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    Gavekal Research

    Momentum Shifts From Europe To Asia

    European equity markets have taken a beating in the last 50 days. The average eurozone stock is down 6%, while Portugal and Austria are both down more than 10%, putting them in correction territory. Germany and France are not far behind, down almost 9%. However, this broad underperformance masks a lot of intense individual pain: 20% of eurozone companies have fallen more than 20%. As always with a large sell-off, there are two approaches one...

    0
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    Gavekal Research

    A Return To Valuation-Driven Markets

    In the earlier articles in this series I argued that the medium term outlook for economic fundamentals and monetary policy is more predictable now than at any time since 2008, and possibly since the late 1990s. If I am right, then over the next year or two asset prices will no longer be driven by the economic statistics and monetary policy decisions which have dominated the post-crisis financial debate and which still obsess market and media...

    0
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    The Problematic Pound

    The United Kingdom may be the world’s fastest-growing major advanced economy, having notched up a year-on-year growth rate of 3.1% in the second quarter. But it suffers from a clutch of seemingly intractable problems: weak productivity and wage growth, a lightweight manufacturing sector, underperforming exporters and an overdependence on domestic consumers and a frothy housing market. Behind each of these problems lies the persistent strength...

    1
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    Gavekal Research

    Five Corners (6 August): Central Bank Balance Sheets

    In our latest bi-weekly review of global economics and investment, we examine the bloated balance sheets of the world’s major central banks. We ask what exit strategies the central bankers have prepared to slim them down again, or whether expanded balance sheets are here to stay. If so, how will central bank bloat will affect investors in the coming years? Overview: Anatole Kaletsky argues persuasively that the US Federal Reserve and other...

    0
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    Growth & Markets Monthly (August 2014)

    This month saw a further improvement, albeit a small one, in our growth indicators. Risk appetite, on the other hand, now looks much more mixed compared with last month’s strong positive tendency. Also noteworthy is the recent spike in our diffusion index of US CPI components, which highlights the abatement of US deflationary pressures. On the asset side, government bonds continue to look expensive, especially in France. Meanwhile, equities are...

    2
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    Gavekal Research

    Wider Spreads And Weaker Equities

    Over the past five weeks, the spread between US high yield debt and US Treasuries has widened by almost a full percentage point. Admittedly, this move could be dismissed as an overdue correction after spreads for high yield debt narrowed to unsustainably tight levels. Unfortunately, it seems that equities markets are no longer in such a forgiving mood. In the past week, the widening of high yield spreads has weighed heavily enough on equity...

    2
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    Gavekal Research

    Monetary Policy Is No Threat To Markets

    In the first two articles of this series, I argued that the US economy has now clearly reached ‘escape velocity’ and that, with little prospect of a renewed recession in the next year or two, investors are forgetting their earlier fears of secular stagnation and becoming increasingly confident about the extraordinary monetary and fiscal policies adopted by all the major world economies (see The Case For A Structural Bull Market and The Global...

    1
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    Gavekal Research

    5C Europe: Targeted Tinkering

    The European Central Bank’s balance sheet has been shrinking since the beginning of 2013, as eurozone banks have moved to repay funds borrowed via the ECB’s long term refinancing (LTRO) facility. The ECB has trumpeted the repayments as an encouraging symptom of a banking system on the mend. But as we pointed out last year, the balance sheet contraction represented a relative tightening of monetary conditions (see Draghi’s Need For Action). As...

    0
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    Gavekal Research

    5C Overview: Central Banks Are Happy With Their Balance Sheet Bloat

    With the end of the US Federal Reserve’s QE3 round of quantitative easing scheduled for October, this is a good time to consider the ‘exit strategies’ central banks might follow as they think about normalizing monetary policy. While the technicalities of each country’s monetary management are different, there are two broad questions that all central banks have to answer: Can monetary policy rely solely on interest rate management, as in the pre-...

    0
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    Gavekal Research

    The Unintended Effects Of Sanctions

    “I know of no instances in world practice and previous experience in which sanctions have achieved their aim and proved effective,” declared Sergei Ivanov in 2006. At the time Ivanov—then Russia’s defense minister—was criticizing US sanctions on Iran. Today he is even better placed to observe the effectiveness or otherwise of economic sanctions. As Vladimir Putin’s chief of staff, Ivanov was among the Russian president’s intimates targeted by...

    2
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    Gavekal Research

    The Euro Has Turned

    This week the euro broke decisively below 1.35 to the US dollar to set a new year-to-date low. The last time the euro fell below 1.35 was in January, but that sell-off proved fleeting, with the currency rebounding strongly to reach a three and a half year high just of shy of 1.40 in May. In an economy battling to regain its competitiveness, that rally hurt, weighing heavily on exports and pushing inflation down to just 0.5%. In contrast, this...

