The rebound in financial markets reflects strong optimism among market participants that real and nominal economic growth and inflation are about to get stronger in the coming years. This view has supported a sharp rebound in valuation ratios (see chart above). At the same time, USD has continued appreciating against most currencies, and the fixed income market has consolidated on the back of rising yields. Lire la suite
We haven’t heard much about Brexit so far… This is going to change. UK’s PM Theresa May is expected to give a speech about her strategy to manage UK’s exit from European union: it’s a two-option strategy: « Soft » or « Hard » Brexit, with consequences that few can yet imagine, since Brexit in itself will be a very lengthy process. Lire la suite
Maybe both actually… Lire la suite
To those who fear market have already priced in a lot of good news, especially on the « Trump » effect on the macro backdrop, and that maybe the « Value » trade is now overcrowded and associated sector rotation (from defensive names to more cyclical ones) is overdone, Morgan Stanley’s equity strategy team, lead by Graham Secker, has some good news. Actually 6… Lire la suite
A very good read to recap 2016, the « RIC » report from Bank of America Merrill Lynch. The returns in the above tables are in dollar terms if I’m not mistaken.
The European consumer staples sector has been characterized by slowing organic growth number, due to volume softness and pricing pressure, which has in turn contributed to its valuation de-rating, on top of sector rotation triggered since July 2016 by the rise in bond yields. What will be the drivers of earnings going forward ? Lire la suite
Question: how long will this hold ?
After the recent rally in stocks, a note of caution from BofAML strategist Michael Hartnett and team. Since it’s difficult to sum it up, here are the key points made by them : Lire la suite
Recovery in earnings, a lower yen, a relatively attractive valuation ratios, favorable technicals (higher demand for Japanese equities), continued support from BoJ, a rebound from capex and high cash distribution potential might be the main driver of a pursuit of the rebound in Japanese equities in 2017, according to Matsuura Hisao, Nomura’s chief strategist. Lire la suite
Have government bond yields reached a low point that will signal the end of the bull market for bonds (which started in the early 80s) ? Well according to some commentators, this might be it. And the recent bond selloff is just a reflection of that. Lire la suite
Yes, probably according to BofAML analysts.
« Our analysis shows fewer bonds trade on a daily basis over the past year. We also find that trading volumes are declining over the past years as a percentage of the stock of corporate bonds. Liquidity is concentrated in benchmark bonds; 5y and 10y bonds exhibit better liquidity both in terms of tighter bid/offer spreads and also higher turnover. Higher spread/yield bonds exhibit better liquidity. »
The latest survey of global fund managers by Merrill Lynch continues to reveal high levels of cash in asset allocation, neutral stance on equities (1% net overweight vs 9% a month ago), yet on the backdrop of positive sentiment towards economic and profit growth…
Interestingly, most investors explain that high cash levels in allocation (net 5.4%) reflect « bearish views on markets »…
Another interesting indicator in the survey is about the « most crowded trades » based on investors’ views.
From Merrill’s note:
« Most crowded trades are all « NIRP-winners »: long High Quality stocks; long US/EU Corporate bonds; long EM debt. Sept FMS shows first meaningful reduction in bond proxy exposure (staples, utilities, telcos – Exhibit 1), as well as reduction in « high growth » US market. But both REITs & tech remain big stubborn longs, and EM equity OW highest in 3.5 years. All vulnerable should Fed and especially BoJ fail to reduce bond vol in Sept. »
When you think about the increasing interest in EM debt, or the sustaining impact of QE on « low vol », « bond proxies », « high visibility/quality » stocks, you get a sense markets are probably ripe for a correction…
One of the latest publication on X-asset strategy comes from Morgan Stanley and the message is pretty grim:
« Our cycle indicators across DM have stalled, pointing to rising risks of a shift from ‘expansion’ to ‘downturn’. The dilemma is that this peak has characteristics of both ‘true’ and ‘false’ turns. We explore our cycle checklist. »
UBS’s Europe strategists stick to their Stoxx 600 340 points target by year-end and provide a useful table of the underlying fundamentals/valuation factors. The following table illustrates where market would be if you change either 2017 EPS earnings growth and 12month forward P/E ratio. Bottom line: if you are cautious right now, don’t touch European equities.
