Archive for the “Market Commentary” Category
The stock market has reached new all-time highs, which is generating considerable interest in the media. That, of course, is no surprise. Perhaps the surprise comes from the fact that stocks have been able to get as high as they have. We are, after all, still looking at an economic situation in the US and elsewhere that is anything but robust. And yet, a look at the monthly chart for the major global stock markets shows that the likes of the S&P 500 and German DAX have broken then 2007 peaks. The NIKKEI still has some way to go to catch up to the others, but is already up better than 50% in 2013, so is making ground rapidly.
Quantitative easing in its various forms around the world is being given quite a bit of credit (or blame) for stocks being able to carrying on rallying despite the headwinds which remain at work. Europe, for example, still faces significant issues in the Euro Zone, and nobody is going to say Japan doesn’t still have a ways to go to get as healthy as it should be.
The interesting part of all this is that the new highs in the stock market are coming in conjunction with a higher dollar. Unlike earlier in the year when it was just a weak euro holding the USD Index up, the latest push that saw the greenback break the 2012 high came on across-the-board strength.
What makes this unusual is the fact that the dollar generally doesn’t do well during good economic conditions because imports tend to rise relative to exports. This is particularly noteworthy at this juncture given that the US has been ahead of many others in terms of getting things pointed in the right direction. We would expect to see import demand boosted as export demand continued to struggle because of weak conditions elsewhere.
So what’s going on?
Well, decreased imports of crude oil (lowest level in 17 years in March) are helping keep the US trade deficit contained. Still, the US continues to run a deficit, which tends to weaken the value of the dollar. The USD must be getting strength from capital flows rather than anything trade related. Certainly that shows in the Treasury market where there was a sharp drop in 10yr Note yields after they peaked in Q1, indicating a considerable increase in demand (similar moves were seen in German and UK rates, it should be noted, but “internal” demand is a bigger factor there than in the Treasury market).
That has reversed of late, though, with yields moving back up in line with higher stock prices. This is the sort of thing we’d expect to see if gains in the equity markets were being driven by expectations for higher economic growth.
So is it quantitative easing? Or is it an improved economic outlook?
The truth is probably a bit of both. There’s no doubt that the increased money supply created by QE in its various incarnations around the world provides a boost to asset prices. It’s simple supply/demand figuring. More money chasing the same (or fewer) securities produces higher prices. At the same time, though, stock prices have risen of late more rapidly than new money is being created by the world’s central banks. Also not supporting the QE impact case very much is the stagnation in oil prices and the persistent weakness in gold, both of which should be pointed higher if QE were a major influence on prices.
Does that mean stocks will keep going even after the money supply taps are turned off? Maybe so. Right now there isn’t a lot to suggest they are due for a major reversal.
The two concerns technicians will point to in the above SPY chart, however, is the market getting extended beyond the upper Bollinger Band of late and the unimpressive volume. The former suggests a market that has perhaps gotten a bit ahead of itself and is therefore due a pause or retracement. The latter is a bit more uncertain. We’d ideally like to see increased volume on a new high, but we’re just not getting it.
This may not be a bad thing, though. Before 2007 the markets moved steadily higher without a lot of volume improvement. We could be seeing something similar again, in which case the worry would be if we saw volume and volatility start to tick up together as we did six years ago.
------- Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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Last week all the talk was about the volatility in Bitcoin. This week gold has jumped to the top of the list thanks to a sharp decline in the precious metal. Some folks are even drawing a link between the two markets. The Big Picture has a good collection of reactions, explanations, and expectations in a recent article. The OANDA blog blames the drop of the last two days to a massive sell order from an investment bank which hit the market on Friday. Not overly surprisingly, the surge in volatility has motivated a hike in gold (and silver) margins.
The big action in gold is not surprising, as it wasn’t all that long ago I wrote suggesting we look for something interesting to develop. We should, though, not look just at gold in dollar terms, but also in terms of other major currencies. The chart below does that.
A few things are noteworthy when we observe a gold cross-section like this. The first is that we can see how in terms of all but euros the price of the metal created a kind of double top between the latter part of 2011 and the second half of 2012. Only in euro terms was there a higher peak last year than in the prior, reflecting the problems underpinning the single currency.
