Weekly Radar: Leadership change in DC and Beijing?
Any hope of figuring out a new market trend before next week’s U.S. election were well and truly parked by the onset of Hurricane Sandy. Friday’s payrolls may add some impetus, but Tuesday’s Presidential poll is now front and centre of everyone’s minds. With the protracted process of Chinese leadership change starting next Thursday as well, then there are some significant long-term political issues at stake in the world’s two biggest economies. Not only is the political horizon as clear as mud then, but Sandy will only add to the macro data fog for next few months as U.S. east coast demand will take an inevitable if temporary hit — something oil prices are already building in.
Across the Atlantic, the EU Commission’s autumn forecasts next week for 2012-14 GDP and deficits will likely make for uncomfortable reading, as will a fractious EU debate on fixing the blocs overall budget next year. But the euro zone crisis at least seems to have been smothered for now. Spain seems in no rush seek a formal bailout, will only likely seek a precautionary credit line rather than new monies anyway and needs neither right now in any case given a still robust level of market access at historically reasonable rates and with 95% of its 2012 funding done. According to our latest poll, more than 60% of global fund managers think Spanish yields have peaked for the crisis. Greece’s deep and painful debt problems, shaky political consensus and EU negotiations are all as nervy as usual. But tyhe assumption is all will avoid another major make-and-break standoff for now. More than three quarters of funds now expect Greece to remain in the euro right through next year at least.
The extent to which the relative calm is related to today’s introduction of a wave of EU regulation on short-selling of bonds and equities and, in particular, rules against ‘naked’ credit default swap positions on sovereign debt is a moot point. This may well have reined in the most extreme speculative activity for now and it has certainly hit liquidity and volumes.
So, where have global markets settled after Halloween? It’s been a pretty mixed bag over the past seven days and lacking in overall direction even if with notable deviations – an interesting factor perhaps in a world obsessed with highly-correlated waves of risk on/risk off . Even though October will now be confirmed as the first month in the red for world stocks since May, our poll shows investors have actually been building more equity and euro zone debt during the month as they pare back cash levels to their lowest since February. Not least because of some surprisingly decent European earnings, eurostocks outperformed and gained almost 1% over the past week. Spanish govt yields are flat over the week, although Italian debt yields are up about 10bp on domestic election jitters there. Broad volatility gauges continue idling around at relatively low, sub-20% levels – Wall St’s VIX is up a bit for all the obvious reasons, while the VDAX is down again and 6-month eur/$ vol continues to fall like a stone to five-year lows as the underlying exchange rate snoozes about 1.30. Emerging market hard currency debt indices, captured by the EMBI+, are down over the past week and spreads with Treasuries have backed up about 25bp — but that’s largely due to Argentina’s sharp retreat on an adverse NY court ruling on its botched debt restructurings.
Perhaps because of Sandy and the elections, Treasury yields have nudged back lower to about 1.70% but it will be fascinating to see how the 10- and 30-year Treasury auctions go next week after the election results.
As to the neck-and-neck election itself, there are so many permutations and combinations of results and post-election fiscal and monetary outcomes that it’s very much just “wait and see” in many eyes now. Some point to the fact that markets tend to rally after elections regardless of the winner. Others talk of how Democratic presidencies have on balance tended to be good for growth and the stock markets. Others, most notably US domestic funds, think Romney would be better for business by cutting their taxes, rolling back government and resolving the “fiscal cliff” more easily in allying with a Republican congress. Others reckon you need to be careful of big pharma stocks if he wins and rolls back Obama healthcare reforms. A quick resolution of the fiscal cliff may boost the short-term growth outlook but that could hit Treasury bond prices too, while Romney’s scepticism of Fed monetary activism may see implied Fed fund rates in the 2014/15 futures market back up higher on speculation of a more hawkish replacement for current Fed chief Bernanke in 2014.
Easy business trend in emerging Europe
Polish central bank governor Marek Belka doesn’t apportion a lot of importance to the fact that Poland can boast the second biggest improvement in the latest World Bank’s ease of doing business index, after Kosovo.
“This year we have improved, but I don’t care too much about it,” Belka said at a meeting in London today.
Others do see a significant trend emerging from the data around Poland which paints an optimistic picture for those wishing to start and do business in Europe, but not necessarily in the developed markets.
Ireland descends from risky debt heights
Good news for Europe as the cost for insuring sovereign debt against default fell in the third quarter of 2012, according to the CMA Global Sovereign Credit Risk report.
Ireland slipped out of the 10 most risky sovereigns for the first time since the first quarter of 2010 according to CMA, making space for Lebanon to enter the club of the world’s ten most risky sovereign debt issuers.
Although Irish 5-year credit default swap spreads tightened to 317 basis points from 554 basis points in the third quarter, there is still a 25 percent chance that Ireland will not be able to honour its debt or restructure it over the next five years.