Another good chart from Morgan Stanley most recent « Cross Asset Playbook », there are tons of useful and valuable material in there, this is just a selection (see previous post as well).
Interesting comments from Barclays’ equity research team…
Lots of numbers and valuation ratios with some granularity at the sector level for MSCI Europe…
A clever question raised by strategist at Nomura, and here are the summary of their answers… Enjoy
From GS’s latest GOAL publication:
« Much of the reason that equities appear cheap versus bonds therefore is simply a reflection of how much bond yields have fallen. Most measures of the ERP will use some kind of long-run historical average measure of profit growth and extrapolate into the future. »
Current levels of ERP assumes that earnings growth of the past 20 years will go one forever. But that’s a hard case to make. In fact, as GS’s strategists put it:
« Here lies the great dilemma for investors: on the one hand, current bond yields imply that valuations can continue to rise for financial assets (as they have already done over recent years), but, on the other hand, to justify current risk free rates into the future, we should assume lower long-term growth (consistent with ‘secular stagnation’).This should cap the level of valuations close to current levels.This is why we argue that while the Long Good Buy for equities still holds – they should do well relative to bonds over the medium term – the market trajectory is likely to be flatter than experienced through 2009 to 2016. »
Merrill Lynch strategists have recently published a very interesting chart that clearly illustrates how western central banks’ QE, by lowering the return on safest assets (aka govies), has forced many investors climb the ladder of risk…
Excerpt from the latest GOAL publication from Goldman Sachs… I’m just picking a couple of paragraphs that give a good understanding of how difficult it is to do proper asset allocation and not be weary of losing it all when markets are distorted by central banks and the prospects for growth and inflation are dull…
Just discovered it thanks to Value Investing World (great site BTW)… Enjoy
The Brexit has been painful for UK banks, but also for REITs with the trouble of many open-ended funds sold in the UK mainly. But what about the stocks themselves ? Well, if you look at the following charts from Exane, there are probably some value to look for from there…
Many fund managers pried their ability to pick stocks, or, as the jargon goes « generate alpha » through stock selection (and with that the handsome fees they charge you). But the following 2 graphs show that rather than picking the right stocks, it’s better to pick the right sectors…
Courtesy of Goldman Sachs who reviewed the performance of UK and European stocks after the Brexit vote… We focus specifically on European stocks although GS’s strategists recommend to be cautious on UK stocks even after the volatility in FTSE 100 & 250.
Jason Zweig from the WSJ published a column titled « Gold is still a pet rock » and its a great read (and obviously JZ is not ‘a moron’ as he calls himself)… He reminds us that if gold is a good « insurance against chaos », its value fluctuates so much it’s a poor protection of purchasing power for short periods of time. Lire la suite
The bank sees 7% YoY EPS growth for S&P 500 in 2017… but this will probably depend on the global macro picture which is not very comforting right now.
That’s a severe correction (knowing it started way before the UK referendum). But Goldman’s analyst add some interesting comments:
» Whilst EUR funding is exhibiting no sign of strains, funding pressures are gradually building in USD (USD/EUR and USD/GBP cross-currency basis) and GBP funding indicators. This said, they remain at levels that are a fraction of previous crises (2009 and 2012) peaks. We maintain that funding shocks are unlikely, given generous central bank backstops – these were sufficient to contain the aftermath of both the Lehman and European sovereign crises. »
European banks are probably stay in such a comatose stage for some time, as long as there are no sign of steepening yield curve or a better macro environment. On top of that, due to there high beta, banks are considered a good play to short the market when everything goes wrong. So be careful if you decide to pick one.
And the answer from Barclays:
« While valuations are certainly not pricing in a full-blown global recession, we are not far away from pricing a 2012-style moderate recession. If such a scenario were to fully materialise, the fundamental floor appears to us to be a STOXX 600 level of 300 (c. 10% below today’s levels). However, if a more benign economic scenario were to occur, as per our economic team’s forecasts, we expect valuations to eventually revert higher. Till further evidence of this materializes, in the near-term, we expect markets to remain volatile and follow economic and political developments. »
Source: Morgan Stanley
Interestingly, one week after the event, systemic risk doesn’t seem to be an issue…
Source: Morgan Stanley
Views per asset classes:
- Equities: stay defensive (global earnings have been falling, and valuation are relatively fair)
- Currencies: USD bull market is not over…
- Rates: lower for longer
- Credit: best option for carry
From GOAL report dated June 26:
« Brexit has driven a sharp drawdown in equities
The UK vote to ‘leave’ the EU has triggered a sharp drawdown in European and global equities. We have long argued that equities are stuck in a ‘Fat & Flat’ range given both elevated valuations and a lack of growth. The impact of Brexit on confidence and the ERP, as well as on European growth, increases the risk that we move downward in this trading range. We have highlighted risks of a correction in our recent GOAL – Global Strategy Paper No. 19 and strategies to mitigate this risk. A key concern remains the lack of diversification or availability of ‘hedges’ for equities as most safe assets, in particular bonds, remain expensive alongside equities.