The other thing to observe is the relatively weaker situation in the so-called commodity currencies. In both AUD and CAD terms we have seen gold prices fall down into the area of the lows from Q1 of 2011. That hasn’t been the case thus far in terms of EUR and GBP. This is suggestive of some extra weakness in the Aussie and Loonie, which should not come as a surprise.
The charts below show AUD/USD and USD/CAD respectively in comparison to gold in a weekly time frame, with a subplot showing the 20-period correlation reading. In the case of the Aussie, the sharp drop in gold has corresponded with a sharp drop in the exchange rate, pulling it back down from the highs of the long-running range. The correlation between the markets had turned back up after having dropped of late, likely indicating a move back toward the commonly seen strong positive relationship between the two markets. If gold remains weak we can thus expect AUD/USD to test the lower end of the consolidation before too long.
In the case of USD/CAD we already have an uptrend at work. Recently the market tested a prior rally peak and found support. The gold sell-off has seen the market push up from there. As yet we haven’t seen a test of the most recent trend highs, but further gold selling could see that happen relatively soon.
Regardless of directional considerations, though, the implication of high volatility in gold is for high volatility in the commodity currencies as they see their exchange rates impacted by the metal’s move. The AUD in particular is at risk of substantial influence because of the addition of its use in carry trade strategies. Because of the risk inherent in a fall in Aussie exchange rates against lower interest currencies, carry trade investors are likely to be quick to exit in a similar way they have been seen to do during the risk-on/risk-off periods of the last few years. As a result, a bit of extra caution is warranted.
------- Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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The catastrophe that beset Cyprus’s ‘too-big-to-bail’ banking sector confirmed that the seemingly never-ending crisis in the eurozone is far from over. Indeed, investors are already busy searching for the member of the single currency that is likely to be next in the firing lining.
The hunt has exposed the Republic of Slovenia as the most plausible candidate for a future bail-out, and the financial markets have responded accordingly. The yield on ten-year sovereign bonds jumped from below five per cent mid-March towards seven per cent by the end of the month, while the yield on two-year notes registered an even larger increase. The resulting inversion of the yield curve confirmed that investors believe the risk of default to be high, as too did the surge in the cost to insure five-year sovereign bonds, which rose by more than twenty per cent following the Cypriot debacle.
But, is investors’ heightened concern justified?
The Republic of Slovenia became the first of the former communist states in Central and Eastern Europe to adopt the euro in 2007. The relatively small country – with a population of little more than two million and an economy that accounts for less than 0.5 per cent of euro-zone GDP – staged an impressive acceleration in economic growth during the years that immediately preceded its accession to the monetary union.
Indeed, annual growth in real GDP accelerated from four per cent in 2005 to seven per cent in 2007; the rapid growth reflected robust domestic demand driven by increasingly leveraged private-sector balance sheets, and vigorous export growth arising from strong external demand.
However, the economic expansion came to an abrupt end once the global crisis struck, as the evaporation of external finance precipitated a sharp decline in investment expenditures, while weak demand abroad caused export volumes to shrink by close to 25 per cent. All told, the Central European nation endured a cumulative decline in real GDP of about ten per cent from the peak in the third quarter of 2008 to the trough in the second quarter of 2009.
The Slovenian economy limped through most of 2009, but a recovery was underway by the following year, only for it to be interrupted by an escalation of the eurozone crisis during the second half of 2011. The resulting double-dip has persisted for six quarters and deepened throughout 2012, as weak external demand weighed on exports, while higher unemployment and lower real wages led to a contraction in household consumption.
Persistent economic weakness has placed considerable stress on the banking sector, with a notable deterioration in asset quality. Indeed, non-performing loans increased to €7 billion last year or 15 per cent of total assets. Eighty per cent of the impaired credit or €5.6 billion stems from the non-financial corporate sector – almost one-quarter of all outstanding loans to non-financial firms.
The declining asset quality is even more troubling among the country’s three largest banks. Non-performing loans exceeded 20 per cent of total assets by the end of 2012, with roughly one-third of all outstanding loans to the non-financial corporate sector turning sour.
The banking sector’s credit woes are unlikely to improve anytime soon, and the non-performing loan ratio is virtually certain to increase further during the current calendar year. Indeed, the economic outlook is far from encouraging, and a return to growth is unlikely before 2014.
