mon

Australia rate decision Tues

Europe Q1 earnings Tues:  HSBC, Lafarge, SocGen, Pirelli, , Commerzbank, Adecco, Banca Generali, Carlsberg, Credit Agricole,

Swiss Q2 confidence, April jobless Tues

French March trade and industrial output Tues

US March consumer credit Tues

US 3-yr debt auction Tues

China April trade data Weds

Europe Q1 earnings Weds: Deutsche Telekom, CRH, Aegon, ING, Dexia, Henkel, J Sainsbury, Next, Standard Chartered,

German 5-yr bund auction Weds

German March industry output Weds

Madagascar Presidential Elections Weds

Norway rate decision Weds

US 10-yr Treasury auction Weds

China April inflation Thurs

SKorea/Malaysia/Egypt rate decisions Thurs

Europe Q1 earnings Thurs:  Barratt, Beazley, WM Morrison, Old Mutual, Repsol, Tullett Prebon

UK March industry and manufacturing Thurs

Bank of England rate decision Thurs

US 3-yr Treasury auction Thurs

Europe Q1 earnings Fri: Unicredit, ArcelorMittal, TUI

German/UK March trade, Italy March industry Fri

G7 finance ministers and central bank governors meet in London Fri/Sat

EBRD meeting in Istanbul Fri/Sat

Pakistan general elections Sat

Bulgaria parliamentary elections Sun

One of the more startling moves of the week was the fresh rally in euro government debt – with 10-year Italian and Spanish borrowing rates falling to their lowest since late 2010 when the euro crisis was just erupting and 2-year Italian yields even falling to 1999 euro launch levels. The trigger? There’s been a slow build up for weeks on the prospect of new Japanese investor flows  seeking liquid overseas government bonds  – but it was signs of a sharp slowdown in Germany’s economy that seems to have had a perversely positive effect on the region’s asset markets as a whole. The logic is that German objections to another ECB rate cut will ebb, as will its refusal to ease up on front-loaded fiscal austerity across Europe. If its own economic engine is now suffering along with the rest, significantly just five months ahead of German Federal elections, then a tilt toward growth in the regional policy mix may not seem so bad for Berlin after all. And if euro economies are more in synch, albeit in recession rather than growth, then perhaps it will lead to a more effective regional policy response.

All that plays into the intensifying “growth vs austerity” debate, which had already shifted at the Washington IMF meetings last week and was sharpened this week by by EU Commission chief Barroso’s claim that the high watermark of EU’s austerity push had passed. On top of the Reinhart/Rogoff research farrago, it’s been a bad couple of weeks for the “austerians”, with only a UK Q1 GDP bounceback of any support for case of ever deeper fiscal cuts,  and investors smell a change of tack. Their reaction? Not only have euro government borrowing costs fallen  further, but euro equities too rallied for 4 straight days through Wednesday. Those arguing that investors would run screaming at the sight of a more growth-tilted policy mix in Europe may have some explaining to do.

Next week is back on monetary policy watch however. The ECB takes centre stage amid rate cut talks hopes for help for credit-starved SMEs. The FOMC meets stateside aswell just ahead of the critical US April employment report.

Major events next week:

Iceland/Malatsia elections Sat

EZ biz/consumer confidence Mon

German April inflation Mon

Italy/France/Belgium govt bond auctions Mon

Europe Q1 earnings Mon: Fiat, Volkswagen, Deutsche Boerse

US March pending home sales Mon

Japan March jobless, spending, production, housing Tues

Europe Q1 earnings Tues: BP, Deutsche Bank, UBS, Lloyds, EdF, Whitbread

German April unemployment Tues

EZ April inflation Tues

UK March mortgage/credit data Tues

US Q1 earnings Tues: Marathon, Pfizer, FMC

US April consumer confidence, Chicago PMI Tues

ADB meeting in New Delhi, Weds-Sun

UK local elections Weds

US April manufacturing ISM Weds

FOMC decision Weds

Global manufacturing PMIs Thurs

European Commission Spring forecasts Thurs

ECB decision/presser Thurs

BoE decision Thurs

US Q1 earnings Thurs:  AIG, Kraft, International Paper

US March trade Thurs

BOJ minutes Fri

India monetary policy statement Fri

US Q1 earnings Fri: ADP, Moody’s, Duke Energy

US April employment report/Services PMI Fri

Figuring out what was driving pretty violent market moves this week was trickier than usual – and that says something about how much the herd has scattered this year, with ‘risk on-risk off’ correlations having weakened sharply. Just as everyone puzzled over a potential “wall of money” from Japan after the BOJ’s aggressive reflation efforts, the bottom seemed to fall out of gold, energy and broader commodity markets – dragging both equity markets and, unusually, peripheral euro zone bond yields lower in the process.  As dangerous as it may be to seek an overriding narrative these days, you could possibly tie all up these moves under the BOJ banner – something along these lines: the threat of a further yen losses pushes an already pumped-up US dollar ever higher across the board and undermines dollar-denominated  commodities, which have already been hampered by what looks like yet another lull in global demand. Developed market equities, whose Q1 surge had been reined in by several weeks of disappointing economic data and an iffy start to the Q1 earnings season, were then hit further by a lunge in heavy cap mining and energy stocks. The commodities hit may also help explain the persistent underperformance of emerging markets this year. What’s more the lift to Italian and Spanish government bonds comes partly from an assumption any Japanese money exit will seek U.S. and European government bonds and relatively higher-yielding euro government paper may be favoured by some over the paltry returns in the core ‘safe havens’ of Treasuries or bunds. The confidence to reach for yield has clearly risen over the past six months as wider systemic fears have receded – something underlined in dramatic style this week by a huge lunge in gold,  now lost almost 20 percent in the year to date.

