History Backs Bernanke Betting Volatility Variable Won’t Hurt
By Joshua Zumbrun - Mar 30, 2011 12:01 PM GMT+0800
Play VideoMarch 1 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke speaks about the surge in oil and other commodity prices and the potential impact of the rising prices on the U.S. economy. Bernanke, in his semi-annual testimony before the Senate Banking Committee, says the rise probably won't cause a permanent increase in broader inflation and repeated borrowing costs are likely to stay low. (Excerpts. Source: Bloomberg)
Ben S. Bernanke, chairman of the U.S. Federal Reserve. Photographer: David Maung/Bloomberg
Federal Reserve Chairman Ben S. Bernanke is betting that surging prices for food and fuel won’t wind up breaking the cost of living for Americans. The historical record shows the odds are in his favor.
The Fed watches two key measures of inflation, known to economists as headline and core. The first is based on a basket of goods and services bought by the average American consumer. The second strips out volatile food and energy prices, providing a better picture of long-term trends.
While both have averaged about 2 percent a year since 1996, based on the personal-consumption expenditures index, headline inflation has jumped as high as 4.5 percent and fallen to minus 1 percent. In the same period, changes in core prices ranged from increases of 0.7 percent to 2.6 percent.
"From an economist’s perspective, it’s right to focus on the core,” said Vincent Reinhart, a former Fed official who is now a resident scholar at the American Enterprise Institute in Washington. “Appropriately, the Fed’s goal is headline inflation, but it’s headline inflation in the future, and therefore core is the good predictor.”
The rate of “pass-through from commodity-price increases to broad indexes of U.S. consumer prices has been quite low in recent decades,” Bernanke, a 57-year-old former Princeton University professor, said March 1 in his semiannual monetary- policy testimony to Congress. That points to a “temporary and relatively modest increase in U.S. consumer-price inflation,” he said.
Testing an Assumption
Surging prices of oil, corn and other commodities are testing that assumption. Crude oil has jumped 35 percent in the past six months, corn is up 38 percent and cotton is up 89 percent.
“If you talk to an average family in New Jersey and you say, ‘What is your food bill? What is your gas price? What is your tuition?’” they are “not going to tell you there’s deflation,” said Senator Robert Menendez, a New Jersey Democrat, when he questioned Bernanke after his testimony. “In a real context, I’m wondering how this macroeconomic policy is going to get to the average person in a way that changes their lives in a more positive way.”
A gallon of gasoline averaged $3.587 on March 28, the highest since October 2008, according to Heathrow, Florida-based AAA, the nation’s largest motoring organization. The increase helped push consumer confidence to the lowest level since August, as the Bloomberg Consumer Comfort Index dropped to minus 48.9 in the week to March 20.
Rise and Fall
David Resler, chief U.S. economist at Nomura Securities International Inc. in New York, says prices of commodities can fall just as quickly as they rise. Corn jumped 21 percent from the start of the year to March 3 before dropping 8 percent. Oil fell 8 percent between Jan. 1 and Feb. 15, then rose 25 percent by March 7. Since then, it has declined about 1 percent.
Bernanke is “saying the rate of change is temporary or transitory, and he’s almost certainly right,” said Resler, the second most-accurate forecaster of the inflation rate in the past two years, according to Bloomberg News calculations. Oil may “move sharply lower” once the crisis in the Middle East passes, he said. “It’s hard to envision prices continuing to rise at these rates.”
Rapid moves in oil were even more pronounced in 2008, when the price of a barrel reached $145 in July because of possible supply constraints from Middle East conflicts and production disputes in Russia. The price dropped to $34 a barrel in December as tensions eased.
Extremely Rapidly
If the Fed had focused strictly on headline inflation, which rose to 4.5 percent in July 2008, it likely would have raised rates in the midst of the recession that began December 2007 and then had to drop them extremely rapidly as overall prices turned negative, according to Paul Ashworth, chief U.S. economist at Capital Economics Ltd. in Toronto. Instead it continued cuts it began in September 2007, when the federal funds target rate was 5.25 percent, eventually slashing its benchmark to near zero by December 2008.
“You can make errors,” Ashworth said. “In 2008 if you’d followed strictly headline, then you’d look like idiots when headline inflation was actually below zero in 2009.”
The bond market agrees with Bernanke’s assessment. Investors anticipate inflation of 2.7 percent in the next 12 months, as measured by the difference between yields on nominal bonds and Treasury Inflation Protected Securities. That reflects their expectation that the current surge in commodities is temporary and modest; in the next five years, investors estimate inflation will average 2.3 percent annually.
