Race to the bottom
It is a difficult time to be an economics student. Correct answers to complex questions are hard to come by at the best of times but the current envir…
Posted in: CIO Blog
On the Pulse - Equities - Invest in value for the longer term but mind the value traps
We challenge the commonly held belief that risk and return always go hand in hand. Our analysis of past performance shows that lower-risk equities ha…
Posted in: On the Pulse
Market Pulse - First Quarter 2015
Tails of the unexpected Predicting what is going to happen in markets is a fruitless task. Forecasts of economic growth and asset returns are often w…
Posted in: Market Pulse
It is a difficult time to be an economics student. Correct answers to complex questions are hard to come by at the best of times but the current environment is littered with exceptions, often to non-existent rules. One core issue is the cause of most consternation: can you fix a highly indebted global economy, on the verge of collapse in 2008, by taking on more debt?
Welcome to 2015. Another year goes by and the number of questions about the prospects for the global economy continues to grow in size and in complexity. It is customary at the beginning of January to make predictions about the year ahead. Yet history shows that forecasts rarely materialise...Read more
Blink and you would have missed it. Global equity markets were up 2 per cent in October, but that positive monthly performance hides the big intra-month gyrations in markets. Spooked by an International Monetary Fund (IMF) report on economic growth, or lack thereof, global equities lost 8 per cent between mid-September and mid- October, only to bounce back strongly by the end of October. Government bond yields also fell, as you would expect when equity market volatility increases. Interestingly, fear led yields to dive in the US and the UK, two countries that are expected to raise rates in the near term.Read more
Central banks are finally going to raise interest rates; at least that is what some policymakers are telling investors. Although some central banks are signalling rate rises, the next phase of global monetary policy is likely to see diverging paths between the major central banks. The Bank of England (BoE) and the Federal Reserve (Fed) are poised to tighten monetary policy by exiting quantitative easing programmes and by increasing interest rates, while the European Central Bank (ECB), the Bank of Japan (BoJ) and the People’s Bank of China (PBC) are injecting monetary stimulus into their banking systems and economies.Read more
The world is on the brink. Numerous geopolitical events are threatening to spill over into the economy and derail the recovery that is finally gaining momentum. In addition, these tragic events have increased the uncertainty in financial markets in what has been a relatively calm year. The stories of human suffering combined with the risks of military escalation have dominated the press - including the financial media. The all-too-familiar red bannered “breaking news” headlines continue to hit the newswires on a daily basis, making it impossible to miss the unfolding geopolitical tensions. While regional conflicts inevitably hurt local economies, the key question for investors should be how much do they affect broader financial markets? Should investors adjust their portfolios when those red alerts hit their screens, or should they stick to their investment processes by focusing on fundamentals?Read more
When the Bank of International Settlements (BIS) – the Central Banks’ bank – warns that a crash is coming, it is best to sit up and take notice. In the BIS’ recent annual report, it suggests that the low interest rate environment created by policymakers, its very own members, has put, "global financial markets under the spell of monetary policy". With equity markets hitting record highs and yields across the fixed income space hitting record lows, the BIS says investors are being forced to accept more risk for inadequate return.Read more
Scottish voters will vote against independence on 18th September 2014; at least that is the indication from the latest opinion polls, which are suggesting approximately 47 per cent will vote "no" and 32 per cent will vote "yes" (with the rest undecided). The bookies are showing an even higher probability of a "no" vote with odds at a paltry 2/11. Nonetheless, with just over three months to go until the referendum, there is still plenty of opportunity for politicians to unleash promises and policies to swing the voters.Read more
The global economy is finally back on its feet. With unemployment falling, growth rising, consumer confidence increasing and retail sales improving, central bankers have much to be excited about. However, recent central bank minutes and rhetoric belies confidence in the recovery. Central bankers are still worried, about the one thing that got them to initiate quantitative easing in the first place: deflation.Read more
The ringing of the opening bell at the stock exchange is one of the most iconic images of corporate success and economic health. In 2007 – when the world economy was roaring and markets were at a peak – 214 companies went public in the US. Just one year later – as the wheels fell off the global financial system – that number plunged to 31. During the doom and gloom that followed, initial public offerings (IPO) were relatively rare. And then suddenly in 2013, the IPO market roared back into life: over the year, 222 companies came to market; almost as many as the two prior years combined. It was also a prolific year in the UK, where 31 companies were publicly listed; three times are many as 2012.Read more
Financial markets do not need central bank support anymore, or so it seems from recent events. In January, emerging market fears triggered a strong sell-off in global risk assets. However, a February rally more than reversed the fall and some equity indices actually hit record highs. Then, in March, an ongoing crisis in the Ukraine led to a sharp sell-off on the first trading day of the month, only for markets to recover within 24 hours. Yet there is something critically absent from the post-fall recoveries of 2014 compared to the ones witnessed over the past five years: the absence of intervention from central banks and other policymakers.
