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Global Horizon
Bonds the canary in the coal mine
Event
Since early October there has been a “risk on” move with a rise in equities
and commodities, plus a fall in the US dollar. For these trends to be
sustained, we believe there needs to be an ongoing sell-off in bonds.
Impact
The day after the Fed announced “operation twist” the yield on US 10-year
bonds posted a closing low of 1.72%. In our view, the market is pricing in a
deflationary scenario even though the Fed has clearly signalled it will do
what it can to avoid deflation. Investors will eventually shift to riskier
assets seeking higher returns and we think the switch to equities will
occur when investors are less concerned by contagion from Europe and
begin to expect steady but lower growth in the US.
We previously stated there needs to be a bond sell-off of 50 to 100bps before
there is sustained upward momentum in global equities. Specifically, we
believe the environment for equities would be more positive if bond yields
remain above the forward dividend yield for the S&P 500. Given a current
forward dividend yield of 2.32%, this would amount to a rise in bond yields of
about 60bps from the recent low, and so far we are up 46bps.
It is important to keep in mind that over the past 20 years market volatility has
typically been higher in September and October as turning points typically
occur in these months. Volatility and risk then fall over November and
December, with December typically the best month of the year for returns.
Outlook
Negative momentum in equity markets has driven the S&P 500 equity
risk premium to its highest level since 1973, at just over 3 standard
deviations above the long-term average. This supports our conclusion
that equities are cheap relative to bonds and that a switch between the
two will occur at some point. Given progress is being made to contain
and manage the sovereign and banking problems in Europe, and with
recent US economic data not as bad as it could have been, we believe
there is justification for an equities rally of 3 to 4 months.
While waiting for a stronger sell-off in bond markets, we think investors
should be looking to invest more in equities, and with a less defensive
strategy, especially given the seasonal winds that typically lift equity
returns between November and April. Higher beta can be obtained from
cyclical, value or emerging market stocks. That said, we are not
suggesting a rapid or wholesale switch into high beta names given there
are still some long term headwinds for stock markets.
In terms of Country selection, among developed markets the October update
of the Macquarie Country Alpha model suggests to favour UK, US and
Canada. In emerging markets, the latest results favour Southeast Asian
countries, particularly Thailand and Indonesia.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Global Horizon
Bonds the canary in the coal mine
Event
Since early October there has been a “risk on” move with a rise in equities
and commodities, plus a fall in the US dollar. For these trends to be
sustained, we believe there needs to be an ongoing sell-off in bonds.
Impact
The day after the Fed announced “operation twist” the yield on US 10-year
bonds posted a closing low of 1.72%. In our view, the market is pricing in a
deflationary scenario even though the Fed has clearly signalled it will do
what it can to avoid deflation. Investors will eventually shift to riskier
assets seeking higher returns and we think the switch to equities will
occur when investors are less concerned by contagion from Europe and
begin to expect steady but lower growth in the US.
We previously stated there needs to be a bond sell-off of 50 to 100bps before
there is sustained upward momentum in global equities. Specifically, we
believe the environment for equities would be more positive if bond yields
remain above the forward dividend yield for the S&P 500. Given a current
forward dividend yield of 2.32%, this would amount to a rise in bond yields of
about 60bps from the recent low, and so far we are up 46bps.
It is important to keep in mind that over the past 20 years market volatility has
typically been higher in September and October as turning points typically
occur in these months. Volatility and risk then fall over November and
December, with December typically the best month of the year for returns.
Outlook
Negative momentum in equity markets has driven the S&P 500 equity
risk premium to its highest level since 1973, at just over 3 standard
deviations above the long-term average. This supports our conclusion
that equities are cheap relative to bonds and that a switch between the
two will occur at some point. Given progress is being made to contain
and manage the sovereign and banking problems in Europe, and with
recent US economic data not as bad as it could have been, we believe
there is justification for an equities rally of 3 to 4 months.
While waiting for a stronger sell-off in bond markets, we think investors
should be looking to invest more in equities, and with a less defensive
strategy, especially given the seasonal winds that typically lift equity
returns between November and April. Higher beta can be obtained from
cyclical, value or emerging market stocks. That said, we are not
suggesting a rapid or wholesale switch into high beta names given there
are still some long term headwinds for stock markets.
In terms of Country selection, among developed markets the October update
of the Macquarie Country Alpha model suggests to favour UK, US and
Canada. In emerging markets, the latest results favour Southeast Asian
countries, particularly Thailand and Indonesia.
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