While all that logic may be plausible, there have been dozens of other reasons floating around for the seemingly erratic twists and turns of the week.

The only truth so far is that everyone is still just guessing about the likely extent of a Japanese outflow and confidence about global growth has received another setback.

It’s possible the BOJ focus may be a distraction from what looks likes the yet another Spring slowdown in the world economy – a worrying portent for Europe in particular where much of the continent is still in recession or semi-recession since late last year. Most forecasters and asset managers seem to retaining faith in the gradual recovery thesis, but they are nervous as economic surprises turn negative everywhere. Next week’s flash readings for April business surveys, or PMIs, may well be the number of the week as a result – with Q1 GDP from the US and UK also topping list of data releases too. Any fallout from this Friday’s G20 meeting in Washington could also set the tone early next week as yen moves may be discussed alongside growing doubts about the wisdom of austerity in recessions. Otherwise, it’s a big week for Q1 earnings on both sides of the pond.

Final day of IMF Spring Meeting Sun

Israel rate decision Mon

EZ April consumer confidence Mon

US March existing home sales Mon

Europe Q1 earnings Mon: Suez, STMicro

US Q1 earnings Mon: Halliburton, Texas

OECD Japan survey Tues

Global April flash PMIs Tues

Italy April consumer confidence Tues

UK March govt borrowing data Tues

US March new home sales Tues

Hungary rate decision Tues

US Treasury 2-yr auction Tues

Europe Q1 earnings Tues: Scania, SEB, Swedbank, Stora Enso

US Q1 earnings Tues: Amgen, DuPont, Xerox

NZ rate decision Weds

German April Ifo Weds

German 30-yr bond auction Weds

US March durable goods orders Weds

US Treasury 7-yr bond auction Weds

Europe Q1 earnings Weds: ABB, Credit Suisse, Barclays, Daimler, Ericsson, France Tel, GSK, Iberdrola, Nordea, Peugeot, Standard Life, Svenska Handelsbanken

US Q1 earnings Weds: Boeing, T Rowe Price, Qualcomm

UK Q1 GDP Thurs

Euro group’s Dijsselbloem at European Parliament Thurs

Europe Q1 earnings Thurs: Unilever, Astrazeneca, BAT, Bayer, Santander, Saab, Saint Gobain, Areva, Pernod Ricard, Volvo

US Q1 earnings Thurs: Exxon, Colgate-Palmolive, Coca Cola, Dow Chemical, Time Warner, UPS,

Japan March, Tokyo April inflation Fri

France’s Hollande in Beijing Fri

BOJ decision and presser Fri

French April consumer confidence Fri

EZ March credit/M3 Fri

SNB AGM Fri

US Q1 GDP Fri

US Q1 earnings Fri: Tyco

Malaysia/Iceland parliamentary elections Sat

US Q1 EARNINGS START/DUBLIN EURO GROUP MEETING/US T-SECRETARY LEW IN BERLIN-PARIS/US-FRANCE-ITALY GOVT BOND AUCTIONS/FRANCE NATL ASSEMBLY VOTES ON LABOUR REFORM/VENEZUELA ELECTIONS

World markets have started the second quarter in an oddly indecisive mood given that Q1 turned out to be yet another bumper start to the year, looking to extend record stock market highs on Wall St but lacking the juice of new information to make a decisive break while Europe splutters and emerging markets and commodities head south. Two important pieces of the U.S. jigsaw will likely emerge over the coming week  with this Friday’s US employment report and the start of the Q1 corporate earnings season next week.

But there’s clearly been a more general rethink further afield among global investors given the breakdown in cross-asset and cross-border correlations – meaning it’s no longer enough to just get Wall St right and adjust your global risk button accordingly. It looks much harder work to get regional or asset allocations and positioning right. As Wall St flirts with new highs and US and Japanese equity funds continue draw hefty inflows, there’s been a pullback from all things Europe surrounding the Cyprus saga and parallel growth disappointments across the region and EPFR data last week showed redemptions from euro stock, bond and money funds continued.

Euro stocks, as a result, are now flat for the year after two consecutive months in negative territory wiped out all of frothy January. And while you’d have made a cool 10 percent in developed market equities collectively in the first quarter and almost 9 percent on Wall St alone, you’d be in the red in emerging markets and badly burnt in gold, metals and commodities at large. So while the headline equity story suggests a G7 global recovery is underway at last, as the OECD suggested last week,  that’s not the signal from commodities and the emerging world. Could it really be just be a domestic US recovery story all on its own?

As a result it’s hard to find a binding theme so far in early April and market pricing this week reflects that somewhat, even though Easter-related holidays in many western markets contributed to the lack of direction. Apart from earnings season starting bell, next week has the euro group meeting in Dublin,  new US Treasury Secretary Jack Lew in Berlin and Paris and a hefty slate of data and debt auctions everywhere.

