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'


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.

Tags: ,


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?

Tags: , ,

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.

Tags: , ,

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.

Tags: ,

Why Is Gold Weak?

by Michael J. Howell5. December 2012 12:47

The US dollar gold price has retreated back to test its long-term support line at circa $1700/oz. Gold is a pure liquidity phenomenon and its weakness tells us alot about how little new liquidity policy-makers are creating. We have noted in recent weeks that the US Fed has broken its QE3 'promise' stated on Sept 13th to add some US$85 billion per month to its balance sheet. It may ultimately 'catch up' thereby fuelling a 'Risk On' rally in 2013. But why has it stalled? The explanation may lie in Chairman Bernake's speech in early November to the New York Economic Club where he appeared to tie QE to progress on resolving the 'fiscal cliff'. In short, he is keeping his powder dry untill either he sees fiscal progress, or may be is forced to act by market turmoil. Gold is a convenient benchmark of this QE, as is the 10-2 yield curve. Investors can afford to wait until both indicators turn higher. It may be a jittery few weeks. Traditionally, the period between Election and Inauguration in the US has seen roughly twice normals level of market volatility, and that without a 'fiscal cliff'.

Tags: , ,

November Liquidity Databook Published

by Michael J. Howell29. November 2012 14:39

Latest Liquidity Databook for November published. Main points are flatlining of major Central Bank balance sheets despite assurances of QE3. Only positive signs come from BoJ. Credit data shows further strong rebound across EM and weak growth in West. US credit growth is seeing renewed slump in shadow bank lending, offset by credit growth from commercial banks.


The EM Story: Part 2

by Michael J. Howell28. November 2012 13:32

Our more positive stance towards EM equities since mid-summer largely rested on evidence that the huge capital outflows had at least stopped. Latest data for October show a pick up in EM inflows, with India being a clear beneficiary. As previously argued, 'Risk On' phases typically see large pro-cyclical inflows into EM. 2013 is stacking up to be 'good'.

Tags: ,

Money Quits Japan

by Michael J. Howell28. November 2012 13:30

Latest October capital flow data show an acceleration in money flows leaving Japan. This may be due to the upcoming Elections and expectations of monetary easing. Notwithstanding, it is a stark contrast both to recent patterns and evodence from other major economies. It likely helps to explain recent Yen weakness.

Tags: ,

A Small Start to QE3?

by Michael J. Howell28. November 2012 13:24

Our concerns about the slow start to QE3, i.e, only US$5 billion net since mid-September or nearly US$150 billion short of 'target'. Has been eased a tad by last week's jump in net debt holdings by the Fed of US25-30 billion. This together with signs of movement from the EU on Spanish debt suggests that markets may get the reassurance they need by year-end. We continue to expect that this 'second wave' of liquidity comes in during 2013. Risk asset markets will response accordingly.


Copyright © - All rights reserved