Potential for further weakness & volatility in global equities We think equities will remain volatile and stay defensively positioned in our asset allocation (neutral equities over 3- and 12 -months, overweight cash over 3 months). While we think investors have been lightly positioned into the drawdown, we feel that due to policy uncertainty and lack of growth, risk appetite might remain low in the near term. However, a combination of further declines in valuations and positive growth/policy surprises are needed to stabilise equities within their ‘Fat & Flat’ range.
Lowdown on the drawdown
Comparing the current EURO STOXX 50 drawdown to history indicates that it might continue (most drawdowns have lasted more than a month), valuations might have to drop further and bonds have been less good hedges for equities. Gold and Yen performed best as ‘risk off’ hedges. »
Skip directly to 28:00 for the start of the meeting…
Don’t underestimate Grexit risks warns Veronique Riches-Flores, from RF Research.
If Greece were to exit Eurozone, which would be unprecedented and is not anticipated by current European treaties (as far as I know), the consequences would be dire for financial markets.
Even more so since financial markets are globally overvalued, as illustrated in the above chart…
« When people jump into stocks even though they know valuations are high… it’s a bubble ». Well at least that’s pretty clear. Interesting interview from famed Prof Shiller.
This is « old » stuff, but valuable content rarely ages. Since I just happened to have read Pabrai’s book (a MUST READ), this is a great opportunity to learn it « live ».
Courtesy of Exane BNP Paribas’economist team, the Grexit case in a nutshell, actually 2 charts that might help clarify some points. According the Exane, Grexit now has a 40% chance to materialize.
About the timeline for the coming summer…
And here are the scenarios in the event of Grexit:
Obviously, investors should think about ways to protect their portfolios, but they shoudl also raise cash and be prepared to seize investment opportunities.
Well, another broker, another view on how investors in Europe currently assess the financial markets right now… from Morgan Stanley, here are the summary of their « Investment Seminar »…
Lastet investor survey from BofAML is out, and guess what… people are more bearish than a couple of months ago… Yet their bearishness translates into more portfolio protection rather than simply get off the boat. So far, that’s probably the least painful trade.
« The uncertainties that made us cut our risk OWs to small have not gone away and merit hedging. The biggest one comes from an early end to the cycle caused by the lack of productivity growth. Inflation will be the warning sign and should be hedged. »
Another good read from Jan Loeys and team at JPMorgan… Lire la suite
Back in 2003, reading The Intelligent Investor blew my mind. I had been a financial reporter for a couple of years, in a publication that was supposed to give valuable investing ideas to individuals. From 2001 to 2002 we just witnessed the market crash, and failed to help investors protect their capital. All the way down to capital destruction, bad investment advices, all to be ashamed of when I think about it in retrospect (I sincerely apologize for that by the way).
After having read Graham’s book, I actually wondered why no one had ever asked me to read the book BEFORE I joined the newsroom… The paper is still in business, but I’m not sure their readership has greatly expanded since 2003… Lire la suite
Had a great time in Omaha last week end. Thanks Mr B.
Derivatives specialists at Goldman have put up an interesting piece of research. Unfortunatelly, it only covers the US equity market.
Over the past 9 months, the cost of SPX 55% OTM 5 year equity puts has more than doubled while the cost of 10 year puts is up 50%+. Long-dated options markets appear increasingly concerned about the potential for a decline in the S&P 500. Equity valuation and CDS spreads have been highly correlated with put prices over the past several years, but long-dated put prices have diverged. We see reason for concern as put prices were up a similar amount in 2007 ahead of the financial crisis, diverging from credit and equity at that time as well.
