Monday, April 14, 2014

The story so far...

The first quarter of 2014 saw most of the developed markets looking a little nervous, but with the beginnings of a rally in Asian and EM equities (after a long period of relative underperformance), and a fairly robust outcome for fixed income investments (which also lagged badly in 2013).

Much of the nervousness in the US, Europe and Japan can be attributed to bouts of uncertainty about central bank policy direction, especially in the US via the new Janet Yellen-led Federal Reserve and in Japan post the recent sales tax increase. The periodic twitchiness over geo-political frictions in the Ukraine were also an issue. The latter has the potential for shorter term shocks, but it's the former which will have the biggest effect on the market.

Initial statements from Janet Yellen were interpreted - wrongly  - by markets, as suggesting that interest rate rises were on the cards earlier than expected, possibly by as early as 2015. Initial market falls were arrested when Ms. Yellen made what one strategist referred to as "one of the most dovish speeches I have ever read from a Federal reserve official". To quote from coverage of the speech in the WSJ:

Ms. Yellen said Monday the U.S. economy and job market are still far from healthy, and still require plenty of support from the central bank’s low-interest-rate policy. The unemployment rate currently stands at 6.7%, well above the 5.2%-5.6% range that Fed officials see as normal. Annual inflation is running just above 1%, well below the central bank’s official 2% target.

“The U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress” of low and stable inflation and maximum sustainable employment, Ms. Yellen told a conference on community investment. She pointed to several aspects of the labor market that suggest it continues to operate well short of its potential.

So the implication is that under the Yellen chairmanship, rates will be held "lower for longer" until such time as unemployment levels have fallen substantially below the previous target of 6.5%.

All of this is good for markets in that it implies that monetary policy, as managed by an ever accommodative Federal Reserve will remain loose for as long as needed. When you combine this with similarly loose rhetoric from the heads of the ECB and the BoJ and QE in its various forms seems destined to be with us for a while.

So whay then have markets proved jittery in recent weeks?

Its partly down to geo-politics and the uncertainties caused by ructions in Ukraine which sits astride important oil and gas pipelines for Western Europe. This seems likely to continue for a while, but we think will begin to have a diminishing influence as both sides slip into a pugnacious stalemate.

More of an issue though is that markets rallied so strongly in 2013, and the perception that valuations were beginning to look stretched at a time when earnings expectations are being revised downwards. Without earnings growth, markets remain dependent on continue re-rating for further advances.


 

Having said that, on the basis of the latest quarterly market commentary market valuations don't actually look that stretched at all: the S&P500 is still at an 8% discount to its long term average, and less than half the top of its historic valuations range. The same applies for pretty much everywhere else, with the possible exception of ASEAN.

That said, there are areas of market excess: the Russell 2000 mid cap index appears to be on a PER of about 62 x earnings, whilst NASDAQ looks similarly stretched. The latter has fallen by nearly 8% since this years peak in early March as earnings have disappointed.

Despite these probably justified declines, we don't think there is too much to get overly concerned about, largely because of those accommodative central bankers. With a "lower for longer" interest rate mantra, the outlook for equities - partly by default, we admit - still looks positive, and this year it may possibly be the moment for Asian and Emerging Markets to recover a bit of lost ground, simply because although tapering in the US may be an ongoing fact, interest rates aren't budging for a while. 

Another chart from JP Morgan highlights the valuation gap that opened up in 2013:

 

 We have a relatively balanced allocation between the US, UK/Europe and Asia/EM in our equity portfolios, with the balance being accounted for by fixed income. The latter two asset classes have outperformed a bit so far in 2014, and we expect this to continue.


Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

 


Monday, February 24, 2014

Up, down, flying around...

They can fly upside down with their feet in the air, they don’t think of danger, they really don’t care. Newton would think he had made a mistake, to see those young men and the chances they take. Up, down, flying around, looping the loop and defying the ground…” Lyrics from “Those Magnificent Men In Their Flying Machines” 1965



Waaaaaaay back last October, I headed our monthly client report with a quote from the song of an otherwise very dated 1960's movie (I'm old enough to have seen it the first time round), "Those Magnificent Men In Their Flying Machines" which supposedly chronicled the antics of a group of competitors in a London - Paris air race in 1910. The aim was to prove that Britain was "number one in the air". Needless to say an American wins it (jointly with a jolly chivalrous Brit, old boy) after fighting off the French, the Germans, and the proverbial pantomime villain. It had a budget of $6.5m and made $31m at the box office.

The way that markets have been behaving recently reminds me a lot of that 1965 movie: a lot of aerial acrobatics with climbs and falls, but with little thought of danger. Such has been the effect of central bank support, that it seems to have been the equivalent of a $6.5m budget producing a $24.5m profit.

As we've noted before, however, the bears disagree. In their view, loose money will create inflation, although, paradoxically, they also feel that while loose money might have done much for equity prices and the value of property in London and New York, it's done relatively little or nothing at all for employment and real wages.

It strikes us that - usually - you can't have both at the same time, and at present, the existence of still significant amounts of excess capacity (which keep prices down) are more of an issue than the possibility of rising prices at some point in future when capacity is being more fully utlised. Prices will only start to go up when capacity shortages are created by an excess of demand over supply, and we don't seem to be there yet.

So, for the time being, even with the occasional bout of aerial acrobatics, the average trajectory for markets seem likely to continue to be a steady climb, particularly in those countries where central banks remain supportive: the US, UK, Europe and Japan. We still like these, and still favour them for our portfolios for the first half of this year.

In Asia and the Emerging Markets, the picture remains more unpredictable, even if the outlook is not as homogeneous as some have been suggesting. The "good" markets, such as Vietnam, Philippines, Korea & Taiwan, still look fairly robust, whilst the "bad" markets such as the members of Morgan Stanley's "Fragile Five" (Turkey, Brazil, South Africa, India and Indonesia) have specific issues which seem unlikely to lead to a more generalised degree of contagion.China remains a conundrum, with debate evenly balanced between those predicting a crash and those predicting an eventual government driven recovery (we're in the latter camp).

In a sell-off, however, investors tend to be indiscriminate in their charge for the exits, and that's where the buying opportunity comes in: outflows from EM's have amounted to $26bn since the November of last year, but only -$12bn since the beginning of last year (that's because the first half of 2013 saw significant inflows, especially into EM debt, attracted by higher relative yields).

Eventually these outflows will reverse, possibly in conjunction with an acceleration of growth in Developed Markets, which will drag EM's up with them. This will start to reverse the relative underperformance of EM vs. DM, if only because at some point valuation of DM's will run into resistance whilst highlighting the relative value to be found elsewhere.

We're already beginning to see some changes in view: Credit Suisse forecasts that the Indonesian market has upside of 15-20% for 2014, and presumably more, if you assume that this will occur at the same time as a rally in the Rupiah. For EM's as a whole, over the last month or two, earnings upgrades have been bigger and more frequent than those for DM's. The Indian election in April/May could prove a watershed if a new government builds on a lot of the recently constructive work undertaken by the central bank.

Time will tell whether or not this gradual improvement is sustained, but by the second half of this year, maybe those EM aviators will finally get off the ground...

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.