    1
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    Gavekal Research

    How And When To Short French Bonds

    Earlier this month I recommended—for the first time in my career—an unhedged short position in the French bond market (see It’s Time To Go Short French Bonds). For investors who are uncomfortable with such ‘naked’ shorts, there may be an alternative. They could go short the French OAT and go long the German bund. This Daily sets out the risks involved, together with a decision rule to determine timing.

    2
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    Gavekal Research

    The Price Of A Diminished US Dollar

    Nature, it is said, abhors a vacuum. In much the same way, geopolitics cannot tolerate a power vacuum. So it is small surprise that as a chastened and diminished United States has retreated from direct involvement in the Middle East and adopted a less interventionist diplomatic and military stance elsewhere in the world, ambitious opportunists have stepped forward to fill the gap. In East Asia, China has assumed a far more assertive attitude...

    2
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    Gavekal Research

    5C Europe: It's All About Earnings, Not Valuation

    With continental European equities trading on a forward P/E ratio that is nearing a 10-year high of almost 14.5, compared with 8-10 in early 2012, valuation has clearly ceased to be a driver of market performance. European stocks may be 10% cheaper than their US equivalents, but compared with their average historical discount of 15%, they are not cheap.

    0
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    Gavekal Research

    The Pound's Rally Runs Out Of Road

    Sterling has been on a tear lately. Over the last three months the pound ranks as the world’s best performing major currency. Supported by the relatively strong growth of the UK economy—gross domestic product grew at a 3% rate in the first quarter—a buoyant property market, and hints from Bank of England governor Mark Carney that he could begin to raise interest rates before the end of this year, the pound has climbed 2.25% since mid-April to...

    0
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    Gavekal Research

    A Fore-Tremor Of Shocks To Come

    It is tempting to dismiss yesterday’s spasm in financial markets as a summer ‘silly season’ over-reaction to a little local problem, easily contained. After all, the problems at Portugal’s Banco Espirito Santo are hardly a new phenomenon. The bank insists its capital buffer is more than big enough to cover any potential losses. The Portuguese authorities still have €6bn in their financial rescue fund. And the European Central Bank has declared...

    0
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    Gavekal Research

    It's Time To Go Short French Bonds

    Monday is le quatorze juillet, July 14, France’s national day. In Paris a grand military parade will march along the Avenue des Champs-Élysées as air force jets streak overhead to mark the 225th anniversary of the French Revolution. Yet, behind the pageantry celebrating the glories of the republic, all is not well. For two years I have maintained that France has been facing a secondary depression. As expected, the economy is now getting worse,...

    6
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    Gavekal Research

    Five Corners (9 July 2014)

    Nothing should stay the same and so we are tweaking the format of Five Corners to make the whole report focus on a key thematic issue that impacts all major centers of the global economy. We kick off with an in depth look at inflation which is again rearing its head even as the specter of deflation continues to haunt the most growth-challenged regions.

    0
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    Gavekal Research

    Italy’s Irrational Optimism

    “Optimism is the madness of insisting that all is well when we are miserable.” Voltaire’s words are relevant to eurozone asset markets as monetary policy has allowed the band to keep on playing, even as the economic superstructure takes on water. Those underlying problems are reemerging with France’s July PMI falling to 48.1 and industrial production in Germany down 3% since February. But arguably the most vivid display of hope triumphing over...

    0
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    Gavekal Research

    Europe's Growth Plateau

    It looks as if the eurozone’s growth rate has reached a plateau. Purchasing managers’ indexes in Germany and France have slumped as exports have hit a soft patch and fiscal retrenchment has begun to bite. Meanwhile, with borrowing rates for Spanish and Italian businesses stubbornly high, activity in the euro-area’s periphery remains subdued. Although gross domestic product growth in the second quarter could still edge fractionally higher from...

    2
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    Gavekal Research

    Growth & Markets Monthly (July 2014)

    Having watched our growth indicators soften over recent months, we are now witnessing a momentum shift since our economic activity indicators have perked up markedly. Moreover, the velocity of money has risen rapidly, while our price indicators continue to show lessening deflationary pressure. Hence, it was not surprising to see that bonds are getting more expensive. Unfortunately, equities are not cheap, and this makes it a challenging...

    0
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    Gavekal Research

    5C Europe: The Bullish Consequences Of Inflation Targeting

    Europe’s response to low inflation has been a decisive move toward more aggressive and expansionary policy settings. In early June the Bundesbank signed off on the European Central Bank’s bolder strategy to fight the deflationary threat (see €-Day). Then last week the Swedish central bank unexpectedly cut its repo rate by 50bp, with a majority of members outvoting the chairman—an unusual display of bolshiness in consensus-oriented Sweden.

    2
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    Gavekal Research

    The Emerging German-Russian Axis

    This weekend has seen the European Union do a stitch-up deal so that arch-federalist Jean-Claude Juncker became Commission president. To be honest, who gets to play eurocrat in chief is of no great interest to me, but the manner of the appointment tells us lots about the changing nature of power in Europe. Governments from Stockholm to Rome reportedly opposed Juncker, but ultimately none would defy Berlin. Also this weekend, it is worth noting...