Slovenia’s pre-crisis credit expansion was concentrated primarily in the non-financial sector, with the outstanding debt relative to GDP jumping from below 60 per cent to more than 90 per cent by the time economic recession struck. The rehabilitation of corporate sector balance sheets has barely begun, and the debt ratio continues to move higher, as the cumulative decline in GDP outpaces the overall reduction in outstanding debt. The deleveraging process seems certain to intensify in 2013, and as a result, investment spending is sure to decline.
Weak investment spending is likely to be compounded by soft household expenditures, as high unemployment continues to weigh on demand. Further, the external environment is unlikely to provide much support to exports in the year ahead, while efforts to reduce the public sector deficit below three per cent of GDP will act as an additional impediment to growth. All told, it is not unreasonable to assume that the economic recession will continue throughout the current calendar year.
The continued contraction will place further strain on the beleaguered banking system. However, it is important to appreciate that the Slovenian banking sector is nowhere near as outsized as Cyprus, or Ireland for that matter, with assets amounting to 130 per cent of GDP, and recapitalisation needs are estimated to be in the region of €1 billion to €2 billion or three to six per cent of GDP. These sums appear manageable in the context of a government debt ratio below 50 per cent of GDP, but credible action to stabilise the banking system is required sooner rather than later.
Investors view the Republic of Slovenia as the eurozone member next in line to require external financial assistance, given a poor economic picture that continues to weigh on its distressed banking system. However, the situation appears manageable – if addressed quickly – but ultimately, the financial markets will determine the country’s fate.
www.charliefell.com
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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There’s been a lot of chatter about Bitcoin of late. This is thanks in large part to its significant upward run, but also because of its high volatility.
For those unfamiliar with it, Bitcoin is a decentralized, completely digital currency. It has no central bank and requires no financial institution to create or transfer. In these days where the likes of the Federal Reserve, Bank of Japan, and others are printing money in massive quantities, Bitcoin has garnered considerable attention as a currency that could represent a safe haven against inflation created by in incessant money supply expansion of the central banks, and also a place where people at risk of wealth appropriation (read Cyprus bank customers) could move their money.
There are two issues with that, however.
One is that the Bitcoin supply is actually growing much more rapidly than is the case for any of the major global economies. There is an algorithmically proscribed rate of growth for Bitcoin supply, which is described by the chart below. Eventually that growth rate will slow (with the plan to go flat at 21 million Bitcoins in to 2140), but one need only look at the slope of the left half of the chart to see that the near-term growth rate is quite high.
Source: https://en.bitcoin.it/wiki/File:Total_bitcoins_over_time_graph.png
The other issue is that the small supply (relatively) of Bitcoins means the virtual currency is very subject to volatility. Think of it like a micro-cap stock or a very thinly traded commodity (as observed by Felix Solomon). The founder of Bitcoin acknowledges this, viewing it as early-stage growing pains, but seems to be a bit uninformed when suggesting a $10 billion valuation would reduce choppiness. There is a lot of sovereign currency floating around the world and just the retail portion of global forex trade is a couple hundred billion dollars per day. It wouldn’t take much of that trying to move into Bitcoins to cause a sharp appreciation (which may not be too far away from being possible). That can be readily seen in how much of a rise there has been in the Bitcoin value of late. The currency was below $60 in mid-March.
Joe Weisentahl makes the argument (and was discussed on Bloomberg TV today) that what we’re seeing is a bubble like those seen in other fad markets over the years. There is no fundamental basis for Bitcoin, so nothing to use as a point of reference for its value. That means it is free to float around at whatever price people are willing to pay, which can be great when demand is positive, but it means things can turn quickly, especially given how thin the market is at this point.
We can see just such an example of this looking at the dip in the middle part of the chart where the market when from near $150 to down around $110 in short order, and there was an even bigger dip this week. Ironically, the very interest that has driven Bitcoin higher has also brought structural weakness and other issues to the fore, which is creating some of that volatility, as Business Insider discussed here and here last week.
While in theory something like Bitcoin has the potential to represent a store of value for folks looking to avoid the slow bleed in purchasing power from institutionalized inflation driven by the major central banks, it’s a long way from being ready to operate in that way. Because of its small size and still-developing digital infrastructure, there is considerable risk both in terms of volatility and inability to access/exchange your Bitcoin holdings. That makes it a place more for those speculatively minded who willing to take the risk, and not so much for those looking for a safe place to put their money. It’s just not a big enough market (yet) to consider a realistic alternative investment vehicle.
------- Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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A recent article in the Atlantic has once again brought up the question as to whether the euro can survive (and generated a fair bit of discussion in the comment section). This is a debate that is on-going, of course. In fact, I was in the markets back when the single currency was launched and can say that even then there were a lot of people who didn’t expect it to last for any length of time (certainly not as long as it has done so far). That pessimism was part of what saw EUR/USD dive to near 0.8200 in the year 2000.
The Atlantic article brings up a common refrain in the arguments why the euro must eventually go away – namely the lack of an exchange rate adjustment mechanism to allow struggling economies like Greece to become more competitive through currency devaluation. Now in part that can come from a weaker euro. That hasn’t come against the USD to be sure.
The euro started life with an exchange rate to the dollar near 1.17, but since the market recovered from the initial decline it has only once dipped back below, and even then just fractionally and briefly. Despite all of the problems that have been well documented in the Eurozone since the Financial Crisis, the euro has remained quite strong against the greenback, albeit in a volatile fashion. Likewise for the pound.
There has been considerable euro devaluation against some currencies, however. The euro has really been beaten up against the commodity currencies such as the AUD and CAD. Given the strength in commodities in recent years, and the EZ issues, this is to be expected. The weakness of EUR/JPY is tied in to what many folks see as the inexplicable strength of the yen despite serious problems in the Japanese economy as well. And of course EUR/CHF got so weak because of flight to quality flows that the Swiss National Bank had to support the euro and put a floor under the cross. We have also seen declines in the likes of EUR/NOK and EUR/SEK, which are probably better reflective of exchange rates among real trading partners.
Unfortunately for those countries in the Euro Zone struggling, the weaker euro is only partially helpful. The Atlantic article observes that when excluding Germany a bit over half of all EZ trade is done within the zone. The weak euro has little impact on that fraction of trade, though it definitely helps the more externally export oriented countries (like Germany). Cyprus cannot become more price competitive to potential tourists from Europe because they do not have their own currency to depreciate.
Of course, as we have witnessed in the case of Japan, having your own currency doesn’t automatically mean you get the kind of devaluation you’d like to get to make your export goods more price competitive. The UK also struggled with a persistently strong(ish) pound when the Bank of England really wanted it to fall (though without actually saying so explicitly).
And not that currency devaluations are the quick fix some folks seem to think they are. It’s would be a very messy process in the case of a country exiting the euro – one that could actually make matters worse in the short-term. Just think about what would have to happen to all of the debts and obligations currently contracted in euro terms if a country like Greece exited the single currency. If a Greek company had a euro-denominated obligation and a new drachma devalued by 50% from where it came into the euro, it would be like that company’s obligation doubling!
But politics are very likely to be the major factor here.
There are considerable cost savings to being part of the EZ, not to mention a growing support infrastructure now. Plus, for countries like Germany who do considerable external export business, there is a major benefit to having a currency which is relatively weak. For these reasons and many others, there is going be a strong reluctance among the politicians to break up the euro. As a result, don’t look for it to happen any time soon. Even the expulsion of a single country presents problems as the ECB has repeatedly said there is no mechanism for doing so. Just imagine how long it would take to create that mechanism. Do you want to place bets on politicians moving with haste and expediency when all they have shown thus far is a proclivity for drawing things out?
This doesn’t mean one can’t bet against the euro from an exchange rate perspective. I just wouldn’t hold my breath waiting for the thing to come apart.
------- Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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It is only a matter of weeks since European officials openly congratulated themselves on their seemingly successful efforts to bring the prolonged eurozone crisis to an end. The backslapping subsequently proved premature, as the botched rescue package – designed to help an ailing Cyprus raise part of its emergency funding needs internally and ultimately secure external support of some €10 billion – put policymakers’ incompetence on show for the entire world to see.
The initial proposals are difficult to fathom, given that policymakers’ had months – and not days – to devise a credible plan. The lack of time pressure should have allowed decision-makers to get ahead of the crisis, but this advantage counted for nothing, as the proposed plan to recapitalise the banking system was virtually certain to prove ‘dead-on-arrival,’ given that it violated the hierarchy of claims in the capital structure.
