Greed & Fear - 08 November 2013 - Shifting consensus
· There is now no real consensus among investors on the state of the American economy. In the first half of this year there was such a consensus with the belief that the economy was finally “normalising”. This is no longer the case with the renewed weakness in housing revealing fundamental fragility.
· But there is a growing consensus that continuing trend real GDP growth around 2% is likely to lead to continuing balance sheet expansion at the current rate of US$85bn a month under a Yellen run Fed. The consensus is also of the view that continuing QE at this pace is likely to remain bullish for the stock market.
· While it is natural that indexation should grow in popularity in a trending rising market, it is important to understand that indexing, otherwise known as “passive” investing, makes no fundamental sense for those who believe in free markets.
· The increasing conviction that quanto easing is continuing is the main reason for fund managers’ reluctance to bet against the stock market. But this is predicated on the assumption that the Fed will be run by the doveish Janet Yellen and that the Fed governors will remain team players. The politics of the Fed has now become more important than usual.
· A return to contentious voting patterns at the Fed would trigger a lot of investor angst and uncertainty, and would clearly not be bullish. Still GREED & fear’s base case is that Yellen will take charge once formally appointed and seek to ensure a common consistent line based on the “data dependent” view of quanto easing.
· There appears to be a new wrinkle to the “data dependent” view on quanto easing with a new Fed research paper arguing that the Fed’s unemployment threshold for triggering interest rate hikes would be more effective if lowered from the current 6.5% to “possibly” as low as 5.5%. If this happens, it will be a signal that the Fed is not yet willing to consider the argument that America’s declining labour force participation rate is more structural than cyclical.
· Janet Yellen’s view that deflationary pressures have been far from vanquished remains GREED & fear’s view, even if GREED & fear’s prescription on how to deal with these deflationary pressures remains the precise opposite of Mrs Yellen’s.
· The financial markets have been reminded of the global deflationary backdrop over the past week by the sharp fall in Eurozone inflation. The only surprise to GREED & fear about the Eurozone situation is that inflation in the Eurozone had not fallen more already. But sooner or later Flexible Mario will have to respond to the growing deflationary outlook, as seen in the ECB rate cut today.
· This is a deflationary adjustment in the Eurozone which is more bond friendly than equity friendly so long as investors assume, as they do for now, that the euro will remain in its present form. The latest American complaints about Germany’s rising current account surplus will only make Germany less inclined to take the stimulatory action demanded by the “demand” obsessed neo-Keynesians.
· The stronger euro is a negative headwind for Germany, while soaring energy costs courtesy of Frau Merkel’s precipitous decision to abandon nuclear energy by 2022 puts German industry at a competitive disadvantage, most particularly relative to America.
· While Germany continues to resist for now further moves towards debt mutualisation in the Eurozone, the reality is that such debt mutualisation is likely to happen involuntarily, if not voluntarily, in response to future crises and related debt restructurings. That is so long as the political determination remains in Berlin to retain the euro and the Eurozone in its present construct.
· An attempt by the Yingluck government to get an amnesty bill through the legislature in Thailand has backfired in the sense that it has triggered renewed anti-Thaksin demonstrations over the past week which have seemingly been enough to cause the Yingluck government to back off for now.
· The amnesty bill strategy seems to be based on a hoped for deal, where Thaksin’s return would be a quid pro quo for Democrat Party leaders like former Prime Minister Abhisit Vejjajiva being let off charges relating to the killing of 91 red-shirt demonstrators in 2010. But it appears that this is not happening as yet, which means that the passage of the economically critical infrastructure bill may also be delayed.
· The Indian stock market has staged a decent bounce in the past 11 weeks. Part of this rally relates to the end of tapering neurosis but part also relates to growing hopes that BJP prime ministerial candidate Narendra Modi can win the pending general election which has to be held by May next year.
· The problem for Modi is that it is still six months from the national election. The reality is that his electoral prospects grow the greater the sense of economic crisis and the weaker the rupee. Still there remains no evidence of a turn in the investment cycle, and the current account deficit remains a large 5% of GDP. This is why the recent stock market rally is on fragile ground.
· Still the Indian stock market will have a dramatic rally if the BPJ candidate can achieve a viable majority. This is because business confidence will rise dramatically, and with it the chances of a new investment cycle.