Euro emigration – safety valve or worker drain?
Four years of relentless austerity in many of the euro zone’s most debt-hobbled countries have forced many of their youngest and sometimes brightest workers to grab the plane, train or boat and emigrate in search of work. For countries with a long history of emigration, such as Ireland, this is depressingly familar — coming just 20 years after the country’s last debt crisis and national belt-tightening in the 1980s crescendoed, with the exit of some 40,ooo a year in 1989/90 from a population of just 3-1/2 million people.
The intervening boom years surrounding the creation and infancy of the Europe’s single currency and expansion of the European Union eastwards saw huge net migration inflows back into the then-thriving euro zone periphery — Ireland, Greece, Portugal, Spain and Italy — and created a virtuous circle of rising workforces, higher demand for housing/goods and rising exchequer tax receipts.
But all that has gone into reverse again since the credit, property and banking crash of 2008.
Olympic medal winners — and economies — dissected
The Olympic medals have all been handed out and the athletes are on their way home. Which countries surpassed expectations and which ones did worse than expected? And did this have anything to do with the state of their economies?
An extensive Goldman Sachs report entitled Olympics and Economics (a regular feature before each Olympic Games) predicted before the Games kicked off that the United States would top the tally with 36 gold medals. It also said the top 10 would include five G7 countries (the United States, Great Britain, France, Germany and Italy), two BRICs (China and Russia), one of the developing countries it dubs Next-11 (South Korea), and one additional developed and emerging market. These would be Australia and Ukraine, it said.
Close enough, except that Hungary took the place of Ukraine as the emerging economy in the Top 10 and the United States actually took 46 gold medals — more than Goldman had predicted.
Running for gold? The long-distance investor
What are you best at? Running a sprint? Jumping a few hurdles? Or would you rather gear up for the long-haul with a marathon?
With the London 2012 Olympics in full speed UK investors are going for the long-distance rather than try to follow in Usain Bolt’s speed-lightning sprints, a poll by Barclays Stockbrokers showed.
Thirty-one percent of surveyed clients liken their investment strategy to a marathon ( “investing for the long term” ) and 34 percent to an heptathlon (“long term investment strategy which requires several different approaches.”)
European equities finding some takers
European equities are getting some investor interest again.
As the ongoing debt crisis erodes consumer spending and corporate profits, the euro zone’s share in investors’ equity portfolios has fallen in the past year –Reuters polls show holdings of euro zone stocks at 25 percent versus over 36 percent a year back. Cash has fled instead to U.S. stocks, opening up a record valuation gap between the European and U.S. shares. (see graphics below from my colleague Scott Barber). In fact no other region has ever been considered as cheap as the euro zone is now, a monthly survey by Bank of America/Merrill Lynch found in June.
Next week: Half time…
QE, some version of it or even the thought of it, seems to have raised all boats yet again — for a bit at least. You’d not really guess it from all the brinkmanship, crisis management and apocalyptic debates of the past month, but June has so far turned out to be a fairly upbeat month – weirdly. World equities are up more than 6 percent since June, lead by a 20 percent jump in European bank stocks and even a 20 percent jump in depressed Greek stocks. The Spanish may found themselves at the centre of the euro debt storm now, but even 10-year Spanish debt yields have returned to June 1 levels after briefly toying with record highs above 7% in and around its own bank bailout and the Greek election. And the likes of Italian and Irish borrowing rates are actually down this month. Ok, all that’s after a lousy May that blew up most of the LTRO-inspired first-quarter market gains. But, on a broad global level at least, stocks are still in the black for the year so far. It was certainly “sell in May” yet again this year, but it’s open question whether you stay away til St Ledgers day in September, as the hoary old adage would have it.
On the euro story, the Greeks didn’t go for the nuclear option last weekend at least and it looks like there are some serious proposals on the EU summit table for next week – talk of banking union, EFSF/ESM bond buying programmes, euro bills if not bonds, EIB infrastructure/project bonds to try and catalyse some growth, and reasonable flexibility from Berlin and others on bailout austerity demands. The Fed has announced that it will twist again like it did last summer, by extending the Treasury yield curve programme by more than a quarter of a trillion dollars, and there are still hopes of it at least raising the prospect of more direct QE. The BoE is already chomping at that bit, as well as lending direct to SMEs, and most investors expect some further easing from the ECB in the weeks and months ahead.
Of course all that could disappoint once more and expectations are getting pumped up again as per June market performance numbers. The EU summit won’t deliver on everything, but there is some realization at least that they need to talk turkey on ways to prevent repeated rolling creditor strikes locking out governments out of the most basic of financing — only then have those very same creditors shun countries again when they agree to punishing fiscal adjustments. A credible growth plan helps a little but some pooling of debt looks unavoidable unless they seriously want to remain in perma-crisis for the rest of the year and probably many years to come. It may be a step too far before next year’s German elections, but surely even Berlin can now see that the bill gets ever higher the longer they wait.