    10
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    Gavekal Research

    The Juncker Quid Pro Quo

    Who will be the hero of the hour, basking in universal gratitude when the EU summit culminates this evening with the appointment of Jean-Claude Juncker as President of the European Commission? Believe it or not, the man all the other leaders will be secretly thanking is David Cameron—and investors in Europe should do the same. Cameron is certain to suffer severe embarrassment this evening if he insists on forcing a vote that he is bound to lose...

    1
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    Gavekal Research

    Five Corners (25 June)

    In the latest bi-weekly review of global economics and investment:

    0
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    Gavekal Research

    Turkish Resilience

    Turkey has a fragile economy and resides in a troubled neighborhood. More than one million refugees have arrived from Syria over the last two years and now Iraq is splintering. On the face of it, such developments pose an existential threat to an economy that is heavily dependent on imported oil and runs a structural current account deficit. Yet even as Brent crude hits $114 per barrel, Turkey is muddling through. Yesterday, the central bank...

    0
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    Gavekal Research

    Rising Velocity Is Driving Markets

    As we approach the half-year mark for 2014, it is remarkable how well asset markets have performed this year. Pretty much every major asset class has registered decent gains. US bonds? The long end of the US government bond market is up by 10%, even after the recent mild sell-off. Commodities? The CRB index is up by 8.6%. Global equities? The world MSCI is up by 6%.

    2
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    Gavekal Research

    5C Europe: Eastern Europe’s Zero Inflation

    Central and Eastern European economies have rebounded convincingly since the spring of 2013. Yet while real gross domestic product growth is likely to average almost 3% this year, CEE inflation has fallen below even the eurozone’s. Average consumer inflation in the region has collapsed from 4.3% in September 2012 to 0.3% in May 2014—compared with 0.5% in the euro-area.

    0
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    Gavekal Research

    Being Polish

    Having spent 50 years under the yoke of murderous fascists and then control-obsessed communists, Poland re-emerged in 1989 and embraced free market capitalism. It accepted the need for radical reform which had painful short term effects as inflation soared to almost 600% in 1990 while the economy shrank 14%. The payoff has been growth that since 1993 has averaged 4.3%, compared to 2.7% for a neighborhood group that includes Slovakia, Hungary,...

    4
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    Gavekal Research

    New York Seminar June 2014 - Louis, Anatole & Andrew

    We held our summer seminar in New York on June 10, with Anatole, Louis and Andrew offering their take on the state of the world economy and financial markets. We were also joined by Henrik Christensen who is director of Robotics at Georgia Tech. Audio recordings of their discussions are available below:

    0
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    Gavekal Research

    BNP, Big Brother And The US Dollar

    France’s biggest bank, BNP Paribas, and the US government have gotten into a fight—a fight which threatens to cost BNP US$10bn in fines and possibly even its US banking license. As usual, the official causes of the fight have very little to do with the real ones. The official narrative goes like this: the US government placed embargos on a number of countries, including Sudan, Cuba and Iran. Between 2002 and 2009, BNP’s subsidiary in Geneva,...

    6
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    Gavekal Research

    Can The ECB's TLTROs Do The Job?

    With its latest round of easing measures unveiled last Thursday, the European Central Bank signalled its determination to intervene aggressively in order to stave off deflation and boost economic growth in the eurozone. The centrepiece of its strategy is its new Targeted Longer Term Refinancing Operations. By extending cheap fixed-rate funds to banks making loans to small and medium size businesses, the hope is that the new initiative will...

    0
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    Gavekal Research

    5C Overview: Volatility RIP

    Having weathered fears of depression, a systemic euroland failure and most recently the specter of deflation, investors can be excused for their insouciant attitude to risk. We may not be in sunlit uplands, but for the first time since 2008 the global growth trajectory looks fairly secure and the big central banks have their monetary policy settings in sync. Hence, it is not surprising that volatility across most asset classes is making new lows...

    0
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    Gavekal Research

    5C Europe: €-Day Also Resonated In Eastern Europe

    The D-Day invasion of Normandy in 1944 created the conditions for decades of freedom and prosperity in Western Europe. The action was less decisive for Eastern Europe which ultimately got stuck on the wrong side of Europe’s great divide during the cold war. We suspect the benefits of last week’s slightly less dramatic €-Day will be spread more evenly.

    0
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    Gavekal Research

    5C Asia: Hop Aboard The Momentum Train

    Far from worrying about policy risks or soft patches in growth, investors suddenly seem to see nothing ahead but clear blue skies—the perfect environment for momentum investing.

    0
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    Gavekal Research

    €-Day

    As world leaders gather in France to commemorate the 70th anniversary of D-Day’s decisive battle against tyranny, it is tempting to see yesterday’s European Central Bank meeting as another decisive action on the European battlefield. Unopposed deflation helped tip the continent into chaos 75 years ago. Now it can be argued that the ECB has made history by launching a substantial new assault against eurozone deflation risks: cutting interest...