The original plan envisaged that senior bonds would be made whole, while uninsured deposits would participate in losses, even though these depositors should rank at least pari passu with senior bondholders. Further, Cyprus’s leadership – in a desperate attempt to minimise the losses imposed on uninsured foreign deposits, and thus preserve the country’s status as an offshore banking centre – decided to bail-in insured depositors, even though such liabilities should be considered sacrosanct, so as to avoid devastating bank runs.
It came as little surprise that the deeply-flawed plan, which was intended to raise €5.8 billion and fill the hole in bank balance sheets left by bad debts and losses on Greek sovereign debt, was rejected decisively by Cyprus’s parliament, with not one single Member of Parliament voting in favour of the proposals. Sent back to the drawing board, sanity ultimately prevailed among policymakers, as the revised plan unveiled eight days ago, resembled what one would hope to see in an orderly bank resolution.
The revamped plan scrapped the ill-advised idea to impose a ‘stability levy’ on all depositors, and will “safeguard all deposits below €100,000.” Instead, the banking system will be restructured – the Laiki or Cyprus Popular Bank, the second largest lender, is to be split into a ‘good’ and ‘bad’ bank, with the former to be backed into the country’s largest lender, the Bank of Cyprus, and the latter to be wound down over time.
Both Laiki’s shareholders and bondholders – junior and senior – will be wiped out under the revised plan, while insured deposits, alongside the €9 billion in liabilities that stems from liquidity support provided by both the European Central Bank (ECB) and the national central bank, will be transferred to the Bank of Cyprus.
Meanwhile, Laiki’s uninsured deposits amounting to €4.2 billion will be placed in the ‘bad’ bank. These depositors can reasonably expect to recoup very little – if anything – as they will eventually receive a sum that amounts to no more than the distressed value of the ‘bad’ bank’s impaired assets.
The enlarged Bank of Cyprus will face a large restructuring effort to raise its capital ratio to EU-mandated levels of nine per cent by the end of the programme. Since no bail-out funds are to be used to recapitalise the troubled bank, both shareholders and bondholders are likely to lose all of their investments, while the hit to uninsured depositors – via a deposit-to-equity conversion – could amount to as much as fifty per cent.
The revised plan is a vast improvement on the initial policy blunder, since it respects established credit hierarchy. However, there are still reasons to believe that the Cypriot banking crisis is far from resolved, while the new blueprint could well have far-reaching consequences across the monetary union that are decidedly negative.
The banks may well have reopened last Thursday – with no sign of a disorderly run on bank deposits – but this was purely a function of the €300 daily limit on withdrawals and curbs on cashing cheques. These measures – alongside capital controls that prevent virtually any cash from leaving the island – are supposed to be temporary and last just seven days. However, once lifted, panic is sure to ensue, as depositors scramble to protect their savings.
Cyprus’s banking system has already lost access to normal ECB operations, and is dependent upon emergency liquidity assistance (ELA) from its national central bank. However, a shortage of unencumbered collateral – alongside the haircuts the national central bank applies – limits the availability of ELA, which may prove insufficient to fill the gap left by deposit flight. As a result, further losses could well be imposed on uninsured depositors.
This means that measures are likely to prove anything but temporary, and remain in place far longer than currently envisaged. This should serve as a warning to bank creditors in other eurozone states with ailing and oversized banking systems. Depositors – both insured and uninsured – are sure to be increasingly nervous, and willing to withdraw their cash at the first hint of trouble, which means that banking crises are likely to develop far more quickly than previously.
Further, bank funding costs are likely to increase permanently for troubled banks. The decline in margins and the resulting downward pressure on already-beleaguered profitability could well prove to be a key factor behind accelerated deposit flight.
It may be a small island, but the precedent set in Cyprus could have big consequences for many years to come. Cypriot banking woes are a game-changer.
www.charliefell.com
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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The Chinese property market is back in the spotlight, following the central government’s decision just days ago, to harden its three-year effort to put house prices in an affordable range for ordinary citizens. The latest measures include higher down-payments and interest rates for buyers of second homes in cities with excessive price gains, and perhaps more importantly, a twenty per cent capital gains tax on homeowner profits on sale, as against one to two per cent on sales price previously.
The impact of the latest clampdown on property speculation was immediate, as publicly-quoted real estate developers endured a decline of more than nine per cent, the largest one-day decline since the summer of 2008. The rest of the world barely paused for breath, as the major stock market averages in the US continued their assault on the all-time highs registered more than half a decade ago. Is the complacency justified, or could the Middle Kingdom’s housing market be the elephant in the room that interrupts investors’ latest bout of exuberance?