Stumbling at every hurdle
Financial markets are odd sometimes. For weeks they have fretted about the outcome of the Greek election and its impact on the future of the euro zone as a whole. But today they appeared to dismiss the outcome despite a result that was about as positive as global investors fearful for euro zone stability could have hoped for. So what gives?
The logic behind the weeks of trepidation was fairly simple and straightforward. After an inconclusive election on May 6, a second Greek poll on June 17 was due to give a definitive picture of whether Greeks wanted to stay in the euro and with all the budgetary conditions necessary to keep EU/IMF bailout funds in place. If a victory for parties wanting to scrap the bailout agreement and austerity led to a halt of EU/IMF funds, the fear was that Greece would inevitably be forced out of the single currency bloc in time too. And if that unprecedented event happened, then a chain reaction would be hard to avoid. If one country goes back to its domestic currency, despite all its debts being denominated in euros, investors would then find it impossible not to assume at least some element of euro exit risk for fellow-bailout recipients Portugal and Ireland and possibly even Spain and Italy, where doubts remain about their market access over time.
Extreme tail risk or not, this set the scene for the jittery markets that ensued during the Greek electoral hiatus of May 6- June 17. Athens stocks lost more than 17%; Spanish 10-year government bonds lost more than 7% and the euro/dollar exchange rate was down almost 4%. etc. The fear of euro-wide contagion was so-great that the Spanish bank bailout in the interim had a little or no positive impact. And with the global economic growth picture weakening in tandem with, and partly because of, the euro mess, then prices reflecting world demand in general were hit hard by concerns that another shock to the European banking system could trigger a reversal of trillions of euros of European bank lending from around the globe. Crude oil dropped almost 14%, broad commodity prices and emerging market equities lost about 8%.
Next week: Call and response?
The Greek vote next Sunday now stands front and centre of pretty much all investment thinking, but the problem is that it may still be days and weeks before we get a true picture of what’s happened, whether a government can be formed and what their stance will be. If the new parliament cannot clearly back the existing bailout, even after a bout of horse-trading, then a game of chicken with Europe ensues. Eurogroup meets again on Thursday and there’s a German/French/Italy/Spain summit on Friday. But G20 leaders gather in Mexico as all this is unfolding, so they will certainly be quorate if some sort of global response is required to any initial market shock. What’s more, the FOMC is meeting Tuesday and Wednesday should Bernanke feel the US needs urgent insulation from the fallout regardless of broader action. But it’s certainly not beyond the bounds of reason that coordinated central bank action materializes next week if markets do indeed go skewways after the Greek poll. They have all clearly been consulting on the issue lately via telephone and bilaterals. And the assumption of more QE is there among investors. Three quarters of the 260+ funds polled by BoAMerrill Lynch this month expect another ECB LTRO by the end of Q3 and almost a half expecting more Fed QE over the same time.
And maybe it is this assumption of massive policy response that’s preventing markets capitulating outright. Money is gradually going to ground, but it’s not yet thrown in the towel completely as you can see from major equity indices, volatility gauges and interbank spreads etc. And there are a lot of headwinds everywhere over the next six months, the US election, fiscal cliff, end of operation twist stateside – and that’s in one of the few major western economies that was generating any significant growth this year. In other words, there are no shortage of arguments for another monetary boost. A heavy econ data slate during the week will also reveal just how much the world economy has run into sand this quarter. The standouts are the flash PMIs for June, the US Philly Fed index for June and UK jobs and inflation numbers.
As to the lack of response to last weekend’s Spanish bank bailout, it was weird in many ways that anyone really expected a major rally on this just six days ahead of a Greek vote which could throw the whole bloc into chaos. Even if you thought the Spanish bailout was good, and it was certainly a necessary if not sufficient step, you would still not return to Spanish debt until the next couple of weeks of events had cleared. So, in that respect, it’s unlikely the market made any real judgement on it either way. The subsequent credit rating cuts from Moody’s have not helped and yields have spiked to the 7% level flashing red lights. But it’s hard to see how any exposed frontline euro market, from Spain to Italy and Ireland to Portugal, can really stabilise ahead of the weekend. One fear on the Spanish rescue was of private investors’ subordination to EU/IMF creditors in any workout of Spanish debt. But even that too may have been overstated when it comes to the sovereign. For a start, the interest rate charged on the funds means a massive saving for Madrid compared with prevailing market rates and, as Barclays argued, actually increases the overall pie available for any workout, with a possible increase in projected recovery rates compared with the pre-bailout setup. If that was the big concern, then the subsequent rise in Spanish yields most likely is more Greek than Spanish in origin.