Since the 2008 crisis, investor jitters over economic growth (i.e. Europe, US, Japan) or geopolitical tension (i.e. Italian elections, US government shutdown, Cyprus “bail-in”) have typically required firm central bank intervention – “liquidity crutches” – for upward trajectory to be regained.
So, is the paradigm shifting? Are markets ready to rid themselves of their life support?Read more
2014 will be a negative year for equities. At least that is the conventional wisdom derived from the mysterious “January effect”. The theory is as follows: if January is a down month, the rest of the year is typically a down year. So that is the theory, but does it hold in practice? Let us examine the evidence.
In the past 113 years, the US equity market has registered losses in January a total of 34 times. Out of those 34 times, the US equity market was down 19 times in that year. In other words, when January is a negative month, the equity market registers losses 56 per cent of the time in the same year. While the probability of the equity market going up or down when January is a negative month is similar to that of a toss of a coin, it is nonetheless significantly higher than in years where January is a positive month. In the past 113 years, the equity market was up in January the other 79 times; the market ended negatively in nearly 20 per cent of those years. Unambiguously, the probability of annual losses is higher when January is a negative month than when it is positive.
The above analysis would suggest the “January effect” has some relevance in practice, but is that enough evidence to conclude the five year old bull market is coming to an end? Is this recent wobble the preamble to the bursting of the central bank induced risk-asset bubble?Read more
Welcome to 2014! At the start of each year, it is customary for investors and economists to make predictions about what the year ahead has in store. We take a different stance. Instead of making predictions, we focus on identifying some of the scenarios that could surprise markets.
But before setting out five possible shock headlines for 2014, we begin with a review of the five potential surprises we identified at the beginning of 2013 to see how they panned out.Read more
A simple theoretical model would suggest that if the economy is growing, consumers spend more, companies make more money and are consequently worth more, and, as such, share prices rise. If this paradigm holds, investors should rejoice as economies in much of the developed world appear to be growing again. Refreshingly, given the years of doom and gloom, Japan and the UK lead the developed markets’ fourth quarter growth projections in the IMF’s recent World Economic Outlook report. Even Europe, tentatively, appears to be turning a corner. Indeed, global equities are up 11 per cent in the past six months.Read more
Looking back in time, financial historians will be able to draw a number of lessons from the raucous five years since the financial crisis of 2008. During this period, policymakers, haunted by the spectre of the Great Depression, turned monetary policy into liquidity bazookas also known as quantitative easing (QE). Investors have had little reason to complain. The bubbling and frothy levels of liquidity have been primarily ploughed into risk assets such as equities and corporate bonds since the crisis, bidding up prices across the board.Read more
Risk, in the most typical quantitative sense, is defined as the variance or standard deviation of a portfolio. Yet this somewhat sterile definition does not quite capture what risk is. A quick Google search leads to a more textured definition: risk is the potential of loss resulting from a given action – or even inaction.