    6
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    Gavekal Research

    The ECB's Real Deal

    The European Central Bank has broken with tradition and over-delivered. We had our doubts, but a complete package has arrived, that in the near term should be positive for risk assets and negative for the euro. Leading up to yesterday’s meeting; we said that the ECB needed to come up with a package that lowered short rates. It did. It also needed to provide liquidity operations that were sufficiently attractive for banks to actually use them....

    3
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    Gavekal Research

    Overcoming The Macro Breakdown

    The financial crisis of 2008-2009 heralded a golden age for macro investors. As the wholesale market crash rendered the relative value judgments of stock pickers irrelevant, macro investors enjoyed a boom time—especially ones who had had the foresight to short US housing, global financials, or eurozone peripheral debt. Now, as the crisis recedes further into the rear view mirror, macro investors are struggling to adapt to a world in which...

    0
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    Gavekal Research

    Growth & Markets Monthly (June 2014)

    Having watched our growth indicators soften over recent months, we are now witnessing a momentum shift since our economic activity indicators have perked up markedly. Moreover, the velocity of money has risen rapidly, while our price indicators continue to show lessening deflationary pressure. Hence, it was not surprising to see that bonds are getting more expensive. Unfortunately, equities are not cheap, and this makes it a challenging...

    0
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    Gavekal Research

    As Eurozone Risks Fall, US Risk Rises

    There is now a broad consensus about what the European Central Bank will do tomorrow. The market expects a 10bp to 15bp cut in the interest rate corridor—which would push the deposit rate into negative territory—along with measures aimed at injecting liquidity into eurozone money markets. Many also expect ECB president Mario Draghi to unveil additional tools that he could this summer, including asset purchases. But even as the consensus has...

    1
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    Gavekal Research

    Tomorrow Is Not A Game Changer

    Tomorrow we expect to see the latest Band-Aid solution being applied to the eurozone. Having teased the market for months, it seems likely that the European Central Bank will trim its main refinancing rate, possibly announce a negative deposit rate and even promise a few asset purchases. Forgive me if I don’t roll out the barrel. This is fiddling which does little to correct the fundamental dysfunction at the heart of the system. Let’s be clear...

    1
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    Gavekal Research

    Drumroll To The ECB Meeting

    Yesterday the yield on 10-year US treasury bonds broke downward through 2.5%, its floor ever since last summer’s ‘taper tantrum’. There were two main catalysts for the move. First, there was renewed weakness in the renminbi, as the offshore CNH set a new low for the year with US$-CNH rising to 6.27. Second, there was poor data from Germany and, especially, France, where the ranks of the unemployed continued to expand. Looking at the evolution of...

    0
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    Gavekal Research

    Five Corners (28 May 2014)

    In the latest bi-weekly review of global economics and investment:

    0
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    The Earnings Expectations Paradox

    When it comes to global equity investment, all markets are not equal. Over the last couple of years, investors have evolved distinctly different attitudes about how to discount trends in profit growth in each of the four major equity market regions.

    0
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    Gavekal Research

    An Exceptionally Good Disguise

    When Winston Churchill was facing defeat in the 1945 general election, his wife attempted to cheer him up by remarking that the Labour party’s victory might turn out to be “a blessing in disguise”. “Well then,” the great man retorted, “it’s a bloody good disguise”. To be fair, politicians tend to live in a black and white world. Losses mean bad news, and victories are good. The same cannot be said of investors, for whom good news may well be...

    3
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    Gavekal Research

    A Grand Bargain

    In the run up to this week’s meeting between Russian President Vladimir Putin and Chinese President Xi Jinping, expectations had run high that 20 years of discussions could be concluded with an agreement for Russia to pipe natural gas to China. Russia’s deputy energy minister even stated last week that a contract was “98% ready.” The long history of inconclusive China-Russia negotiations on the issue suggested that his was an overly optimistic...

    0
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    Gavekal Research

    5C Europe: Money Matters

    The slowdown in eurozone GDP growth in the first quarter to 0.2% QoQ has strengthened the chorus of skeptics who question the recovery. Economic indicators come in many forms, with PMI surveys favored by our own European economist Francois pointing to continued growth. However, a closer look at monetary growth trends arguably offers a far less constructive signal as to future economic activity.

    0
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    5C Overview: Keeping China In Check

    How much should we worry about China’s increasing assertiveness beyond its borders? Provocations continue to pile up in maritime Asia, most recently a spat over a Chinese oil rig in what Vietnam considers to be its waters. And last week’s Xi Jinping-Vladimir Putin summit in Shanghai, capped by the signing of a long-delayed US$400 bn gas pipeline deal, conjured the specter of a Sino-Russian concert enabling both countries to defy the United...

    0
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    Gavekal Research

    A Grandmaster At Work

    “Check-mate”. As Vladimir Putin signed Russia’s historic US$400bn gas-supply agreement with China, he must have felt the satisfaction of a chess grandmaster revealing the inexorable outcome of a complicated endgame. In theory, the next phase of the chess game between Russia and the West in Ukraine will only begin with the Ukrainian presidential election on Sunday, but Putin’s positioning of the pieces means the outcome is preordained, whoever...

    1
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    Gavekal Research

    Playing The Bond Markets In A Fixed Exchange Rate System

    Contrary to what some people may believe, I do not wake up in the morning with an irresistible urge to short the French bond market, or to go long US treasuries, or whatever it happens to be. I devise decision rules and I follow them. To build these rules, I always follow the same steps.

    0
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    Gavekal Research

    Europe’s Protest Vote Aids Reflation

    Citizens of the 28 member states in the European Union this week get to elect the 751 members of their supranational parliament. All polls suggest that the protest vote—including the anti-EU vote—will be substantial. This statement of discontent will not, however, be big enough to challenge the majority held by the establishment parties. And barring major surprises, these elections are unlikely to produce big policy changes. However, the scale...

    0
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    Gavekal Research

    Buy Eastern European Bonds

    Here is a paradox that fixed income investors may want to think about. Since mid-2013 sovereign bond yields in Central and Eastern Europe (CEE) have been broadly flat, contrasting with a strong rally in the euro-area periphery. Although the rally in Southern Europe is warranted, this divergence with Eastern Europe is not justified by economic fundamentals. Backed by very competitive currencies, a strong production rebound and spectacular...

    3
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    Gavekal Research

    Time To Sell Treasuries

    The benchmark 10-year treasury yield has traded sideways in a range from 2.5% to 3% since the taper tantrum of last summer. Now it is threatening to break out on the downside. If you expect a collapse in yields, you should load up on bonds and sell everything else. We don’t.

    4
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    The Healthy Man Of Europe

    In today’s Daily Louis argued that the eurozone investment environment may be undergoing a significant reversal as investors face up to the reality that southern economies are still mired in debt traps. Such a viewpoint would militate against a continued overweight position in European equities. Our European strategist and economist Francois will take issue with this proposition, but one European economic fact that cannot be disputed is the...

    0
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    Gavekal Research

    As Spreads Widen, Europe Clouds Over

    You have to go back almost to the darkest days of the euro crisis to see the sort of behavior displayed by Europe’s bond markets yesterday. As GDP growth disappointed across the continent (except for in Germany), yields dropped in the US, Germany, France and the UK, but soared in Italy, Spain, Greece etc... The 20bp or so jump in the yields of Spanish, Italian and Portuguese long bonds in the face of weak economic data begs a question: are we...

    2
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    Gavekal Research

    How To Lose The Eastern Front

    Russia, it appears, has emerged victorious in Ukraine. After the unofficial referendums organized by pro-Russian groups in Ukraine’s eastern regions, Kiev knows it must negotiate with the separatists to avoid national disintegration. A deal on autonomy for parts of Donetsk and Luhansk will have to be made on terms acceptable to Vladimir Putin.

    0
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    Five Corners (14 May 2014)

    In the latest bi-weekly review of global economics and investment:

    0
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    No Magic For ECB In Negative Rates

    At last, the European Central Bank seems ready to do something—judging by last week’s comments from Mario Draghi, reinforced by the Wall Street Journal story that triggered a sell-off in the euro yesterday. The market reaction has been pretty much along the lines described by Francois last week: bond yields in Italy and Spain have fallen to record lows, European stock markets are up 1% to 2%, and the euro has weakened from almost €1.40 to €1.37...

    3
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    Gavekal Research

    EM Carry Trade Looks Vulnerable

    Over the last two months, emerging markets have delivered a handsome rally, with the MSCI emerging markets index recording a 7% return in US dollar terms, compared with just 1% for the developed markets. The trouble is that this rally has been driven primarily by investors’ growing enthusiasm for carry trades in an environment of declining global volatility. Experience teaches this is an engine which can all too suddenly be thrown into reverse

    5
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    Gavekal Research

    The Problem With Piketty

    Thomas Sowell coined a marvelous phrase to describe the well-intentioned social engineers who always know what needs to be done to improve the wellbeing of the downtrodden. He called them “the anointed” and explained how their reasoning always evolves in the same three stages:

    13
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    Gavekal Research

    5C Europe: Europe’s Profit Question

    While Europe’s economy has continued to accelerate, since January analysts have slashed their estimates for earnings growth. The specter has been raised of a profitless recovery. Such an outcome would threaten the European bull market which is increasingly dependent on improved corporate profitability. After all, the aggregate forward P/E ratio of the MSCI EMU is at 14x—a 10 year high—against 9x in mid-2012 (see also Are Earnings Expectations...

    2
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    Gavekal Research

    The ECB Coin Toss: Heads I Win, Tails I Don't Lose

    Today may be the anniversary of the German capitulation in 1945, but when the European Central Bank meets later, the Bundesbank is not expected to surrender to calls for a European version of quantitative easing. As some analysts see it, disappointment at ECB inaction against a backdrop of feeble corporate profit growth threatens a major correction after almost two years of “Europhoria”. I disagree.