· The consolidation continues in the Japanese stock market. Still the latest data on surging construction orders is a signal that an infrastructure cycle is under way. GREED & fear continues to advise investors to stick with the Japanese story with the current consolidation trend representing healthy market action.
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· But there is a growing consensus that continuing trend real GDP growth around 2% is likely to lead to continuing balance sheet expansion at the current rate of US$85bn a month under a Yellen run Fed. The consensus is also of the view that continuing QE at this pace is likely to remain bullish for the stock market.
· While it is natural that indexation should grow in popularity in a trending rising market, it is important to understand that indexing, otherwise known as “passive” investing, makes no fundamental sense for those who believe in free markets.
· The increasing conviction that quanto easing is continuing is the main reason for fund managers’ reluctance to bet against the stock market. But this is predicated on the assumption that the Fed will be run by the doveish Janet Yellen and that the Fed governors will remain team players. The politics of the Fed has now become more important than usual.
· A return to contentious voting patterns at the Fed would trigger a lot of investor angst and uncertainty, and would clearly not be bullish. Still GREED & fear’s base case is that Yellen will take charge once formally appointed and seek to ensure a common consistent line based on the “data dependent” view of quanto easing.
· There appears to be a new wrinkle to the “data dependent” view on quanto easing with a new Fed research paper arguing that the Fed’s unemployment threshold for triggering interest rate hikes would be more effective if lowered from the current 6.5% to “possibly” as low as 5.5%. If this happens, it will be a signal that the Fed is not yet willing to consider the argument that America’s declining labour force participation rate is more structural than cyclical.
· Janet Yellen’s view that deflationary pressures have been far from vanquished remains GREED & fear’s view, even if GREED & fear’s prescription on how to deal with these deflationary pressures remains the precise opposite of Mrs Yellen’s.
· The financial markets have been reminded of the global deflationary backdrop over the past week by the sharp fall in Eurozone inflation. The only surprise to GREED & fear about the Eurozone situation is that inflation in the Eurozone had not fallen more already. But sooner or later Flexible Mario will have to respond to the growing deflationary outlook, as seen in the ECB rate cut today.
· This is a deflationary adjustment in the Eurozone which is more bond friendly than equity friendly so long as investors assume, as they do for now, that the euro will remain in its present form. The latest American complaints about Germany’s rising current account surplus will only make Germany less inclined to take the stimulatory action demanded by the “demand” obsessed neo-Keynesians.
· The stronger euro is a negative headwind for Germany, while soaring energy costs courtesy of Frau Merkel’s precipitous decision to abandon nuclear energy by 2022 puts German industry at a competitive disadvantage, most particularly relative to America.
· While Germany continues to resist for now further moves towards debt mutualisation in the Eurozone, the reality is that such debt mutualisation is likely to happen involuntarily, if not voluntarily, in response to future crises and related debt restructurings. That is so long as the political determination remains in Berlin to retain the euro and the Eurozone in its present construct.
· An attempt by the Yingluck government to get an amnesty bill through the legislature in Thailand has backfired in the sense that it has triggered renewed anti-Thaksin demonstrations over the past week which have seemingly been enough to cause the Yingluck government to back off for now.
· The amnesty bill strategy seems to be based on a hoped for deal, where Thaksin’s return would be a quid pro quo for Democrat Party leaders like former Prime Minister Abhisit Vejjajiva being let off charges relating to the killing of 91 red-shirt demonstrators in 2010. But it appears that this is not happening as yet, which means that the passage of the economically critical infrastructure bill may also be delayed.
· The Indian stock market has staged a decent bounce in the past 11 weeks. Part of this rally relates to the end of tapering neurosis but part also relates to growing hopes that BJP prime ministerial candidate Narendra Modi can win the pending general election which has to be held by May next year.
· The problem for Modi is that it is still six months from the national election. The reality is that his electoral prospects grow the greater the sense of economic crisis and the weaker the rupee. Still there remains no evidence of a turn in the investment cycle, and the current account deficit remains a large 5% of GDP. This is why the recent stock market rally is on fragile ground.
· Still the Indian stock market will have a dramatic rally if the BPJ candidate can achieve a viable majority. This is because business confidence will rise dramatically, and with it the chances of a new investment cycle.
· The consolidation continues in the Japanese stock market. Still the latest data on surging construction orders is a signal that an infrastructure cycle is under way. GREED & fear continues to advise investors to stick with the Japanese story with the current consolidation trend representing healthy market action.