Even though the budget deficit has grown, the cost of financing it is now lower than it was before the credit crisis began in August 2007.
Slack in Economy
Bernanke has said the level of slack in the economy makes it difficult for companies to raise prices, as 14.5 million workers remain unemployed. The manufacturing, mining and electric-and-gas-utilities industries also are using only 77 percent of their capacity, according to Fed data. While core prices rose 0.9 percent in February from a year earlier, the most since October, they remain near record lows.
Bernanke and the Federal Open Market Committee said March 15 they will continue to keep interest rates near zero and maintain record monetary stimulus with purchases of $600 billion in Treasury securities through June. Rising commodity prices will prove “transitory” and “measures of underlying inflation have been subdued,” the FOMC said.
Trichet Surprise
The Fed’s approach sets it apart from the European Central Bank and Bank of England. ECB President Jean-Claude Trichet surprised investors earlier this month when he announced the central bank may raise its benchmark rate in April from a record low 1 percent. In the United Kingdom, a 4.4 percent consumer- price increase in February from a year earlier is pressuring policy makers to consider raising England’s target rate above its record low of 0.5 percent.
“The implication is that, unless U.S. underlying inflation begins to rise, the Fed will continue to lag behind the ECB and the BOE, both of which are much more sensitive to the impact from commodities-driven headline CPI rates on inflation expectations,” said Lena Komileva, the global head of G-10 strategy in London for Brown Brothers Harriman & Co.
Maury Harris, chief U.S. economist in New York at UBS Securities LLC, says Bernanke may be falling behind the curve.
“There ought to be some questions about whether the Fed is on the right track when they say core inflation will be contained,” he said. His team at UBS Securities, the best inflation forecasters for the past two years according to Bloomberg calculations, see prices excluding food and energy rising 1.4 percent this year, compared with the median forecast of 1.1 percent in a Bloomberg survey.
‘Totally Implausible’
The Fed’s credibility also is at risk, Harris said. Ordinary people “find it totally implausible that somebody from the Fed would play down inflation,” he said.
Inflation expectations among U.S. consumers for the year ahead jumped to 4.6 percent this month from 3.4 percent in February, according to a Thomson Reuters/University of Michigan survey. Expectations for five years from now rose to 3.2 percent from 2.9 percent.
Reinhart agrees that concepts like core inflation have little meaning for consumers watching the price of gasoline and groceries rise from one week to the next.
“When you talk about core, you disconnect yourself from the public who think ‘What, you don’t drive or eat?’” he said. Even so, Bernanke is right when he says “the pass-through has been essentially non-existent” for the last several decades, Reinhart said.
To contact the reporter on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net
To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net
Thursday 31 March 2011
From My Last Buy Call on 15 March Till Now - We Have a Breakout
We are in the 2nd half of the bull run. In terms of a football game, we are probably at the 50th - 60th minute. There might be a good 12 - 18 months more to run. It means that we could see the stock market trend higher to as late as Oct 2012.
Likewise, residential real estate could continue to trend higher, because the stock market is a fantastic leading indicator of economic growth whereas real estate is a coincident to lagging indicator. But my take is the government could slap a 5th measure sometime by June or 2nd half of 2011, stopping the residential prices from rising beyond 10% per year. Don't fight the government. You can't win. The truth is, residential price indices have been rising as much do to the shrinkage of units as much as real demand. A shoebox unit on a psf basis can fetch up to 30 - 50% higher. Developers are having a field day selling their little units to aspiring local owners.
Can you get used to living in a 400sf home? In my opinion, shoebox units near financial / CBD districts can attract tenants because people like to live near where they work. But shoebox units in Balestier?? I really doubt if such units can find tenants at attractive yields when completed. 2011 is probably the last and final year of price appreciation for residential. 2012 could be a flat or down year. When stocks start to hit the bear market that year, we could see residential properties sliding down too.
What about the en bloc fever? It could burn until 2012. But remember, Development Charges have been raised. Government land sales at half the price of collective sales are at full force. Cost of construction is beginning to creep up again. We could see a couple more successful collective sales fever, mainly in the central areas, and in small projects before it fizzles out. Developers are very mindful of the avalanche of supply coming in 2013/14. It does not auger well for en bloc fever.
Why will stocks rise until mid to late 2012? I like Russia, Brazil, Latin America, China, nothing more. I love countries that export commodities. I like frontier countries. I don't like the US, or Europe. I only bought Japan on 15 March because of the 20% collapse. It subsequently rebounded by 10% so I'm up several thousands and will go for a trip.