GLOBAL DATA/EVENTS TO WATCH

French govt bond auctions Mon

German Feb industry output Mon

US Q1 earnings Mon: Alcoa

Bernanke speech Mon

ILO regional meeting Mon/Tues

China March inflation Tues

US Treasury Secretary Jack Lew in Berlin/Paris Tues

French national assembly votes on labour reform Tues

Swiss March jobless/inflation/retail data Tues

German/French Feb trade reports Tues

UK Feb manufacturing/industry output/trade Tues

US 3-yr Treasury auction Tues

China March trade data Weds

Japan March bank lending Weds

France/Italy Feb industry output Weds

OECD leading indicator Weds

Poland rate decision Weds

Obama meets Republican senators on 2^nd term agenda Weds

US 10-yr Treasury auction Weds

SKorea/Indonesia rate decisions Thurs

Japan Feb machinery orders Thurs

Italy govt bond auction Thurs

German/French March inflation Thurs

US 30-yr Treasury auction Thurs

Euro zone finance ministers meet in Dublin Fri

Italy March inflation Fri

EZ Feb industrial output Fri

US Q1 earnings Fri: JPMorgan

US March PPI/retail sales/April consumer confidence Fri

Bernanke speech Fri

ECOFIN in Dublin Fri

Venezuela Presidential election Sun

  

US MARCH JOBS REPORT/THREE OF G4 CENTRAL BANKS THURS/NEW QUARTER BEGINS/FINAL MARCH PMIS/KENYA SUPREME COURT RULING/SPAIN-FRANCE BOND AUCTIONS

Given the sound and fury of the past fortnight, it’s hard not to conclude that the messiness of the eventual Cyprus bailout is another inflection point in the whole euro crisis. For most observers, including Mr Dijsselbloem it seems, it ups the ante again on several fronts – 1) possible bank contagion via nervy senior creditors and depositors fearful of bail-ins at the region’s weakest institutions; 2) an unwelcome rise in the cost of borrowing for European banks who remain far more levered than US peers and are already grinding down balance sheets to the detriment of the hobbled European economy; and 3) likely heavy economic and social pressures in Cyprus going forward that, like Greece, increase euro exit risk to some degree. Add reasonable concerns about the credibility and coherence of euro policymaking during this latest episode and a side-order of German/Dutch ‘orthodoxy’ in sharp relief and it all looks a bit rum again.

Yet the reaction of world markets has been relatively calm so far. Wall St is still stalking record highs through it all for example as signs of the ongoing US recovery mount. So what gives? Today’s price action was interesting in that it started to show investors discriminating against European assets per se – most visible in the inability of European stocks to follow Wall St higher and lunge lower in euro/dollar exchange rate. European bank stocks and bonds have been knocked back relatively sharply this week post-Dijsselbloem too. If this decoupling pattern were to continue, it will remain a story of the size of the economic hit and relative underperformance. But that would change if concerns morphed into euro exit and broader systemic fears and prepare for global markets at large to feel the heat again too. We’re not back there yet with the benefit of the doubt on OMTs and pressured policy reactions still largely conceded. But many of the underlying movements that might feed system-wide stresses – what some term a “slow panic” like deposit shifts etc – will be impossible to monitor systematically by investors for many weeks yet and so nervy times are ahead as we enter Q2 after the Easter break.

Cyprus and European banks aside, next week will be about the US employment report and three of the Big Four central banks meeting Thurs. Will the ECB respond to the banking sector and consumer sentiment threats and ease rates or monetary conditions? It has plenty of real sector and inflation evidence already that Q1 underwhelmed in euro. The BoJ meeting will be as important with new governor Haruhiko Kuroda at the helm for the first time amid intense interest in how he will pursue the bank’s new aggressive reflation mandate.

Next week’s big events and data points:

Kenya Supreme Court rules on election outcome Sat

US/China March final manufacturing PMI Mon

Australia rate decision Tues

European March final manufacturing PMI Tues

EZ/Italy Feb jobless Tues

UK Feb mortgage and credit data Tues

German March CPI Tues

Thailand rate decision Weds

US ADP jobs/March final services PMIs Weds

European March final services PMIs Thurs

Spain/France government bond auction Thurs

ECB/BOJ/BOE decisions/pressers Thurs

EZ Feb retail sales Fri

US March employment report Fri

    

CYPRUS BRINKMANSHIP/BERNANKE IN LONDON/BRICS SUMMIT/MARCH CONSUMER SENTIMENT IN EUROPE/JAPAN INFLATION-JOBS-PRODUCTION/US-UK Q4 GDP REVISIONS

Cyprus has hogged the headlines since Friday, with bank closures now extended to a full week as they try to sort out a very messy bailout – made worse by domestic policy missteps over taxing bank deposits. As with Italy’s elections, the saga certainly challenges any market assumption that the euro crisis had abated for good and it’s also loaded with a series of potential precedents – not least the biggest taboo of them all, a euro exit. This is where the politics, brinkmanship and smoke-filled-rooms come in.  Yet as Cyprus is so small and its banks in such a peculiar setup – given the scale of Russian and other foreign depositors – the euro group, ECB and IMF appear determined not to be pressured into a bailout above the already gigantic 60 percent of GDP.

And, as with Greece last year, they will likely stand firm and leave any decision to exit up to the Cypriots themselves. You can’t rule out that they may choose to go and regional risks rise somewhat as a result. But if the islanders are genuinely worried about a 6-10% tax on deposits, they may also think long and hard about the chance those deposits would be redenominated into a heavily devalued Cypriot pound. Just ask the Argentinians what that feels like. A deposit haircut may seem a like a half-decent deal by comparison if some other mix of Russian loans, pension raids or securitised future gas revenues doesn’t stack up.

So, the small scale of Cyprus, a lack of direct systemic banking or sovereign debt linkages and the likelihood of some sort of political deal eventually emerging have all served to limit the fallout from the drama on world markets – rightly or wrongly.   World equities have been knocked back a bit, but remain up 5.75% year-to-date. The VIX popped higher, but remains super-low under 13%. Italian stocks are back to where they were on Friday afternoon, while the more telling Italian and Spanish 10-yr bond yields have even nudged lower. A successful Spanish government bond auction on Thursday, where yields across all maturities fell from the previous auctions in February, showed just how limited any Cyprus contagion has been so far at least.

