How to Understand 2013: Think 'M'

by Michael J. Howell2. January 2013 02:14

If like us you believe in the power and efficacy of Liquidity, then you should think about how liquidity moves? We maintain that it flows in a regular pattern that roughly traces out an M-shape over a decade long cycle. Liquidity leads by around year, but troughs are associated with banking crises and peaks with asset booms. The 'v' of the 'M' is typically shallow, giving approximately two asset booms per banking crisis. Banking crises occurred in 1966, 1974, 1982, 1990, 1998, 2007-08. The next is slated for sometime around 2016/17. Near enough to register, but too distant to worry about. Before then the next Liquidity peak is likely to be 2014, with 2013 a likely year (or should be) of rising liquidity. The last Liquidity peak was in 2010, and the recent 'v' lasted on cue from mid-2011 to late-2012, with liquidity drifting around its mid-levels. Thus, if we and our more prescient assistant history are correct, 2013 should see the monetary spigots open; yield curves steepen, paper currencies weaken, commodities jump and risk asset prices rise. This is our roadmap for 2013.

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The Big Event of 2013: 2012

by Michael J. Howell2. January 2013 01:51

We remain upbeat for this year, convinced the seeds for success were sown in 2012. Three 'liquidity' events proved critical: (1) Draghi at the ECB backstopped Eurozone risk with promises of extra cash; (2) Fed policy switched from attacking inflation to promoting employment. This message resonated among several other key Central Banks, so making it the most significant global policy change since Volcker took over the Fed in 1979, and (3) China's PBoC stepped up the pace of its liquidity injections from mid-year 2012. This halted domestic economic weakness; reversed the whopping outflow of foreign capital and promoted outperformance of EM equities from Q3. More of the same should be expected in 2013: paper currencies, notably the Yen, will remain fragile; commodity prices will pick-up; yield curves should steepen and rates start to rise, against the backdrop of still sluggish but better than expected economic activity. Above all EM equities will outperform: they are typically pro-cyclical and currently are out-of-favour with skeptical global investors, whose exposure remains a whopping two standard deviations below average.

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Bernanke Draghi Svensson Carney Iwata = CB Revolution

by Michael J. Howell21. December 2012 12:20

We celebrated just more than a year ago the appointment of Draghi at the ECB to continue  the good works of Bernanke at the Fed and Svensson at the Swedish Riksbank. Now Carney is slated to take-over the helm of the Bank of England, and rumours suggest that new Japanese PM Abe will turn to Iwata to lead the BoJ in 2013. These pro-employment CB changes are as significant as the selection of anti-inflation Volcker to head the 1978 Fed. The effect on the equity markets in 2012/13 may not be as dramatic as the impact Volcker had on the bond markets thirty years ago, but the positive effect will be felt.

This revolution attacks MV, i.e. money times velocity. Get M up via QE injections and raise V by creating inflation expectations via 'forward guidance', the Evans Rule (e.g. keeping rates low until unemployment drops below say 6,5%) or by weakening the US$. Taken together the latter are like having a nominal GDP target, or much as Carney as recently mooted for Britain.

All-in-all, given the well-known correlation between nominal GDP growth and nominal bond yields, this is poor news for global bonds. We expect yield curves to steepen. Normally this is bullish for other risk assets. The key to this puzzle may be Japan's JGB market. Investors must watch this bellwether in 2013 for confirmation that the new Central Bank Revolution is working its magic.

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More Money For EM...Again

by Michael J. Howell19. December 2012 23:40
Turkey, Thailand, India, Hong Kong and Russia top list of net financial inflows for month of November 2012. Money coming back into Emerging Markets again. Pace of outflows from Brazil slowing significantly.

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2013: Big Questions For The Big Consensus

by Michael J. Howell19. December 2012 15:41

The first flush of November liquidity data allows us to reassess 2013 prospects. Hard evidence of extra cash inflows are thin. Latest data show the aggregate GLI (Global Liquidity Index) slipping back to 46.5 from a value of 57.0 in October, 2012 ('normal' range 0-100). The bulk of this setback came from lower Central Bank Liquidity in both the Eurozone and Japan in November. BoJ liquidity injections measured at an index value of 27.9 are proving remarkably weak in the face of persistent criticism of its policy and expectations that its hand will be 'forced' towards greater ease after the early December Election. Given that latest capital flow data highlight a sharp net outflow of money from Japan, this fact by itself would normally (and may be currently does) signal a domestic monetary tightening in response. Therefore, talk of a further flood of Yen from re-starting the printing presses could prove significant and highly disturbing for the forex and JGB markets in 2013. The long-threatened sell-off in JGBs could prove the key event for global bonds because if Japan can escape from deflation, so can the other economies.