It is important to note that household ownership is a relatively new phenomenon in modern China, and did not exist until 1998, when the government gave birth to a market-oriented housing market through the privatisation of the existing urban housing stock to current occupants at heavily discounted prices. Previously, housing allocation in urban areas was determined by employers, primarily government institutions and state-owned enterprises.
The fledgling housing market was virtually certain to be vulnerable to excessive price rises given the peculiarities of the Middle Kingdom’s chosen growth path. These include low real interest rates in the presence of high growth, a closed capital account, and an underdeveloped financial system that offers few investment options to a nation of high-savers.
It’s hardly surprising therefore, that central authorities have felt compelled, from time to time, to step in and temper outsized increases in house prices. For example, the rapid ascent in urban house prices that began in 2003 and continued through 2007 prompted a serious of administrative measures and financial policies, designed to curb speculative demand.
Efforts to cool the property market proved successful, but renewed – and perhaps even dangerous – stimulus followed the outbreak of the ‘global financial crisis.’ The moderation in prices ended, as property development and consumer mortgage loans surged by roughly 40 and 50 per cent respectively in 2009, and year-on-year gains in house prices reached record levels during the first half of 2010.
Talk of a Chinese housing bubble filled the pages of the respected print media in the West, but the Middle Kingdom’ felt compelled to act for domestic reasons, as it became increasingly clear that speculative buying had driven asking prices well beyond the reach of ordinary citizens.
The measures that followed contributed to moderate price declines of about fifteen per cent across major urban areas, before the most recent ascent in values began following the easing of monetary policy – in the face of economic slowdown – last summer. Most commentators believe that the authorities have averted a housing bust, and in their defence, the month-on-month increases in prices over the last nine months do not seem excessive. Indeed, the year-on-year gain in the country’s largest cities turned positive only recently, and was still less than three per cent in February.
Further, a top-down perspective paints a similar picture. It is beyond dispute that house prices look expensive relative to household incomes at roughly seven times, but China’s notorious cash economy means the actual figure could be far lower. Additionally, rapid income gains have outpaced annual house price appreciation over the past ten years, which would appear to discount bubble concerns.
The final bullish point is leverage. The average down-payment that Chinese banks require is roughly thirty per cent on a first home, and as much as sixty per cent on a second property. Also, home equity loans are virtually non-existent.
Unfortunately, a bottom-up view leads to entirely different conclusions. The substantial number of unused apartments in the major cities is plain for all to see, and the amount of unsold apartments, as measured by floor space, jumped forty per cent over the past eighteen months.
Herein is the true problem in the housing market. Property developers are focussed primarily on the construction of luxury apartments that are purchased by the wealthy for potential capital appreciation with little consideration afforded to possible rental income. Meanwhile, the stores of value for the highest-income brackets remain beyond the reach of the ordinary Chinese, who struggle to find appropriate accommodation, given the developers reluctance to build affordable housing.
Is there a bubble in China’s housing market? The aggregate figures suggest not, but a micro-perspective suggests there are dangerous pockets of overvaluation in high-income segments. Should the world be worried? Time will tell.
www.charliefell.com
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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It should come as no surprise that the uber-bulls have found their voice, and forced their way back into the media spotlight. After all, the major stock market averages continue their assault on the all-time nominal highs registered just as the financial crisis gathered momentum during the autumn of 2007.
Caution is now perceived as a dirty word and stock market bears have gone into hibernation, as bullish opinion is in vogue and virtually certain to capture the public’s imagination – and a sizable share of their hard-earned savings. However, savers need to be aware that the positive commentary is often misguided – and occasionally downright dangerous.
The latest opinion piece to catch the eye was penned by James Glassman, who co-authored the infamous 1999 investment book, ‘Dow 36,000,’ in which he and the economist, Kevin Hassett, argued that the stock market index could reach the headline number within three to five years.
Unfortunately for the authors, the powerful bull market that began almost two decades earlier in the autumn of 1982, came to an end just months after the book’s publication, and the Dow Jones Industrial Average registered a percentage point decline of close to forty per cent over the 33 months that followed the equity index’s secular peak.
Stock prices resumed their upward trajectory over the next five years, but the financial crisis pushed the index down to 6,547 by the spring of 2009 – a level that was more than eighty per cent below the book’s catchy title.