So, unjustifiably complacent? Perhaps – there are certainly lots of bogeymen in this story. But let’s be clear about the “shock factor”. Back on Jan 1, the year kicked off with several “known knowns” ahead that everybody already knew would be messy – the US fiscal cliff, the Italian elections and the Cyprus bailout. And they all proved exactly that – messy. But few investors anywhere could claim to have not been braced for these. To be sure, all could blow up into something worse still, but none yet amounts to an investment ‘game changer’. Radars are up, however, and funds polled by BoAMerrill reckon the euro crisis has moved back to the top of their list of tail risks for the first time since August. We shall see if they continue to hold their nerve as the first quarter closes next week. More worrying for investors in Europe has been the continued funk in business sentiment in March and the Cyprus ructions won’t have helped that much since. Patience in waiting for some broad-based European economic recovery may be more limited than the seeming tolerance of  noisy Cyprus bailout. 

EVENTS/REPORTS TO WATCH NEXT WEEK:

Bernanke speaks in London Mon

African Union finance ministers meet in Abidjan Mon

Italy March consumer confidence Mon

Arab Summit in Doha Tues

France March consumer confidence Tues

US March consumer confidence/Feb durables and new home sales Tues

US 2-yr Treasury auction Tues

BRICS summit in Durban Weds

EZ March biz/consumer confidence Weds

Swiss KOF leading indicator Weds

Italy Jan industrial orders/retail sales Weds

France/UK Q4 GDP revisions Weds

Italian govt bond auction Weds

US Feb pending homes sales Weds

US 5-yr Treasury auction Weds

Taiwan/Czech rate decisions Thurs

German March jobless Thurs

Italy March biz confidence Thurs

EZ Feb credit/M3 data Thurs

US Q4 GDP revision/March Chicago PMI Thurs

US 7-yr Treasury auction Thurs

Japan Feb CPI, Tokyo March CPI, Feb jobless, industrial production, household spending Fri

French Feb consumer spending/PPI Fri

Italy March CPI Fri

US Feb personal income/spending Fri

FOMC/FRANCO-GERMAN SUMMIT/GERMAN-FRENCH-SPAIN AUCTIONS/GLOBAL FLASH PMIS FOR MARCH/UK BUDGET-JOBS-CPI-BOE MINS/ICC HEARING ON KENYATTA/SAFRICA RATES

       The revved-up U.S. dollar – whose trade-weighted index is now up almost 5 percent in just six weeks – could well develop into one of the financial market stories of the year as the cyclical jump the United States has over the rest of G10 combines with growing attention being paid to the country’s potential “re-industrialisation”. As with all things FX, there’s a zillion ‘ifs’ and ‘buts’ to the argument. Chief among them is many people’s assumption the Fed will be printing greenbacks well after this expansion takes hold as it targets a much lower jobless rate. Others doubt the much-vaunted return of the US Inc. back down the value chain into metal-bashing and manufacturing, while some feel the cheaper energy from the shale revolution and the lower structural trade deficits that promises will be short-lived as others catch up. However, with the dollar already super competitive (it’s down 30-40 percent on the Fed’s inflation-adjusted index over the past 10 years) the first set of arguments are more tempting. Even if you see the merits in both sides, the bull case clearly has not yet been discounted and may have further to go just to match the balance of risks.  With Fed printing presses still on full throttle, this has been a slow burner to date and it may be a while yet before it gets up a head of steam — many feel it’s still more of a 2^nd half of 2013 story and the dollar index needs to get above last year’s highs to get people excited. But if it does keep motoring, it has a potentially dramatic impact on the investment landscape and not necessarily a benign one, even if shifting correlations and the broader macro landscape show this is not the ‘stress trade’ of the short-lived dollar bounces of the past five years.

Commodities priced in dollars could well feel the heat from a steady dollar uptrend. And if gold’s spiral higher over the past six years has been in part due to the “dollar debasement” trade, then its recent sharp retreat may be less puzzling . Emerging market currencies pegged to the dollar will also feel the pressure as well as countries and companies who’ve borrowed heavily in greenbacks. The prospect of a higher dollar also has a major impact on domestic US investors willingness to go overseas, casting questions on countries with big current account gaps. As the dominant world reserve currency, a rising dollar effectively tightens financial conditions for everyone else and we’ve been used to a weakening one for a very long time.

Back to moment, stock markets around the world have continued to nudge new highs over the past week, with the upbeat US employment data underlining a still broadly positive global growth tilt even if Chinese data was more equivocal and Europe still looks dour. That said, at least the euro FX rate is going in the right direction for a change to help address the regional funk.

To keep a tally, global stocks are up almost 6 percent as the first quarter enters its final fortnight.

Next week, it will be hard to get beyond the FOMC and a heavy US data slate, though flash global PMIs for March will be critical in seeing whether the wobble in world business sentiment last month was a blip or a trend. The Franco-German summit in Berlin on Monday will be interesting to parse any new direction in euro policy and cooperation, with German/French and Spanish debt auctions throughout the week. Otherwise, it’s big five days for the UK economy with the government’s 2013 budget as well as jobless/inflation/retail/govt borrowing reports and BoE minutes . An ICC hearing on Kenyan election victor Kenyatta in the Hague on Monday will also need watching, with the latest South African rate decision on Wednesday a big moment next week in regional markets there.