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Global Liquidity Update

Asset Allocation: Growth and Equities?

by Michael J. Howell12. December 2012 20:44
A recent FT blog contained academic wranglings concerning the 'fact' that faster economic growth is associated with lower equity returns! The professors are striving to find a paradox when really there is not one. Bonds (taking due account of inflation) correlate negatively with GDP growth and commodity prices (taking due account of resource sector productivity) correlate positively with GDP growth. These two asset markets seem to do what theory says. However, when equities are introduced, sometimes they correlate negatively with bonds and sometimes positively. It looks like equities are at fault. But we know that eps growth is strongly positively correlated to GDP growth, so the true culprit is equity valuation. Since P/Es cannot disappear to zero, this tells us that different valuation regimes must exist that include periods when valuations move oppositely to eps growth. Thus, sometimes equity valuations are pro-cyclical, e.g. right now, and sometimes they are anti-cyclical, e.g. 1980s and 1990s: two periods when they saw their highest correlation to bonds. What explains these regimes is a combination of inflation, the credit cycle and the starting valuation level. Moderate inflations, with strong credit growth, are typically when equity valuations are at their highest. The bottom line is that when economic activity picks up: equities will outperform. See latest research note: 'The Return of TAA'

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EM Another Bullish Sign?

by Michael J. Howell12. December 2012 20:29

EM markets have out-performed on cue since the announcement of QE3. We maintain our view that 2013 will prove another good year, underpinned by the latest Fed announcement and by the visible pick-up in our indicators of EM Central Bank Liquidity. EM Central Banks remain 'tight' on our measures, but these indexes are definitively turning higher. Chinese PBoC liquidity injections have risen moderately but consistently every month since May 2012, and our index of EM Central Bank Liquidity stands at its highest level for a year and more than double its low point value. This is consistent with the monetization of renewed capital inflows: a feature consistent with QE3. Bottom line is that EM equities are highly pro-cyclical. With the Workd economy near a turning point in 2013 and policy-makers focussed on getting more growth not less inflation, EM will outperform.

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QE4?

by Michael J. Howell12. December 2012 18:27

Todays Fed Statement and the similar tone taken by a recent speech from in-coming BoE Governor Carney both show the shift of thinking away from inflation and towards employment as the general 2013-14 policy goal. The Fed as expected emphasised the 'US$85 billion' monthly figure of new injections of cash and cleared any doubts that it might be compromised by the slated end to 'Operation Twist'. It may be a moot point whether this constitutes an increase on the previous QE3 and so can rightly be labelled a QE4. Whichever, investors must view these collective statements by policy-makers as events in 2012 but as processes for 2013. The two key things to focus on are (1) starting point and (2) future delivery. The starting point in 2012 is from a relatively low liquidity point, ie on our measures the Fed is still quite tight. Thus we are fed up of seeing the now standard Central Bank balance sheet graph in the Press showing strong rises since 2008. We simple cannot compare the Fed the BoJ the BoE and he ECB by their absolute balance sheet sizes without taking into account their institutional structures. In short our measures confirm that CBs have much room to ease. Second, promises are one thing and delivery is another. The previous post touched on why the Fed has not delivered yet. Therefore, see this renewed QE3 as a general easing process through 2013. Moreover others will join. Next up the BoJ?

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Where's Our QE3? -- Update

by Michael J. Howell6. December 2012 09:54
Fact: the US Fed balance sheet has barely expanded since Ben Bernanke's much trumpeted QE3 announcement on September 13th 2012. It should, according to our estimates now be ahead by a net US$150-200 billion from this date, but has mustered a puny US$34.7 billion. The bulk of Fed balance sheet movements are driven by changes in the size of the SOMA account. At end-November it touched US$2598.6 billion. It has barely changed since the September QE3 statement, and the slated $40 billion monthly step-up in MBS (mortgage-backed securities) purchases does not appear to figure. Rather than buying at this clip, the SOMA data show that the end-November the Fed has only purchased $40 billion of MBS in total. Does this mean that QE3 is not working? Or, more worryingly, that the Fed has somehow changed its mind and now, may be, awaiting clearer political progress on the 'fiscal cliff'? Both are possible, but we must also take into account the typically long settlement times involving in purchasing MBS (up to 180 days) because the SOMA and the Fed balance sheet are reported on a settlement basis. In short, 'in transit' bonds do not appear. However, we can get a handle on the potential rise by looking at reported 'commitments to buy'. This does show a large step-up confirming that US policy-makers are keeping to some of their promises. The figures highlight, again since mid-September, actual MBS purchases of $39.8 billion and new commitments of $47.3 billion. If it is fair to add these together, and it may not be, the indicated and inferred (to use a mining analogy) totals $87.1 billion, or some 85% of the slated target programme to date. The plain fact is that in terms of hard cash the QE3 has delivered only 39% of the MBS purchases the markets expected and taken overall, in terms of overall Fed balance sheet expansion the QE3 has produced a measly 18% of the promised $85 billion per month that the Fed hinted would be the net expansion after re-invested coupons were taken into account. This net increase is outside the Fed’s Maturity Extension Programme ('Operation Twist') that to date has sold US$595.7 billion US Treasuries of less than 3¼-year maturities and purchased US$622.1 billion of more than 6-year maturities. The bottom line in that QE3 is not delivering. Liquidity conditions in US markets may be OK but they are not expanding along the lines investors once hoped. This likely explains why the US dollar gold price has slipped back below US$1700/oz and why there has been some, but not enough yield curve steeping. These are two unambiguous liquidity signals and we closely watch them to confirm our more detailed analysis of Central Bank operations.

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Christmas Turkey!

by Michael J. Howell5. December 2012 12:57

Our latest monthly capital flow data show that Turkey is currently enjoying the greatest pace of foreign money inflow of any economy on out database. It confirms the general picture noted some weeks ago of returning investor interest in EM.

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