Interest rates in the EU will start to rise in April. They could hike say 4 times in 2011, making it 2.5 - 3%. It still won't invert the yield curve. The German 10-yr bond is at 3.5 - 4% yield. In 2012, when CPI rises beyond 3%, capacity utilisation rises above 85% - 90%, we could see the yield curve inverted in 1H 2012.
The US' Fed fund rates could begin rising after June. We could see it hit 1.5% by end 2011. The 10-yr US T bills is at 3.3%. We could see Fed Fund rates hitting 3.5% by 2H 2012. Inflation in the US could hit beyond 4% then. US stocks could start falling by 3Q 2012, but commodities could rage on until 4Q 2012 or even 1Q2013. We will have a worldwide recession by 2H 2013. It will be the perfect storm where residential properties fall together with stocks. The recession could be worse than the one we see in 2008 because this time, we could face stagflation. Inflation could remain stubbornly high because of high energy, food and material prices. Half a decade of quantiative easing could also rear its ugly head. With inflation falling to 2% in the EU and 3% in the US in 2013, both governments may have limited tools to fight the recession. Quantitative easing will be out of question. There will be limited room to cut rates due to the high inflation. Welcome to the age of stagflation.
Till then, enjoy the ride.
Likewise, residential real estate could continue to trend higher, because the stock market is a fantastic leading indicator of economic growth whereas real estate is a coincident to lagging indicator. But my take is the government could slap a 5th measure sometime by June or 2nd half of 2011, stopping the residential prices from rising beyond 10% per year. Don't fight the government. You can't win. The truth is, residential price indices have been rising as much do to the shrinkage of units as much as real demand. A shoebox unit on a psf basis can fetch up to 30 - 50% higher. Developers are having a field day selling their little units to aspiring local owners.
Can you get used to living in a 400sf home? In my opinion, shoebox units near financial / CBD districts can attract tenants because people like to live near where they work. But shoebox units in Balestier?? I really doubt if such units can find tenants at attractive yields when completed. 2011 is probably the last and final year of price appreciation for residential. 2012 could be a flat or down year. When stocks start to hit the bear market that year, we could see residential properties sliding down too.
What about the en bloc fever? It could burn until 2012. But remember, Development Charges have been raised. Government land sales at half the price of collective sales are at full force. Cost of construction is beginning to creep up again. We could see a couple more successful collective sales fever, mainly in the central areas, and in small projects before it fizzles out. Developers are very mindful of the avalanche of supply coming in 2013/14. It does not auger well for en bloc fever.
Why will stocks rise until mid to late 2012? I like Russia, Brazil, Latin America, China, nothing more. I love countries that export commodities. I like frontier countries. I don't like the US, or Europe. I only bought Japan on 15 March because of the 20% collapse. It subsequently rebounded by 10% so I'm up several thousands and will go for a trip.
Interest rates in the EU will start to rise in April. They could hike say 4 times in 2011, making it 2.5 - 3%. It still won't invert the yield curve. The German 10-yr bond is at 3.5 - 4% yield. In 2012, when CPI rises beyond 3%, capacity utilisation rises above 85% - 90%, we could see the yield curve inverted in 1H 2012.
The US' Fed fund rates could begin rising after June. We could see it hit 1.5% by end 2011. The 10-yr US T bills is at 3.3%. We could see Fed Fund rates hitting 3.5% by 2H 2012. Inflation in the US could hit beyond 4% then. US stocks could start falling by 3Q 2012, but commodities could rage on until 4Q 2012 or even 1Q2013. We will have a worldwide recession by 2H 2013. It will be the perfect storm where residential properties fall together with stocks. The recession could be worse than the one we see in 2008 because this time, we could face stagflation. Inflation could remain stubbornly high because of high energy, food and material prices. Half a decade of quantiative easing could also rear its ugly head. With inflation falling to 2% in the EU and 3% in the US in 2013, both governments may have limited tools to fight the recession. Quantitative easing will be out of question. There will be limited room to cut rates due to the high inflation. Welcome to the age of stagflation.
Till then, enjoy the ride.