 

Events and data to watch next week:

China annual parliament meeting ends Sun

Merkel/Hollande summit Berlin Mon

ICC hearing on Kenya’s Kenyatta, The Hague Mon

EZ Jan trade Mon

UK Feb inflation Tues

German March ZEW Tues

US Feb housing starts/permits Tues

German 10-yr bund auction Weds

UK Feb jobless Weds

EZ March consumer confidence Weds

UK 2013 budget Weds

BoE minutes Weds

EU’s Rehn at EU Parliament Committe Weds

FOMC decision/presser Weds

Obama visits Israel Weds

SAfrica/Iceland rate decisions Weds

Japan Feb trade Thurs

Global flash March PMIs Thurs

UK Feb retail sales/govt borrowing Thurs

French/Spanish bond auctions Thurs

US/UK index-linked bond auctions Thurs

Egypt rate decision Thurs

US March Philly Fed index/Feb existing home sales Thursday

German March Ifo/French March biz climate Fri

Financial markets have had one of those weeks of frenetic activity when each asset class blames the other for driving direction, few agree on an overall driver and it’s hard to square relative moves.  What seems to be true is that idiosyncratic and locally-focussed factors are back in vogue – witness the lunge in sterling as the BoE nods at more QE and higher inflation, or the sudden dive in commodities even as global stock markets nudged 5-year highs. Micro or national issues are getting more play as the stress busting of recent months seems to have reduced cross-market correlations  that characterised every ebb and flow of the overarching ‘global crisis’ for years.

To be sure, the longer-range theme of global reflation, the return from “safe haven” bunkers, and a gradual rotation out of low-yielding bonds remains the big backdrop and has helped explain the buoyancy of stock markets to date, the relative weakness of sterling and the yen as persistent  money printers into the recovery, and the rise in core US/German/UK government borrowing rates alongside a sturdy bid for Italian and Spanish bonds.

But the week has thrown several curve balls into the mix. Fed minutes showed its policymakers musing yet again over when to wind down QE while euro area business surveys disappointed recovery hopes yet again in February. Commodities have retreated sharply on the perceived demand shock, with the dollar sharply higher on hopes the greenback presses will be turned off well before  sterling or yen equivalents at least. But it gets more difficult to square some of the rest – gold’s nosedive this week could be argued as a haven exit perhaps, but its inflation-hedge role seems at odds with Britain and Japan actively pumping up prices. A more hawish Fed and dollar rise might be a better guide. And the drop in oil, metals and world equities (latterly) seems to riff off that too, for all the coalface talk of fund liquidations, supply boosts and chart hoodoos etc. Yet if the Fed slows QE – which would slow its bond buying — then bonds should surely be falling too? Not so – 10-year Treasury yields have slipped back below 2 percent all of a sudden. So is the bond market getting a dollar boost or is it worried about demand slowdown from the risk of a March 1 sequestration? If it’s the latter and that’s justified, then you can expect Fed chairman Ben Bernanke to sound a very different tone at his congressional testimonies next week. But what then of the supposed demand shock from the FOMC minutes? hmmm. It all starts to get a bit circular.

 

Maybe Europe has more answers. The latest business survey funk won’t be helped by messy Italian elections at the weekend and the delayed Cyprus bailout. The by-now merciful retreat of the euro, especially as the nervy market interest rate rise on LTRO paybacks looks set to dissipate –  may be itself be a driver by pushing the dollar higher and disturbing global positioning.

Otherwise, the end of the shortest month next Thursday may simply be creating its own wobbles.  Next week will see flash Chinese PMI for Feb and likely upward revisions to both US and UK Q4 GDP, correcting the suggestion from early estimates that the entire G7 contracted in Q4 last year. Flash euro zone and German CPI will keep the inflation watchers on the boil, while a useful contrast with euro-wide, German and Japanese jobless figures.

And so as March comes into view, the effervescent January for global markets has turned a bit flat in February. Year-to-date global equity gains remain about 4.5 percent – still significantly loaded in developed markets as emerging market indices have underperformed yet again. Yet if 2013 is to be another bullish year, the February pause may be a useful speed limit. If the two-month average rise were to continue all year, then gains for the year would be less than the 30%+ record years of 2009 and 2003. Back on planet earth.

Global events and econmic releases to watch:

Italy parliamentary elections Sun

Cyprus Presidential election run-off Sun

China HSBC Feb flash PMI Mon

Reuters Summit on euro zone future, Brussels Mon-Weds

APEC finance/cenbank meeting Jakarta, Tues/Weds

Bernanke’s semi-annual testimony Tues/Weds

US Feb consumer confidence, Jan new home sales, Tues

EZ Feb biz/consumer confidence Weds

French Feb consumer confidence Weds

Swiss Feb KOF confidence index Weds

EZ Jan money supply/credit Weds

UK Q4 GDP revision Weds

SAfrica budget presented to parliament, Weds

US Jan durable goods Weds

French Jan consumer spending/PPI Thurs

German Feb jobless/inflation Thurs

US Q4 GDP revision/Feb Chicago PMI  Thurs

Japan Jan spending/CPI/jobless/capex Fri

Global Feb manufacturing PMI Fri

EZ flash Feb inflation/Jan jobless Fri

UK BOE Jan mortgage/credit Fri

US Jan consumer spending/saving, Feb UMich sentiment Fri

 

