Stock Markets

Why Europe Is Doing The ‘Ice Bucket Challenge’ With A Glass Of Water

‘Grand’ gestures with minimal effects, Europe is doing the ‘Ice Bucket Challenge’ with a glass of water. Measures won’t measure up to much. Little movement in interest rates, not enough assets to buy and ultimately – you can put out as many cream cakes as you’d like, but if people aren’t hungry, they aren’t going to eat. The pressure is rising and more is needed. Europe has become a ‘binary trade’, and it is important to invest in those set to benefit regardless.

(Click on the image below for a quick video clip summary)

cnbc FMHR Sept 2014

2 Measures That Won’t Measure Up To Much… (more…)

3 Ways Cyprus is a ‘Game Changer’ for Europe

Published on the Front Page of the Huffington Post Business

With strong words to support the Euro, Mario Draghi, the European Central Bank President, quelled fears over the future of the Eurozone. However, the bailout negotiations in Cyprus revealed cracks in this ‘floor’ supporting the region and markets. A ‘Banking Union’ has been undermined, imbalances within the region magnified and individual systematic risk returned. Divergences within the global banking sector will widen but with the Fed likely to remain accommodative, bullish market sentiment may continue to overshadow concerns elsewhere. Nevertheless, this recent turmoil has highlighted that we’re far from an end to the crisis.

[Click image below or this LINK to watch this as a TV Clip]

cnbc march 20 2013

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From Rome With Love? The 3 Issues To Watch For Italy & Global Markets

This article made the Front Page of the Huffington Post Business

Political uncertainty in Italy could impact global markets, but provide a “fantastic buying opportunity.”

cnbc squawk

Like Jennifer Lawrence’s fall at the Oscars, unexpected but a chance to shine ‘comedically‘, Italy’s elections have shocked investors but provided attractive entry points to strong international firms, insulated from domestic woes (as well as offer up some funny one-liners from candidates). The possible loss of eagerly anticipated labour reforms, financial restrictions and market contagion provide shorter term sources of turmoil. However, existing reforms are likely to continue, market retrenchment is healthy and to be exploited for longer term opportunities.

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What to watch this week: Policy drives market direction (Prezi slideshow)

With political pitfalls possible, eyes on Chinese easing, and a flight to quality by investors, policy is driving market direction. This week, the minutes from the latest Federal Reserve meeting will be scoured for signs of further fiscal support. Moreover, the Bank of England’s inflation report will be reviewed for changes to the outlook for growth and inflation. Central bank rhetoric will determine how investors trade. (Watch this as a slide show…)

Political Pitfalls Possible

France’s new President will meet German Chancellor Merkel today with opposing views on the fiscal treaty (see previous post). Furthermore, until a Greek coalition is formed, turmoil there will continue.

Eyes on China Easing

After data disappointed last week, the Bank of China cut the reserve requirement ratio by 50 basis points on Saturday. This is the equivalent to injecting around $64 billion into the banks. Investors remain watchful on Chinese policy, hoping it remains accommodative as the economy cools, to protect global growth.

Flight to Quality

Unsurprisingly, with the climate uncertain, investors have rushed into perceived safe havens. With much money still on the sidelines, a reversal of this trend could provide a hefty boost to markets. Appetite for risk is a crucial current driver.

QE3 Back on the Table?

The Federal Open Market Committee (FOMC) minutes will be scoured for signs of fiscal support. Housing market weakness and elevated unemployment has caused Bernanke to leave the door open for further stimulus. Any indication of inflation easing could put the possibility of QE3 back on the table. Although still unlikely, with elections due this year, the pressure is on for policy to remain accommodative.

A Worse Outlook for UK Inflation and Growth?

The Bank of England’s inflation report will give investors colour on the headwinds for consumption and the economy as a whole, as growth and inflation forecasts may be amended. Plunging purchasing power will keep consumer spending stifled. As rising inflation data calls an end to a 5 month easing trend and continues to surprise on the upside, investors will be watching for an increase in the inflation forecast. Higher energy prices and lending rates have kept the risk to the upside and as we dip back into recession, businesses are unlikely to boost hiring. Investors will therefore focus on whether the growth outlook is downgraded. Headwinds are severe and sentiment remains depressed.

Europe – Lacking a Long-Term Solution

Over the last few days we have seen a tremendous amount of volatility in the markets, epitomising the lack of clarity with which many investors have struggled. The contagion continues to spread as we hear rumours of a possible downgrade of French government debt although it is far more likely to occur for Italy first. Fundamentally, there is a lack of a long-term solution and the knee-jerk reaction by some EU countries to ban short selling not only misses the point, it may negatively impact the very stocks it is trying to protect. So as we see movement to safe havens, we also see room for opportunistic buying – as long as you invest with those with strong balance sheets unlikely to be hit in future earnings downgrades and have a long enough time horizon to withstand the volatility.

Italy and France to be downgraded? The Contagion Continues to Spread

The markets are already betting for the ratings agencies to downgrade France’s debt with credit default swap spreads widening to double their level at the beginning of July. A rising expense to insure against default implies the market believes it to be more likely. However, Italy is the more likely downgrade candidate in the short-term. The reasons given behind Portugal’s downgrade a few months back apply equally to Italy – an unsustainable debt burden (Italy has the third largest in the word at €1.8tn) and a low likelihood of being able to repay these obligations (as it dips back into recession). The European Financial Stability Fund is losing its credibility since even its increase to €440bn is not enough to cover future potential bailouts and would need to amount to at least €2tn. The crux of the problem, as I’ve iterated before, is that you can’t solve the problem of debt with debt and austerity does not foster growth. Instead debt burdens are increasing at a faster rate than GDP growth in many western economies so the situation is only getting worse.