For investors, this translates into the potential to lose money by making – or not making – an investment. Ironically, not taking risk at all is the surest way to lose money. This can also be thought of as having no aim other than capital preservation. An investor wishing only to preserve capital can start with £100 and simply do nothing. The notional £100 will be returned at the end of any and every investment horizon, and while capital has indeed been preserved, money has been lost due to the compounding and corrosive effects of inflation.Read more
“Will he or won’t he?” are the questions investors have been trying to answer for the last few months. ‘He’ is Ben Bernanke and the questions being asked are about the withdrawal of the huge monetary stimulus that has flooded markets with cheap credit. If “he won’t”, the good times will keep rolling. But the fear that “he will” sends most investors scurrying to review their positions with trepidation. Listening to central bank rhetoric only adds to the confusion, but focusing on the facts provides some clues as to what might happen.Read more
As investors, we are all different. Or are we? While we may have different income requirements and tolerances for risk, we all fundamentally want the same thing: at the very least, we want to preserve the purchasing power of our savings over time. Investment losses clearly have the potential to quickly - if not spectacularly - slash our capital values (and therefore purchasing power). However, inflation can also destroy purchasing power; it just tends to be slower and more constant. Increasingly higher prices for goods and services results in our money buying less over time. This permanent erosion of purchasing power can be more punishing than the gyrations of financial markets. For example, one hundred pounds kept under the mattress over the past five years is now worth only eighty pounds today in terms of purchasing power; simply put, money has lost 20 per cent of its real value. Global equities on the other hand have managed to preserve purchasing power over the same period, even against the backdrop of a global financial crisis filled with economic doom and gloom.Read more
Commodity markets have had a lacklustre start to the year. Overall, commodity prices are down 5.1 per cent so far this year, and are in negative momentum. Precious metals, such as gold and silver, and industrial metals, such as aluminium and copper, are down 15.7 and 12.3 per cent respectively, while energy prices are up 4.5 per cent. Despite this recent weak performance, commodities still have a role in multi asset portfolios, but given the negative momentum, we now hold only a marginal allocation.Read more
The year is off to a strong start with equity markets continuing to climb. While the equity rally in the first quarter of 2012 was broad – developed and emerging markets both rose – the rally in 2013 has been fragmented. American and Japanese equities have led the way, up 10 per cent and 19 per cent respectively. In contrast, emerging market equities have lagged, down 1 per cent so far this year. Nonetheless, emerging market equities remain a good investment opportunity.Read more
Currency markets are at war. With policymakers under tremendous pressure to boost domestic economic growth – and having nearly exhausted most conventional means – many are now actively targeting weakness in their own currencies. Japan has drawn its sword for battle; recent efforts to stimulate its economy have caused a stir in the $4 trillion a day foreign exchange markets. This has led to a rise in currency market volatility, contrary to the relative calm in equity markets.Read more
2013 is off to a flying start. Global equities are up 5.0 per cent and investors appear to be in an increasingly ‘risk-on’ mode. Current positive momentum could keep equity markets well supported; however, the risk of a correction cannot be ignored. To that end, combining ‘risk-on’ assets with ‘risk-off’ assets, such as gold is prudent to balance out the risks in portfolios.Read more
Headlines proclaiming that the so-called fiscal cliff (the ending of Bush-era tax cuts and the start of planned spending cuts) is averted have reignited markets. Global equity markets rallied on reports of a deal.Read more
As 2012 draws to a close, pundits will inevitably forecast what 2013 has in store for the global economy and financial markets. Forecasting is a fruitless task. History is replete with embarrassing and erroneous forecasts made by bona fide experts. So in this end-of-year blog, rather than forecast what will happen in 2013, we assess potential risks and opportunities that are not currently priced into the market, but could define 2013.Read more
Financial history is replete with bubbles and crises; indeed markets seem to travel from bubble to bubble. In the past two decades, markets have suffered from two major bubbles which burst and left some economies in recession. First came the dotcom bubble in the late 1990s followed by the housing bubble in the run up to the 2007 credit crunch. The question now is “where is the next bubble going to come from?” With bond yields at all time lows, the sovereign bond market, especially in the US and the UK, is expensive and posturing as the next big bubble.Read more
Central bankers are at it again. Last month they gave the market another round of liquidity injections. The European Central Bank unveiled its Outright Monetary Transactions (OMT) programme to assist the weaker Eurozone economies by buying their debt. The Federal Reserve then unleashed QE3 to help the labour market by reducing mortgage rates. There has been much talk about what the US needs to do to avoid the twin predicaments of slow growth and deflation that the Japanese economy has faced since 1989. To avert a Japanese-style lost decade or two, the Federal Reserve, and other central banks, have committed to keeping rates lower for longer and the monetary taps open. So is the US doing enough to avoid being the next Japan?To answer this question, it is useful to look at the similarities and differences between the crises faced by the two economies.Read more
If by ‘it’ we mean the stock market, then the answer is nothing.