G20/EUROGROUP/EURO Q4 GDP/STATE OF THE UNION/BOJ/UST, GILT AND ITALY BOND AUCTIONS/EUROPEAN EARNINGS

Hiccup. February has so far certainly brought a more sober, if healthier, perspective to world markets. Global stocks are off about half a percent this week, letting the air out gently from January’s over-inflated 5 percent surge. The focus is back on Europe, where the threat of a euro FX overshoot (in the face of LTRO paybacks and rising euro interest rates alongside stepped-up “global currency wars”) has fused with a plethora of unresolved national debt conundrums and a stream of ‘event risks’ on the region’s calendar. Euro stocks have retreated to December levels as the currency move and fresh political angst has taken the wind out of earnings and growth projections after such a steep rally over the past six months. Name anything you want – the tightening race for this month’s Italian elections and Monte di Paschi scnadal there, a delayed Cyprus bailout and elections there this month, the Irish promissory note standoff with the ECB etc etc – when things turn, they all these get amplified again even if none really are likely to be systemic threats in the way we’d become used to over the past two years. The slight backup in Italian/Spanish yields to December levels shows sentiment turns still pack a punch, the European earnings season has been mixed so far, there are political murmurs about capping the euro and the political calendar over the next six weeks is a bit of a minefield for nervy markets. All the issues still look resolvable – the tricky Irish bank debt rejig looks on the verge of a resolution; few still believe Berlusconi be the next Italian PM (only 5 percent on betting website Intrade think so, for example); and Cyprus is expected by most to get bailed out eventually. Today’s ECB will be critical to most of those issues, but next week’s euro group gets a chance to update everyone on its role in them aswell). The issue likely to gnaw deepest at investors is the regional growth outlook  and,  in that respect, the euro surge is about as welcome as a kick in the teeth at this juncture. (Euro Q4 GDPs out next week). The French clearly want to rein in the currency but don’t have the tools or the German backing. Draghi and the ECB will likely have to come to rescue again, though he will not admit to euro targeting and so may drag his feet on this one until the move starts to burn. Interesting times ahead and interesting G20 finance meeting in Moscow next week as a result.

To keep this week’s market wobble  in Europe in perspective, however Wall St still continues to hover close to record highs as the Q4 GDP shock was probably correctly dismissed as a red herring; Japan’s TOPIX is now up 35% in three months (well, about 15% in euro terms), and Shanghai is up 18% in just two months. It’s curious to note that Shanghai was the top pick of the year when Reuters polled global forecasters in December and average gains for the whole of 2013 were expected to be… 17 percent. So, stick with the growth and the currency printing regions for now it seems – even if you do get whacked on the exchange rate.

So while a market pause at least has been well warranted, the big 2013 theme of a long-term investor retreat from core debt and re-allocation toward  equity will likely prevent major corrections as long as the underlying global growth story – modest as it is – holds up and builds some steam. ANd that is a long-term story and won’t be decided over a week or even a few months. US Treasury auctions next week may be the ones to watch in that regard.

                   

GLOBAL DATA/EVENTS TO WATCH NEXT WEEK:

UK/Swiss January inflation Mon

Euro group Mon

Indonesia rate decision Tues

Europe Q4 earnings Tues: ThyssenKrupp, Barclays, Glencore etc

ECOFIN meeting Tues

EZ Dec industrial production Tues

Swedish rate decision Tues

ECB’s Draghi in Madrid Tues

US 3-year Treasury auction Tues

US Obama State of the Union Tues

Europe Q4 earnings Weds: ING, SocGen, Peugeot etc

Italy govt bond auction Weds

US Jan retail sales Weds

US 10-yr Treasury auction Weds

SKorea rate decision Thurs

Japan Q4 GDP Thurs

BOJ decision Thurs

EZ/Germany/France/Italy Q4 GDP Thurs

Europe Q4 earnings Thurs: ABB, BNP Paribas, Nestle, Rio Tinto etc

UK gilt auction Thurs

US 30-yr Treasury auction Thurs

G20 finance ministers and central bankers meet Moscow Fri/Sat

UK Jan retail sales Fri

US Jan industrial output Fri

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

EU Council meets on EU budget Thurs/Fri

German/UK Dec manufacturing output Thurs

UK Dec trade data Thurs

BOE rate decision Thurs

ECB rate decision and presser Thurs

US Q4 earnings Thurs: Sprint-Nextel, Hasbro

US Dec consumer credit Thurs

China Jan trade and inflation Fri

US Dec trade data Fri

 

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.

But what sort of money is behind this price move? Well, new cash flowing into equity funds so far this year has been the highest on record at some $55 billion. Retail investors have certainly been big participants, with Lipper data showing new-year retail inflows to U.S.-based stock funds at their highest since 2001. HSBC points out that 9 consecutive weeks of net retail buying of equities is “longer and larger” that any of the sporadic bursts seen over the past two years and emerging market equity appears to be a clear favourite.

But what of the bigger behemoths?

An HSBC analysis on global fund holdings (based on data provided by fund tracker EPFR) reckons big international funds are far less pessimistic than they were six months but are still broadly neutral on equity overall. “We measure this by tracking the holdings of high and low beta sectors and it is now only marginally in favour of low beta sectors”

And despite a big recovery in European bank stocks in tandem with an easing of the euro crisis, it reckoned international institutional funds remained underweight the sector. HSBC added:

By being underweight an outperforming sector they have to buy to stand still. This explains why the underweight remains large even though there has been plenty of buying.

The report goes on to show that institutional investors are positioned very cautiously in the US, with the biggest overweight in the underpeforming healthcare sector.

There remains potential “fuel” for further upgrading relative to benchmarks at least.