Glassman remains undeterred however, and believes that the original forecast is within reach. He writes, “From its low of 6,547 on March 9, 2009, the Dow has risen 117 per cent. Another 117 per cent in four years would put it at 31,022, just 16 percentage points shy of the magic number.”
It is important to remember that Glassman’s original thesis was premised on the belief that, “investors had mistakenly judged the risk in stocks to be greater than it really was.” The authors argued that the stock market deserved a higher valuation multiple, since the historical data demonstrated that, “over long periods, stocks were no more volatile, or risky than bonds.”
The basic idea is that time washes away all sins, and as a result, stocks are a safe asset for investors with sufficiently long investment horizons. Known as time diversification, the contention rests on the use of the standard deviation of annualised returns as the appropriate risk measure, which as a matter of basic statistical fact, decreases as the time horizon increases.
The argument is totally misleading however, because it is the terminal portfolio value that matters to investors, and in this regard, it is the standard deviation of total returns that is the appropriate risk measure. It may well be true that the standard deviation of annualised returns decreases in proportion to the square root of time, but the standard deviation of total returns does the opposite. In other words, a 25-year investment is five times as risky as a one-year investment – the dispersion of potential terminal portfolio values grows ever larger as the time horizon increases.
The idea that stock market investments are safe in the long-run rests not only upon the standard deviation argument, but also upon the observation that the probability of loss decreases with time. However, the problem with this line of reasoning is that losses of different magnitudes are treated the same. Is a thirty per cent loss on a $1 million retirement fund in year-thirty really equivalent to a thirty per cent loss in year-one?
It is important to note that not only does the potential magnitude of losses increase with time, but so too does the risk of catastrophic losses. For example, incurring a loss of forty per cent is ten times more likely after three years than it is after one year. It is clear that the risk in stock investing is very real as the time horizon grows.
For those who remain unconvinced, then consider the words of Professor Zvi Bodie, “If it were true that stocks are less risky in the long-run, then the cost of insuring against earning less than the risk-free rate of interest should decline as the length of the investment horizon increases. But the opposite is true.”
Stocks may still be safe for long-term investors if returns are mean-reverting. Fortunately, there is substantial evidence to support this case and valuation multiples typically act as the pendulum. In this regard, the verdict is against the uber-bulls and believers in Dow 36,000, as valuation indicators with statistically significant, predictive ability call for minimal investment in stocks right now.
It is a sign of the times that the champions of time diversification are back in the media spotlight, but investors should be aware that the advice could prove hazardous to their financial health. The arguments were bogus when Dow 36,000 was published in 1999, and they remain bogus today.
www.charliefell.com
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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It is a low-return world, and even the Chairman of the Federal Reserve, Ben Bernanke, recently admitted that he, “takes very seriously…the possibility that very low interest rates” could prompt “portfolio managers dissatisfied with low returns” to “reach for yield.” Unfortunately, such concern is already reality, as ultra-accommodative monetary policy has helped push the yields available on both ‘risk’ and ‘safe’ assets to levels that virtually assure lacklustre returns for a traditional 60:40 equity/bond policy mix over long horizons of ten years or more.
The less-than-inspiring outlook for long-term investment returns is a matter of simple arithmetic, yet much of the investment community continues to cling to the belief or hope that pension plan assets will ultimately deliver satisfactory outcomes for long-term savers. There are few who dispute that ‘safe’ assets are likely to deliver sub-optimal returns over long horizons, but many – conditioned by the outsized investment performance of the 1980s and 1990s – continue to argue that the gains on ‘risk’ assets will make up the difference. The ill-founded arguments are likely to prove wrong.
The fact of the matter is that the rewards generated from traditional asset allocations has been so good for so long that many have come to see high inflation-adjusted returns as some sort of birthright. Both global equities and bonds have delivered annualised real returns in excess of six per cent over the past thirty years, but current valuations suggest expectations that extrapolate this trend for a traditional 60:40 mix into the future are nothing more than wishful thinking.
Real bond returns have been nothing short of breathtaking over the past three decades, but with twenty-twenty vision, that’s understandable given both the starting point and subsequent fundamentals. Ten-year Treasuries offered a yield of more than fifteen per cent in the autumn of 1981, but the disinflationary monetary policy conducted by Paul Volcker during his time at the helm of the world’s leading central bank, saw the yield drop below nine per cent by the time he was replaced by Alan Greenspan six years later.