A simple theoretical model would suggest that if the economy is growing, consumers spend more, companies make more money and are therefore worth more. As such, share prices rise. It is simple and logical. The corollary is also theoretically true. When the economy contracts, people become unemployed and consumers spend less. Companies therefore generate fewer sales and start to lose money, and so company share prices decline.Read more
Is it possible to make money in a world where, in just three years, 40 per cent of economic output is wiped out and unemployment shoots up from 3 per cent to 25 per cent, leaving a quarter of the working population out of a job? Is it possible to make money in a world where, over a decade, the stock market halves in value, bankruptcies become the norm not the exception, and uncertainty permeates the media and everyday life? The answer is yes.Read more
Financial markets are caught between two regimes; mountains of debt and the ensuing growth burden pull the market in one direction, while liquidity injections pull it in the other. Our central thesis is that the risks from the mountains of debt outweigh the return potential from the liquidity injections, hence our defensive stance year to date.Read more
After a strong start to the year, the sugar rush from central bank liquidity has started to wear off. While positive investor sentiment lifted markets higher in the first few months of 2012, the elephant in the room - the eurozone sovereign crisis - went largely unnoticed. However, recent developments in Spain have woken investors up to the realities of the sovereign debt crisis.Read more
The mountains of sovereign debt are still there, budget deficits are still enormous, and the global economy is still operating below capacity. So what is there to be cheerful about? Liquidity.Read more
Uncertain and challenging, these are two words that are likely to be used for many years to come to describe the prevailing economic climate. Major economies are buried under mountains of debt and growth is not forthcoming; conditions that have often taken economies down the slippery slope of credit rating downgrades and debt restructuring. Despite this, February proved to be another strong month for risk assets with the equity market up 7 per cent so far this year, the 11th best start to the year since 1962.Read more
“How will it end?” This is the question on all investors’ minds. It has been nearly five years since the credit crisis broke in 2007, and the world is still no closer to putting this chapter of economic history behind us. It would be an understatement to say we live in uncertain times, and it is impossible to predict what exactly will happen next. Still, historical evidence suggests the end game must involve bringing debt back to sustainable levels for both the private and public sectors.Read more
Financial markets are like a sick patient in constant need of saving. Since the credit crisis broke in 2007, policymakers have announced package after package to save the financial markets from meltdown. On 30th November 2011, central banks launched yet another programme to ease the stress in the banking system by reducing US dollar funding costs in the swap markets. This helped the markets rally on the day, but the question now is “is it enough?”Read more
When asked how they make investment decisions, investors often discuss a myriad of economic and market indicators they follow to help them form a view on markets. If they are feeling jovial, investors may jokingly answer by citing one of the oldest adages in the world of investing, “we buy low and sell high”. This sounds like a simple rule, but in practice, it is often a challenge to determine whether the market is low or high at any point in time. Wouldn’t it be great to have a way of establishing if the market was near a low, or more importantly for wealth preservation, near a high so we could avoid losing money? Luckily we can. Empirically, valuation is the most dependable way of identifying the highs and lows in markets.Read more
Three years ago the world banking system went into crisis and sent the global economy into a savage recession. The world’s leaders came together and acted in a co-ordinated manner to deliver the largest economic policy stimulus in history using just about every tool they had; infrastructure spending funded by borrowing, tax cuts, dramatic cuts in interest rates and abundant liquidity in the money markets. At first it seemed to work, the world came out of recession in the second half of 2009, and continued to grow into early part of 2011. However the action of both equity and government bond markets since the third quarter is clearly indicating that investors now feel the world is slipping back into recession.Read more
The globalisation of the world economy has accelerated in the last 20 years on the back of the trend towards freer trade following the Uruguay Round talks which concluded in 1994 and the opening up of the Asian economies to international investment, enabling multinational companies to take advantage of the much lower labour costs, initially in Asia and then more particularly, in China, to manufacture their goods and then ship them to western consumers who paid for them on credit provided by their banking systems who derived their deposits, ultimately, from the savings of those same Asian workers.Read more
With just a few hours to spare the America political system managed to come to an agreement that would have prevented the US government from spending any more money, possibly leading to a default on Treasury debt. Markets had always expected such an outcome but the bitter divisions between Republicans and Democrats on taxation policy came quite close to wrecking things. A compromise was found but the details of that compromise are very disappointing.Read more
