« Croissance atone vs Liquidités abondantes. Qui gagne? » Une excellente question posée par les stratégistes de JPMorgan.
« Markets took a breather this week, after last week’s fireworks, with equities and credit largely flat, and bonds yields and commodities down. It was a quiet eek for data, but what we got was on the softer side. We continue to think global growth is bottoming, but the evidence so far confirms only that growth has come down and that Q3 seems equally soft as Q2. There seems no real evidence yet of a rebound in growth. All we have is a rise in orders relative to inventories in flash PMIs, a rise in confidence, & surging financial asset prices.
The weak economic data of the past two years and rising asset prices have created a conundrum to investors on what they should really follow — the weak fundamentals or the good “technicals »? We have argued here frequently that liquidity driven asset reflation in a market with high risk premia and defensive positions trumps weak economic growth, as long as the latter does not deteriorate into recession. Hence, we have chosen to remain long risk assets despite repeated downgrades to economic growth projections. We like to make clear though, that these so-called technicals are to us very fundamental and are not as short term in nature as many would suspect. And this for three reasons.
For one, the relative supply and demand for financial assets is not a mere short-term technical but is based on the first fundamental law of economics, which is that of supply and demand. Government supply of government debt and cash is many times the supply (net issuance) of corporate debt and equities. Hence the latter, scarcer corporate securities should rise in price against the much more abundant supply of government liabilities (high-powered money and government debt). This force is not a short-term technical impact, but in fact works more slowly and profoundly.
Second, credit and equities are characterized by much higher risk premia versus government debt than we typically see in this point of the cycle. Central banks are now acting not merely to increase the supply of cash, but are also casting their policy in term of providing downside risk protection (insurance). We would classify the ECB’s OMTs as exactly that. They will be implemented only if needed and with an explicit objective to eliminate risk premia on sovereign EMU debt. The Fed’s new QE3 similarly is conditional on the state of the economy and labor market and will be accelerated if the economy weakens. If only US and Euro fiscal authorities could similarly reduce downside risk, risk premia would surely come crashing down. Risk premia are thus fundamental and not merely technical.
Third, it is frequently argued that markets are running ahead of still weak fundamentals (growth) and are thus wrong. We would argue that the transmission process of monetary policy in a world of zero interest rates runs exactly from markets to growth. It is through asset reflation that central banks try to stimulate growth. Hence market will lead economies. Don’t fight a determined Fed, ECB, BOJ and BoE, especially not when they work together.
To be clear, we are not telling you to ignore economic growth. Stronger growth would have given us higher equity prices. But at this point in the cycle (we assume we are mid-cycle), volatility of economic data is trumped by relative supply & demand & changing risk perceptions, as long as we do not have another recession. Growth, however, does have an impact on relative country and sector performance. The top chart shows how growth forecasts for 2012 have been stable in DM, but have trended down in EM over the past 6 mths, which likely explains why EM equities have underperformed. The 2nd chart shows how cyclical stocks have not kept up with their high-beta nature over the past 2 years, underperforming defensives, despite an overall rally in stocks, likely as cyclicals are more vulnerable to downgrades in growth. »