    0
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    Gavekal Research

    Will The Last Businessman To Leave France Turn Out The Lights?

    This week the French government announced its opposition to GE’s proposed US$13.5bn acquisition of Alstom’s energy business, even though the bid won the approval of Alstom’s board. Instead ministers have indicated their preference for a rival deal with Germany’s Siemens. Either way, Alstom’s energy arm will still pass into foreign control, becoming just the latest in a long string of businesses to quit France.

    7
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    Gavekal Research

    Why Are Bond Yields So Low?

    As long as men continue to age, they will probably complain that “things were better in their day” and that “the world is going to hell in a hand-basket”. Ignore for a moment that the proportion of undernourished people fell from 23% of the developing world in 1990-92 to under 15% in 2010-2012, that more than two billion people gained access to improved sources of drinking water in the past decade, and that never in history have so many people...

    9
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    Breaking The Pattern: This Could Be The Year To Buy In May

    Sell in May and go away. This time-honored adage has served equity investors extremely well for the past four years. In every year since 2010, stock markets have corrected sharply, falling from a high in May to a low in the summer or early autumn: in terms of the S&P 500 by 15% in 2010, 19% in 2011, 9% in 2012 and 5% in 2013. Given that the S&P closed last week less than 1% shy of its all time high and that the Dow Jones Industrial...

    0
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    Growth & Markets Monthly (May 2014)

    For a second straight month, our growth indicators have weakened, suggesting the possibility of another summer lull. The outlier is US employment, as evidenced by last week’s very decent non-farm payroll report. We were also intrigued by the recent pick-up in US 5-year inflation expectations, which does not seem to fit with the narrative of constant deflationary pressures. Combined with recent US wage growth, could this imply that there is a...

    0
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    Five Corners (30 April 2014)

    In the latest bi-weekly review of global economics and investment, Arthur Kroeber considers the implications of Asian deflation. Will Denyer & Tan Kai Xian consider the strong rental market for US homes and wonder what this means for the broader housing sector. Nick Andrews looks up close at reduced liquidity in the eurozone’s financial system. Chen Long looks at a favorable convergence between national GDP numbers and the growth claims made...

    0
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    Sweden Is Not Turning Japanese

    Swedish policymakers have faced a dilemma in seeking to navigate the dog days of a long boom. The last five years produced a “triple merit” scenario of rising asset prices, falling interest rates and an appreciating currency. But nothing lasts forever and the last six months has seen tension over the right policy mix with business groups arguing for lower rates to spur ebbing growth. For its part, the Riksbank has been focused on containing a...

    2
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    What Ails The Dollar

    A curious brew of cheap money, a grinding cyclical recovery and “new economy” verisimilitude has helped drive Wall Street to new highs. And yet even as equity investors have scaled the wall of worry, the dollar has remained uninspired. The unit arguably started a structural upswing in 2008 but the recent performance has been lackluster with the DXY index at the bottom of its trading range.

    4
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    Not The Cruelest Month

    Contrary to literary lore April has not brought cruel tidings for the eurozone economy. Yesterday’s release of the zone’s composite output PMI for March showed the measure of activity hitting 54, its highest level in four years. The survey has now generated expansionary readings above 50 for ten straight months. Gradually, accelerating economic growth is unfolding, which validates a consensus forecast of 1-1.5% economic expansion for this year...

    0
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    Easy Eurozone Trades Are Running Out Of Road

    Investor enthusiasm for government debt from the eurozone’s southern periphery persists unabated. Last week the yield on Spanish 10-year bonds dropped to its lowest level since September 2005. Before too long, however, I believe investors will find themselves bumping up against some hard truths imposed by simple accounting identities. In this I find myself taking a somewhat different view to the one recently expressed by François (see Believe In...

    3
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    5C Overview: How Much More Asian Deflation?

    The latest news from Asia’s biggest economies is uninspiring. China’s growth grinds lower, and the renminbi has declined by 3% against the US dollar since January. Japan is suffering the anticipated effects of this month’s consumption tax hike, and Anatole has predicted that the BoJ will respond later this year with a fresh round of money-printing which could push USD/JPY well above its established level of 102 to the dollar.

    0
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    5C Europe: Liquidity Liaisons

    In the last week European Central Bank president Mario Draghi has changed tack. Where previously he appeared worried by the strength of the euro, he now seems more sanguine. A strong euro may be pressing inflation lower but that strength results largely from a necessary normalization of European financial markets, he says. Quantitative easing is certainly not imminent, but a cut to the Main Refinancing Operation rate is possible.

    0
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    Will The ECB’s Flirtations Lead To Anything?

    The 19th century French statesman Talleyrand once said “in order to avoid being called a flirt, she always yielded easily”. The same cannot be said of the ECB which in recent months has been teasing the market by talking a big game, but delivering relatively little. Like Jürgen Stark in Tuesday’s Financial Times, you could argue that the ECB’s job is mostly done: bond spreads have retreated from crisis levels, equity markets have roared back,...