The second quarter ended with markets rallying on the news that the Greek government had managed to deliver its parliamentary majority for the further austerity measures that the IMF and the EU demanded in return for continued access to bailout monies that means it can avoid defaulting on debt repayments. For Greek politicians this means they keep their jobs and the goodwill of other European politicians for a little while longer, whilst German and French politicians can claim to be good Europeans (for helping out a fellow euro country in distress and ensuring that there is no crisis within the euro) and at the same time not be forced into providing a second bailout of their domestic banking systems.Read more
Looking at the history of financial market bubbles, one interesting but neglected fact is that they have all tended to be fairly localised affairs. The often-quoted Tulip Bubble of the 1630s only really affected Holland and Dutch speculators, and in more recent times, the bubble in Japanese property and equity markets was mainly first enjoyed and then endured by Japanese investors and institutions. Foreigners generally do not seem to have got caught up in the “groupthink” that can persuade otherwise sane people to pay astronomically high amounts for certain assets. Arguably the TMT bubble of the late 90s had a more international dimension, with both Europeans and Americans paying vast prices or the hope of the internet and technology in general. In fact the internet has probably developed even further and faster than many would have dreamed possible then, but unfortunately companies overall have not found ways to translate that technological change into huge profits.Read more
The credit crisis of 2008 would normally have led to an enormously long and deep recession in the Western world as banks and consumers sought to reduce the size of their balance sheets. That it didn’t was down to governments who sought to protect both their economies and their national banking systems using money they had to borrow from financial markets. Most governments are now having to face up to the implications of that decision.Read more
In the years up to 2007, the global economy found itself subject to several key trends which boosted “disinflationary growth”. That is they were good for growth, but also helped to keep inflation low. The transition of the Chinese population from farms to cities was the key force here as 20 million workers every year were able to leave work which just managed to feed them to find new jobs in manufacturing in the cities at wages they could only dream of previously but which were fractions of the wages paid to similar workers in developed economies.Read more
The living standards of the average UK household are being squeezed in every direction, and this, as the Governor of the Bank of England recently reminded us, is the unwelcome but necessary outcome of the end of the debt-fuelled spending boom of the first seven years of this century.Read more
In 2009, several Eurostar trains broke down inside the Channel Tunnel and the media blamed "the wrong sort of fluffy snow" for the incidents – an excuse which was greatly derided at the time. Central Banks may be about to use the same sort of excuse for inflation rates in the UK and Europe which are above the targets set for them. One would expect some rather more opaque language than "the wrong sort of inflation" from Central Bankers, but it would be a fairly accurate description.Read more
2011 promises to be a very important year for politicians. The decisions they make or don’t make this year will have profound consequences for their economies and the financial markets.Read more
As the EU and IMF conclude their second European bailout of the year (should there be an award for Best Bailout of 2010 one wonders), the markets are focussing their attention on Portugal and Spain as the next recipients of such assistance, and on whether the euro can survive. It is helped by the deliberate non-existence of an exit process. This was for two reasons; the first being that if there were such a process, its very existence would make it more likely that it would be used and it would thus be counter-productive and the second that in the event of the sort of disaster now striking the eurozone, then the euro's designers assumed and indeed desired that it would force a move towards greater political union in order to enforce and save the monetary union. Thus the EU would demand much stricter budgetary control over the offender in exchange for the money necessary to get them out of their problems.Read more
This year, stock market earnings per share in the US and the UK are expected to be only a little below the records set in 2007, and analysts are confidently expecting that 2011 earnings will exceed those records. What makes this even more impressive is that this is an industrial company phenomenon – banks are reporting large profits thanks to zero interest rates, but their earnings per share are a fraction of the record levels of a few years ago due to the huge increase in the number of shares they have had to issue to repair their balance sheets. Industrial corporate profit margins are near 60 year highs.Read more
Recent weeks have seen several countries take a clear step towards an easing of economic policies. Japan was first; following a party leadership challenge to the current prime minister (which was defeated), he immediately reversed his economic policy of not intervening in the foreign exchange market and ordered a massive $20bn+ operation to sell yen and buy dollars in an effort to push down the value of the yen – such a policy has always been actively discouraged by the Bank of Japan, but the government had indicated that it would do more in an effort to boost the Japanese economy.Read more