Outlook for banks: Headwinds for banks remain

European banks remain highly correlated to the future of the periphery. German banks, for example, have exposure to the PIIGS (Portugal, Ireland, Italy and Spain) amounting to more than 18% of German GDP. Commerzbank revealed that a €760m write-down for Greek debt holdings wiped out their entire Q2 earnings. That’s before we look at France who have an even higher exposure and here in the UK, our banks have nearly £100bn exposed to struggling economies. Furthermore, these banks need to refinance maturing debt (at a rate of €5.4tn over the next 24 months) at higher rates and with demand shrinking.

Will the ban on short-selling help? No, it misses the point

The markets are concerned with government fiscal credibility not its regulatory might. Instead, the ban could increase volatility and negatively impact the very stocks it is trying to protect. ‘Shorting’ was acknowledged by the Committee for European Securities Regulators as beneficial for “price discovery, liquidity and risk management” just last year, so we may well see higher volatility than we would have without. Secondly, it limits fund ability to bet on financials going up. Hedge funds use shorts to remove market risk, buying shares in one bank and borrowing and selling shares in another. If they are forced to close these ‘borrowed’ positions, they will have to sell the other bank shares they have bought outright, causing further selling pressure and price falls. Most interesting was the timing of the implementation, just before an announcement was made that the Greek economy shrank by 7% in Q2 – fuelling fears the ban was needed since there’s more bad news to come.

How to trade these markets: Movement to safe haven offering opportunities

So how can you invest in these markets? A possible support to the stock markets is the ‘search for yield’. Sitting on cash can’t be satisfying for long, with rates as low as they are, and the dividend yield on the Eurostoxx is now double the 10 year German ‘bund’ yield. This means that even if markets go sideways, the return generated from holding European stocks could be more attractive than either if the other options. In addition, valuations are looking reasonable, at a near 8x forward earnings. Therefore we may see flows returning to the markets. However, be warned, we are starting to see earnings downgrades and volatility may remain. Therefore invest in companies with strong balance sheets and maintain a medium to longer-term time horizon.

A Sustainable Recovery? “What’s driving the markets and how should I invest?”

The recovery is “neither strong nor balanced and runs the risk of not being sustained,” (Olivier Blanchard, the IMF’s chief economist)

INVESTMENT INSIGHT: Closely monitor the economy/markets – look to exploit overreaction on the downside, but with protection against future market pullbacks (E.g. via managers able to short / hedge exposures quickly).


Highlights

SENTIMENT DOMINATES: Markets driven by sentiment, cash on sidelines desperate to be invested

STIMULUS TO DECREASE: Earnings growth driven by cost cutting (a limited stimulus), to fall

INVEST WITH PROTECTION: Investing but with downside protection

 

Answer

The aggressive fiscal policies we have seen and the possible stabilisation or even turnaround in some data points have given fuel to the bullish. Nevertheless, with markets rallying so far from their lows, strongly driven by sentiment and perhaps ahead of fundamentals with investors focused on good news only, the possibility of a pullback is even higher. The market is moving from pricing in stabilisation to looking for a sustainable recovery, which is very risky. Further support for the possibility of a pullback comes from the fact that the rally which took the market to its current level, from March to year end last year, was arguably a low-quality, high beta and short-covering rally driven by discretionary consumer names which should be the most negatively affected in a recessionary environment (see charts below). Notice that since this point, the World Equity Index is flat, but the sector disparity has continued to widen. Nevertheless, I am also aware that there is plenty of cash on the sidelines and many managers judged against a benchmark cannot afford to miss out on another rally.

MSCI World Index +73% since 2009 low. Source: Bloomberg

During the 2009 equity market rally, the MSCI World Index (white) appreciated in value by ~70% from March low to year end. US Consumer Discretionary (orange) rallied ~90% whilst Consumer Staples (yellow) rose ~41%. Source: Bloomberg

What drove this rally? Markets rallied on better-than-expected corporate earnings but

  1. analyst estimates were so low that companies were bound to beat them;
  2. they were driven by cost cutting which companies cannot continue indefinitely;
  3. there has been talk of a “new normal” with growth in earnings reaching only 3% instead of the 5% we have been used to (Bill Gross)[1]

Bill Gross cites a move to a high persistent level of unemployment as support for his view. With lower income, higher savings, rising foreclosures and a credit restraining banking system, there still remains a strong case for the Bears to cling to. Across the “Pond”, the fragility of the UK market was highlighted when the BoE unexpectedly announcing massive expansion of quantitative easing program back in May of last year.[2] Many are now focusing on the possibility of a “double dip”, questioning how governments will be able to exit from their fiscal stimulus programs without dragging a muted recovery back into recession. This is before we discuss Europe which is widely believed to make a slower exit from the crisis.

US Unemployment Rate (%) at a heightened level. Source: Bloomberg

President Obama himself was given a stern warning from investment guru Warren Buffett about the severity of the situation. “He said, ‘We went through a wrenching recession. And so we have not fully recovered. We’re about 40, 50 percent back. But we’ve still got a long way to go’,” (Obama, July 2010)[3].

The situation remains unclear. At present there is enough data out there for Bulls to find reasons to be bullish as well as enough for Bears to find support for being bearish.

 

INVESTMENT INSIGHT: Until clarity returns, continue to closely monitor the situation to look for good entry points to exploit overreacting on the downside, but with the ability to protect from future market pullbacks (E.g. via managers able to short / hedge exposures quickly).