    0
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    Portugal Dashing For The Exit

    Even though Portuguese bonds have returned investors a 45% gain over the last year, this paper argues that they should stay long. The 10-year maturity still offers the second highest yield in the eurozone at about 3.65%. That amounts to a 220bp premium over bunds and 60bp above Spanish bonos. Although the dramatic improvement in European financial conditions stems largely from European Central Bank promises to support the euro system, Lisbon’s...

    0
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    Five Corners (16 April 2014)

    In the latest bi-weekly review of global economics and investment, Charles Gave explains why it still pays to run a balanced portfolio, despite the market’s rotation. Will Denyer argues that outlook for US consumption remains favorable, even though consumer cyclicals have taken a beating. François-Xavier Chauchat examines the reasons behind the euro’s persistent strength. Andrew Batson looks at Beijing’s new focus on jobs and finds the...

    0
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    5C Europe: The Consequences Of A Capped Euro

    Over the last decade the three main factors which have correlated with the euro/US dollar exchange rate have been the 2-year yield spread between German and US bonds, oil price moves and the level of default risk in Europe’s periphery (see What Drives The EUR-USD). In the last couple of years the first two variables have barely moved so the euro’s strength must be explained by lower CDS spreads in the eurozone periphery.

    0
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    The French Turnaround

    As overvalued technology stocks face a severe market comeuppance, it apparently falls to France to offer some good news! Manuel Valls has kicked off his premiership with bold pledges to cut both taxes and spending. In doing so, he has reinforced the more pro-business tone that President Hollande articulated in January. The Spanish-born prime minister has also begun to clarify a reform agenda that should help French companies claw back their lost...

    0
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    5C Overview: Why A Balanced Portfolio

    Last August I suggested moving from a fully invested position in equities to a “balanced portfolio” with equities hedged by high quality government bonds. What underlay this recommendation was a simple reality: the global consumer price index had by that point dipped to about 3.3% and the G7 core CPI measure was down to 1.1%.

    0
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    Believe In The ECB

    Two irreconcilable views typify opinions about the European Central Bank. One crowd looks longingly at the Federal Reserve, the Bank of England and even the Bank of Japan as they embrace the new “unconventional” orthodoxy in order to arrest a collapse in monetary velocity, and so in economic activity. They are shocked that the ECB does not join in, especially as the European patient seems to crave the same pain relief from persistent...

    1
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    Draghi's Faustian Bargain

    On Thursday European Central Bank president Mario Draghi added Easter to the list of reasons why inflation is so far below target; another exogenous factor that the ECB can do little about and that, in time, will fall out of the calculations.

    5
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    London Seminar April 2014 - Anatole, Arthur, Louis & Francois

    We held our spring seminar in London on April 2, with Anatole, Arthur, Louis and Francois offering their take on the state of the world economy and financial markets. Audio recordings of their discussions are available below:

    0
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    Growth & Markets Monthly (April 2014)

    Please find the latest monthly review of our models and indicators. In this edition we note two important changes. First, our growth indicators have taken a turn for the worse, and second our indicators on risk appetite have deteriorated. Since we have seen no significant rises in market spreads, this is probably more a sign of a slightly overextended rally, then a real erosion of financial conditions. Could the rally in risk assets be about to...

    0
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    Bet On Europe Vs The US-EM Axis

    Following decades of European economic integration, euro coins and notes were introduced with great fanfare in January 2002. Equity investors barely noticed as their attention was focused on the emerging trans-Pacific economic relationship between the US and China. Initially, this axis relied on the buying power of the US consumer and the production capabilities of the Chinese factory lands. But as the decade wore on this simplified “ChinAmerica...

    4
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    How To Treat The Fall In Velocity

    Debate continues to rage in our office as to the sustainability of the US economic recovery. On the plus side of the ledger, we can book factors such as decent bank loan growth (both for households and corporates), rising wage growth, falling unemployment and solid business surveys. On the negative side, we find a weakening housing sector (which has been the lynchpin of the US recovery), intensifying disinflationary pressure, and long bond...

    0
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    Is Turkey A Joke--Or A Buy?

    As Turkey prepares for local polls this Sunday, the country’s leaders would appear to be sliding into a parallel universe. After a Turkish court overruled his ban on Twitter, Prime Minister Erdogan came back yesterday with a similar prohibition on YouTube. This kind of repression might have been doable in the Cold War era, but is laughable in light of modern communications technology, and smacks of desperation. Yet against a backdrop of...

    0
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    5C Europe: By The Power Of Poseidon

    A familiar criticism of the Troika reforms is that Greece cannot be Germany. But this misses the point. Structural reforms such as those approved by the Greek parliament this week aim to leverage the talents it does have by breaking closed shop arrangements in key parts of the national logistics sector.