Yet what of the more conservative defined-benefit pension funds or insurance funds  being pressured by liability-matching pressures and stricter mandates or guidelines? Regardless a possible Great Rotation over the next decade or so, how are these funds likely to behave shorter term?

Credit Suisse points out some market speculation that funds traditionally balanced evenly between equity and bonds may tend to rebalance portfolios at fixed intervals and so may be forced to return funds to neutral by selling equity at the end of a month that saw a big outperformance of stocks over bonds.

The potential size of this shift in the United States is eye-opening — at some $92 billion worth, according to CS.

Yet it downplayed the fear of some mass mechanical movement, highlighting three broad categories of behaviour among such fund managers — those who rebalance daily and will already have smoothed out positioned; those who do so at fixed periods such as month-end or quarter-end; and those who have significant discretion on timing and positioning within a broad remit.

We estimate that Private Defined Benefit Pension plans would need to reallocate about $34 billion, State and Local Pension Plans about $44 billion, and “Hybrid” mutual funds about $14 billion, for a total of about $92 billion – which we know is much higher than what is likely to be seen given the number of managers who rebalance more frequently or have discretion.

Month-end price histories over the past four years also show this to have had only a limited market impact, CS said. That said, it does tally somewhat with the early month surge turning flatter into this week.

But this is mechanistic behaviour should be fleeting by definition. Changes in how fund mandates and remits change over time is a far bigger issue and that will likely also take much longer to parse on aggregate.

 

 

 

With a week to go in January, global stock markets are up 3.8 percent – gently nudging higher after the new year burst and with a continued evaporation of volatility gauges toward new 5-year lows. That’s all warranted by a reappraisal of the global economy as well as murmurs about longer-term strategic shifts back to under-owned and cheaper equities. But, as ever, you can never draw a straight line. If we were to get this sort of move every month this year, then total returns for the year on the MCSI global index would be 50 percent – not impossible I guess, but highly unlikely. So, at some stage the market will pause, hestitate or even take a step back. Is now the time just three weeks into the year?

Well lots of the much-feared headwinds have not materialized. The looming US budget ceiling showdown keeps getting put back – it’s now May by the way, even if another mini-cliff of sorts is due in March — but you get can-kicking picture here already. The US earnings season looks fairly benign so far, even given the outsize reaction to Apple after hours on Wednesday. European sovereign funding worries have proven wide of the mark to date too as money floods to Spain and even Portugal again. And Chinese data confirms a decent cyclical rebound there at least from Q3′s trough. All seems like pretty smooth sailing – aside perhaps from the UK’s slightly perplexing decision to add rather than ease uncertainty about its economic future. So what can go wrong? Well there’s still an event calendar to keep an eye on – next month’s Italian elections for example. But even that’s stretching it as a major bogeyman the likely outcome.

In truth, the biggest hurdle is most likely to be the hoary old problem of over-inflated expectations. Just look at the US economic surprise index – it’s tipped into negative territory for the first time since late last summer. Yet incoming US data has not been that bad this year. What the index tells you more about has been the rising expectations. (The converse, incidentally, is true of the euro zone where you could say the gloom’s been overdone.) Yet without the fuel of positive “surprises” we’re depending more on a structural story to buoy equity and that is a multi-year, glacial shift rather than necessarily a 2013 yarn. The start of the earnings season too is also interesting with regard to expectations. With little over 10 percent of the S&P500 reported by last Friday, the numbers showed 58% had beaten the street. That’s not bad at first glance but a good bit lower than the 65% average of the past four quarters. On the other hand, it’s been top-line corporate revenues that have supposedly been terrifying everyone and it’s a different picture there. Of the 10% of firms out to date, 65 percent have reported Q4 revenues ahead of forecasts – far ahead of the 50% average of the past four quarters. Early days, but that’s relatively positive on the underlying economy at least.

And the Apple story is yet another case in point. Even though its shares fell about 10% in after-hours trade on anything from a slight revenue miss, future guidance and market-share concerns — it says more about the scale of expectations built into this one, if spectacular, corporate story. Look at the actual numbers  and you see in absolute terms, its supposedly worrying iPhone shipments were still up 29% over the year to a new record and iPhone sales in greater China more than doubled. A tough crowd to please now, clearly, but again telling us more about expectations that underlying activity. For what it’s worth, Apple’s bottom-line earnings beat the street. 

And finally, the other big – structural rather than cyclical – story in play over the past 10 days has been the unwind of the euro safe-haven plays – hardly surprising given that now two of the three bailout countries (Ireland and Portugal) are back in the private markets again default-free and the one-time big worry (Spain) is drowning in foreign creditors all of a sudden. Bund, Treasury and Gilt yields of course have all been pushing higher, even though QE limits that move. But perhaps the biggest manifestation of the safe-haven exit has been the 3% Swiss franc retreat – who said the SNB couldn’t hold the line? Sterling’s slide too is as much to do with this as it is related to Cameron’s EU sideswipe. Watch out for others too – Nordic markets perhaps? London property? Gold is still higher on the year, but that just underlines the fact it was always more an inflation-hedge rather than haven from systemic shocks.       

Next week turns macro again in west of the Atlantic again – with the FOMC, US December payrolls and US Q4 GDP easily the dominant releases for world markets. European earnings season will keep people on their toes too as the likes of Deutsche Bank reporting amid some renewed jitters about European and German bank restructuring and regulatory pressures.