Monetary policy that prioritised opportunistic disinflation continued under Greenspan, and by the end of the 1990s, the yield available on the benchmark Treasury bond hovered around six per cent. All told, Treasury bond investors earned annualised real returns of close to eight per cent during the 1980s and 1990s – the best two-decade performance in all of American financial history.
More was to follow of course, as the disinflationary trend gave way to deflation fears following the South-East Asian crisis in the late-1990s and the collapse of the stock market bubble at the turn of the New Millennium, but the biggest fillip to the realised returns on ‘safe’ assets came with the crisis in structured finance that stemmed from misguided lending in the sub-prime mortgage space.
Treasury yields continued their long journey downwards, and the inadequate recovery in the post-crisis economy ensured that yields remained close to all-time lows. That remains true today, with the ten-year benchmark bond yielding less than two per cent, a level that does not compensate for long-term inflation expectations. This virtually assures that – absent deflation – investors can expect to realise negative real returns in ‘safe’ US assets over the next ten years.
Traditional investors might turn to corporate credit to boost returns, but the story – adjusted for risk – is much the same. The current spreads for lesser-quality corporate credit imply a real yield of just two per cent, and incorporating likely default rates and recoveries, suggests that investors can expect to earn even less.
The debt markets provide little optimism for high future returns, so all hope rests on the equity market. Stock returns exceeded all expectations during the 1980s and 1990s, and though equity markets endured a torrid decade during the first ten years of the New Millennium, the major market averages still sport valuations that are well above long-term norms.
Indeed, the stock market’s current dividend yield in combination with long-term real growth suggests that investors should expect no more than three per cent per annum in real terms – less than half the historic average. Of course, even this sub-optimal outcome does not take account of the well-known tendency for valuation ratios to mean revert, in which case the most likely annualised real return is closer to one or two per cent.
It is a low-return world, and traditional policy mixes are unlikely to deliver annualised real returns of more than one to two per cent over the next ten years. The plain facts may well encourage return-chasing, but the astute will keep their powder dry – and remember the words of the late investment visionary, Peter Bernstein, “The market’s not a very accommodating machine; it won’t provide high returns just because you need them.”
www.charliefell.com
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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Stocks are trending higher and the dollar is doing the same. That’s not something we’ve seen much of over the years. We can see from the chart below comparing the S&P 500 to the USD Index how unusual it is for the two to move in the same direction. No doubt the recent positive correlation has thrown a number of algos for a loop.
Of course the whole risk-on, risk-off pattern of the markets holding forth during long periods since the Financial Crisis played a major part in defining a negative correlation between stocks and the US dollar. Traders and investors would either flee from “risky” assets into the safety of the greenback (and US Treasuries), or do the reverse. Obviously, that’s not what’s happening at the moment.
So what’s happening now?
I’d argue we’re back to more “normal” markets which are less psychological and more fundamental. By that I mean exchange rates are moving on market participants’ perceptions of the differences between economies, rather than just reacting to fear.
That said, it is often the case that the USD falls in periods of economic strength. This is driven by American demand for imports. These days the US seems to be the strongest among the major Western economies, so we would expect to see a similar pattern. The markets, however, are reflecting other dynamics at work. Monetary policy is a big factor.
Better economic figures in the US lead investors to start to look at when the Fed will start taking a less accommodative stance. In and of itself, that tends to be positive for the greenback (less or no asset purchases means reduced increase in dollar supply). At the same time, though, Europe continues to have significant issues, and the same can be said of Japan. No one is talking about tighter monetary there, so those currencies are suffering by comparison.
The question is how long that will continue.
As we can see from the chart below, which includes the German DAX index as the lower plot, European stocks too have broken the 2011 highs and are close to the ones from 2007 (the FTSE is showing comparable performance).
The implication of rising stocks on a global basis is the anticipation of better times ahead. Stock market investors may have it wrong (wouldn’t be the first time), but if they don’t, then we should look for improvement in the European situation in the months ahead. That would very likely then mean the dollar losing its strength as more traditional patterns are seen (dollar weak in good economic times). That will be worth watching, as it we don’t see the USD rolling over before too long it may be a sign the stock rally will have trouble continuing.
------- Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.
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