Where Warren Buffett, the most acclaimed and respected investor, converses about Berkshire Hathaway’s past, present and future. A must read !
For now on, « deflationary fears have receded », claims Goldman’s strategists. So far so good for European equities which shot up more than 13% YTD and still have steam to run up further, according to the bank.
ECB decision: 60 bn € of asset purchase on a monthly basis, starting in March and for as long as the inflation trajectory of the Eurozone is not sustainable. This was partly priced. The expansion of ECB’s balance sheet is ON, so this will certainly have some impact on markets.
Key items of ECB policy action:
Here are a couple of first market reactions and commentaries.
Barclays’ equity research theme has published a note about the 3 questions investors may ask about ECB QE and its impact on market.
Here’s the summary:
For those investors who did not have time to read all Morgan Stanley’s reports about ECB QE and its impact on asset classes, here’s the summary of the summary.
Yield search isn’t a new theme. It’s actually been around for a couple of years. But with a growing number of bond yielding zero or less, due to the « globalization » of ZIRP, the chase for yield is intensifying.
Here’s the stock of bond yielding below 0, that is that investors have to pay for to own… Japan is a clear leader, but we now see Germany, France, the Netherlands joining the club. While Japan is above 2tn€, the Eurozone is close to 1.4tn€…
And obvisouly, the equity market doesn’t seem to care (although that’s partly true). From SocGen’s quant team (one of the greatest read coming from a broker).
As shown in a report published today, SocGen reminds us that Eurozone equities have been a very nice performer over the last 30 months and « trade on an aggregate at P/E premium to the rest of Europe and the rest of the world ». The question they ask therefore is: « Where is the equity upside, if any, from ECB QE? »
First off, the rebound in EZ equity market has 2 reasons: the level of equity indices after the market crash of 2008-2009 and then after July 2012, the main driver of EZ equity rebound was of course multiple expansion, or, its equivalent, market risk premium compression. Lire la suite
In a summary: cash levels remain high. Deflation in Eurozone is seen as the major risk (along geopolitical tensions). Investors are somewhat still optimistic about global growth, but less so than previous month and their expectations regarding EPS going forward have come up a tide grim.
The most contrarian call is Energy and Materials, but as long as oil prices do not recover, that probably to risky a call.
From Suki Mann, FI strategist at UBS (bold statements from us):
« Corporate bond market capitulation: Is it coming?
We believe that if the ECB announces any kind of corporate bond buying this week, investors could well embark on a fairly aggressive grabfest ahead of the actual commencement of the programme.
Already bereft of supply, decent yield, spreads unchanged into the macro-headwinds; and, plenty of pent-up demand for paper as cash keeps rolling-in to the asset class, we think that the actual announcement could see a lurch tighter in spreads. That is, QE is not in the current price. Some think it is, we don’t.
How much can spreads tighten? The answer ultimately depends on the modalities of the program (size, duration, mix). »
From Srikanth Sankaran & Shrina B. Poojara at Morgan Stanley fixed income research team:
« We maintain a constructive bias on credit heading into Thursday’s ECB meeting. Despite the outperformance of European credit in recent months, we do not think that QE upside is fully priced in. A 20-25bp compression in IG spreads is likely, should the ECB deliver.
Sovereign QE is now our economists’ base case: Our economists’ base case now is €500 billion of government bond purchases and €100 billion of private sector asset purchases. In terms of timing, the complexity of designing a sovereign QE programme makes January 22 an ambitious start day. Announcement in January and execution in March is more realistic, they think. »
Here’s the summary of their views:
I’m not sure how this is good news for the liquidity of financial markets. First we had the regulatory pressure on exchanges to open them to competition, which split away the liquidity and has made it more difficult for money managers to buy/sell even equities.
Second we had the regulatory pressure on insurers, banks, pension funds to limit their risk appetite with contracyclical rules (which basically says: « you have to buy bonds when they are expensive and sell equities when they are quite cheap »).
So now, big money managers (Fidelity, etc…) are said to organize dark pools which would exclude hedge funds and investment banks (good thing) but in the end would reduce overall market liquidity. Imagine what will be left to individual investors if this project goes through and goes global…
Although the bank predicts the European equity market might gain c. 8% over next 6 months from QE’s announcement, its economist are still scratching their heads regarding the ability to implement and the benefits of this kind of measures. Lire la suite