GLOBAL DATA/EVENTS TO WATCH

Europe Q4 earnings Mon: Ryanair

EZ Dec M3 money/credit Mon

Italy Jan consumer confidence Mon

US Q4 earnings Mon: Caterpillar, BioGen, Yahoo

US Dec durable goods orders Mon

US 2-yr note auction Mon

India rate decision Tues

Europe Q4 earnings Tues: AMS, Sandvik

France Jan consumer confidence Tues

US Q4 earnings Tues: Ford, Pfizer, Amazon, Corning  

US Jan consumer confidence Tues

US 5-yr note auction Tues

Europe Q4 earnings Weds: Nordea, Roche, Swedbank

EZ Jan consumer/biz confidence Weds

Italy govt bond auction Weds

German 30-yr bund auction Weds

US Q4 earnings Weds: Boeing, ConocoPhillips, Marathon

US ADP Jan private sector jobs data Weds

US Q4 GDP Weds

FOMC rate decision Weds

US 7-yr note auction Weds

Japan Dec industrial production Thurs

RBNZ rate decision Thurs

Europe Q4 earnings Thurs: Deutsche Bank, Astrazeneca, Shell, BSkyB, Diageo, Ericsson, Infineon, LVMH, Novo Nordisk

German Jan CPI/jobless Thurs

UK Dec mortgage/credit data Thurs

Egypt central bank meeting Thurs

US Q4 earnings Thurs: Dow Chemical, Viacom, UPS, Colgate-Palmolive

US Jan Chicago PMI Thurs

Japan Dec jobless/spending Fri

Europe Q4 earnings Fri: BBVA, BT, Electrolux

Global Jan manufacturing PMIs Fri

EZ Dec jobless, flash Jan CPI Fri

US Q4 earnings Fri: Exxon, Chevron, Aon, Merck

US Jan payrolls Fri

US Jan UMich consumer confidence Fri

 

Global markets have found themselves at an interesting juncture of underlying new year bullishness stalled by trepidation over several short-term headwinds (US debt debate, Q4 earnings, Italian elections etc etc) – the net result has been stalemate, something which has sunk volatility gauges even further. Not only did this week’s Merrill funds survey show investors overweight bank stocks for the first time since 2007, it also showed demand for protection against a sharp equity market drops over the next 3 months at lowest since at least 2008. The latter certainly tallies with the ever-ebbing VIX at its lowest since June 2007. Though some will of course now argue this is “cheap” – it’s a bit like comparing the cost of umbrellas even though you don’t think it’s going to rain.

Anyway, the year’s big investment theme – the prospect of a “Great Rotation” back into equity from bonds worldwide – has now even captured the sceptical eye of one of the market’s most persistent bears. SocGen’s Albert Edwards still assumes we’ll see carnage on biblical proportions first — of course — but even he says long-term investors with 10-year views would be mad not to pick up some of the best valuations in Europe and Japan they will likely ever see. “Unambiguously cheap” was his term – and that’s saying something from the forecaster of the New Ice Age.

For others, the very fact that Edwards has turned even mildly positive may be reason enough to get nervy! When the last bear turns bullish, and all that…

In the meantime, we’ll just have to keep monitoring the incoming news and data for direction. The balance of risks is still on the upside over the course of the year, but there will be bumps. Year-to-date on the MSCI World is still up almost 3 percent as vol ebbs and euro peripheral debt auctions and sovereign debt prices continue to fly.

We still have to see Q4 China GDP this week and the US earnings season is just cranking up. Judging by JPM and Goldman on Wednesday , the banks look ok so far. GE will get into the real world economy a bit more on Friday. Next week we then have the big techs like Apple and Microsoft and this is the sector making many anxious. Beyond that, the radar captures potential signals from Lower Saxony’s elections  on Sunday for September’s German parliamentary polls, we have the first eurogroup of the year on Monday and outstanding issues such as legacy bank debts, a Franco-German summit in Berlin, January’s flash PMIs worldwide and UK Q4 GDP. Israel elections jump into the mix and a South African interest rate decision too as the  drums sound again on the notorious ‘currency wars’.

As Moscow takes up the helm of the G20 grouping this year, Russian central banker Alexei Ulyukayev said on Wednesday: “We’re on a threshold of a very serious, confrontational actions in the sphere that is known … as currency wars.”

GLOBAL DATA/EVENTS TO WATCH

Germany’s Lower Saxony regional elections Sun

Euro group first meeting of 2013 Mon

African Union summit Mon to Mon, 28th

ECOFIN meeting Tues

German Jan ZEW index Tues

UK 10-yr gilt auction Tues

UK Dec govt borrowing data Tues

Israel national elections Tues

France’s Hollande visits Berlin Tues

US Q4 earnings Tues: IBM, DuPont, Google, AMD, Texas Instruments

US Dec existing homes sales Tues

Europe Q4 earnings Weds: Unilever, Novartis, Siemens

French Jan business climate Weds

EZ Jan consumer confidence Weds

UK Dec jobless Weds

BoE mins Weds

Jordan national elections Weds

Davos WEF forum Weds-Sun

US Q4 earnings Weds: Apple, MacDonalds

Global flash Jan manufacturing PMIs Thurs

OECD public debt forum Paris Thurs/Fri

Europe Q4 earnings Thurs: Nokia

SAfrica rate decision Thurs

US Q4 earnings Thurs: Microsoft, Amgen, Xerox, AT&T, Bristol Myers Squibb  

U.S. 10-yr TIPS auction Thurs

German Jan Ifo Fri

UK Q4 GDP Fri

US Q4 earnings Fri: Halliburton, Honeywell, Proctor & Gamble

US Dec new home sales Fri