    0
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    A Reason For The Bundesbank's Turn

    Common enemies make good friends. It would seem the strong euro is, increasingly, uniting Germany and other members of the European monetary union. Yesterday Bundesbank President Jens Weidmann even opened the door to quantitative easing, a very un-Bundesbank emotion. Our guess is Germany is less worried about deflation or financing the peripherals, and more concerned that the region’s export competitiveness is getting crushed.

    1
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    The UK Budget: Lies That Work

    Britain’s government budget this week was not really a statement of economic policy, but a program for winning next year’s general election. In this sense, George Osborne’s speech was a natural development from the 2013 budget, which launched Britain’s present economic recovery. Almost nobody predicted the remarkable transformation of the British economy that immediately followed last year’s budget because what Osborne did was deliberately...

    2
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    The Sword Is The Axis Of History

    As Anatole recently argued, we can all breathe a sigh of relief that the tussle over the Crimea has likely been resolved without serious bloodshed and at minimal cost (see All Over Bar The Annexation). But in the longer term it is clear that these events may cast a long shadow over international relations for years to come. Indeed, as British politician Ernest Bevin famously said, “don't open this Pandora’s box, it is full of Trojan horses...

    2
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    All Over Bar The Annexation

    Bertrand Russell once quipped that ‘wars are not won by who is right, but by who is left’. With that in mind, markets should welcome the result of yesterday’s referendum in the Crimea. After all, had the result been ambiguous, whether because of a low turn-out, or a split electorate, then the more fanatical elements on either side of the divide might have been tempted to take up arms to settle the issue. However, with the vox populi confirming...

    23
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    5C Europe: Turkey Compared To The Other "Fragiles"

    In dollar terms, the Turkish stock market has lost more than -40% since May last year, when financial markets began to price in the effects of the Federal Reserve’s tapering. With a price to book of 1.3x, the MSCI Turkey index traded cheaper only during the months that followed the Lehman crisis, from October 2008 to March 2009.

    2
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    Italy Aligned On Thatcherite Keynesianism

    While economists and observers around the world debate at length what the European Central Bank could and should do to fight low inflation, we continue to see more clarity on eurozone fiscal policy settings. After French President Francois Hollande’s turn in favor of tax and spending cuts in January, the new Italian Prime minister Matteo Renzi yesterday outlined a host of easing and reform measures. If implemented, Renzi’s reforms would clearly...

    5
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    Russia's Permanent Interests

    Nineteenth century statesman Lord Palmerston famously said that “nations have no permanent friends or allies, they only have permanent interests.” As anyone who has ever opened a history book knows, Russia’s permanent interest has always been access to warm-water seaports. So perhaps we can just reduce the current showdown over Crimea to this very simple truth: there is no way Russia will ever let go of Sevastopol again. And aside from the...

    12
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    The Ambiguous Message Of A Strong Euro

    Over recent days the euro has broken out against a number of key currencies, exceeding 1.38 against the USD, 8.40 against the Chinese renminbi, and 50 against the ruble, a new historical high. Against its 20 largest trading partners, the euro nominal effective exchange rate is now back to where it was in the summer of 2011, and towers 10% above its low from the summer of 2012. With the risk of war at Europe’s borders, and deflation risks...

    4
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    ECB: Searching For The Silver Bullet

    It is that time of the month again when the European Central Bank meets, warns that it is ready to tackle deflation, then does nothing. As the governing council goes into today’s conclave, inflation is dangerously below target at 0.8%, and no higher than it was the last time the ECB vowed to act. Is this the day that Mario Draghi actually follows up on his promises?

    0
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    Southern Europe’s Unavoidable Deflation

    Last week we published a piece by Francois which argued that a “reflating” Southern Europe was close to exiting its debt trap nightmare, while the promise of further counter-measures by the European Central Bank meant that Europe faced no serious deflation risk. I would respectfully differ, and in this paper will seek to show that Southern Europe is sliding further into a “secondary depression,” which is likely to worsen just so long as the...

    3
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    Realpolitik In Ukraine

    Oscar Wilde described marriage as the triumph of imagination over intelligence and second marriage as the triumph of hope over experience. In finance and geopolitics, by contrast, experience must always prevail over hope and realism over wishful thinking. A grim case in point is the Russian incursion into Ukraine. What makes this confrontation so dangerous is that US and EU policy seems to be motivated entirely by hope and wishful thinking. Hope...

    2
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    5C Europe: In Italy, Hope Springs Eternal

    Italy, home to the eternal city, looks to have become a land of timeless stagnation. Unlike Spain and Ireland whose credit bubbles at least caused rapid growth before the bust, Italy's problems have brewed for years.

    0
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    Bet On Reflation, Not Deflation

    The widely touted notion that Europe faces a Japanese-style deflation sits uncomfortably with its fast recovering financial markets being led by fragile Southern Europe. In recent months, both bonds and stocks from Spain and Italy have been stellar performers. This apparent contradiction stems from a misunderstanding about the way the European Central Bank runs policy—the deflationists have tended to conflate recent soft CPI and PPI readings...

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