Sunday 20 March 2011
Time to Load Up on Commodities, Don't Count the Stock Market Out, There's Value Yet
Inflation has hit the Euro Zone. Its core inflation hit 2.4% last month and the ECB has announced they are going to hike rate. The only big western nation that hasn't hiked rate is the US. But it will happen sooner than expected. Japan's earthquake and Tsunami will cause the country to turn to refined oil products and thermal coal to run its generators. Oil products, and crude oil will rise. Food prices will rise higher because Japan's food supply is contaminated. The rebuilding of north Eastern Japan will cause copper, iron ore prices to sky rocket. There is no hiding place.
The world must wean itself from fossil fuels if it wants economic growth without the crippling effects of inflation. There are no viable alternatives except nuclear option but the world is now thinking twice after Fukushima. How? We are packed in a corner with no way out. Either we face the deadly effects of global warming or live with the threat of nuclear fallout. We are on a brink of a great human disaster that can wipe out millions of people in this decade. I shudder... I pray this can be avoided. My passport is ready and my family and I will run first.
Published March 19, 2011
Don't count the stock market out, there's value yet
There are blue chips with expected dividend yield of over 6%; that beats keeping money in the bank
By TEH HOOI LING
SENIOR CORRESPONDENT
WE ARE in very uncertain times now and the catalogue of issues is endless: the seemingly intractable sovereign debt problems and persistent high unemployment in the developed world; the financial aftermath of the devastation in Japan following the earthquake last week; rising food and commodities prices which are exacting a big toll on the lowest strata of the economy; widening income disparity, the gradual shift of economic centre of gravity from the West to the East; rapid urbanisation of hundreds of millions of people; climate change; the fast depletion of resources from this earth. The list goes on.
No one can tell for sure how things will pan out. There could be a lot of unknown unknowns just lurking around the corner. History may not provide much of a reference if we are moving into totally uncharted waters. Still, we shouldn't be paralysed into inaction just because there are many uncertainties out there. For one thing, inaction which involves the clinging on to dear cash may turn out to be a losing proposition given that the worth of cash gets eroded by inflation over time.
Yes, what has happened in the past may be totally irrelevant going forward. But there will always be certain things that continue to make sense. For example, if a company is able to create value and make profit, and there is a chance to participate in its business at a reasonably low cost, a rational person would and should consider doing it.
The next question then is, what is a reasonably low cost? For me, it would be one that would give me a significantly higher return than other available alternatives at the moment.
The price would also have to be low enough to give me some assurance that it does not have much room to go down further, and cause permanent loss to my capital. In this respect, history, for better or worse, provides us with some benchmarks to look at. Robert Shiller, professor of economics at Yale University, popularised a market valuation metric where the current market price is measured against the average earnings per share (EPS) of the last 10 years. This will even out the cyclicality of earnings.
Today, the ERP is at 7% - a reasonably good level from which the market had chalked up decent gains, going by the past. We were at similar levels back in July 2009, February 2008, December 2005 and January 2003.
I tested that out on the Straits Times Index, the one calculated by Datastream, which goes way back to 1973. In Chart 1, you can see that from 1983 till now, the STI trades between 10 times and about 35 times of its average past 10 years' EPS. We are now at 17.7 times earnings, or about one standard deviation below the average multiple that the index traded at in the past 40 years or so. Hence, at current levels, stocks can't be said to be expensive, but neither are they a screaming buy. We are now at levels last seen in mid-2003, early 1999, late 1997, and early 1991.
How about the equity risk premium (ERP)? This is a measure of the expected return of an equity investor over and above the risk free rate. I use the earnings yield (the inverse of price-earnings ratio) minus the one-year interbank rate as a proxy for ERP. The higher the ERP, the higher the supposed return for holding equities.
In Chart 2, you can see that the ERP shot through the roof - it went as high as 19 per cent - in March 2009, just before the capitulation of the market following the global financial crisis. That's the highest the measure has been in its 24-year history, and that also proved to be one of the biggest buying opportunities of all time.
Today, the ERP is at 7 per cent. Again, that's a reasonably good level from which the market had tended to chalk up decent gains, going by patterns in the past. We were at similar levels back in July 2009, February 2008, December 2005 and January 2003.
And finally, the dividend yields of a number of Singapore stocks are still expected to be juicy based on analysts' expectations. I downloaded the data from Bloomberg and categorised the stocks based on their market capitalisations.
Among big cap bluechip stocks, we can find more than 10 which are expected to deliver more than 6 per cent in dividend yield. That beats keeping money in the bank, and it outpaced the expected inflation rate for this year as well. Among the stocks are StarHub, Mapletree Logistics and Ascott Residence. There are also many smaller companies which are paying much more generous dividends. The caveat is of course the sustainability of their payouts.
Finally, just a reminder that the list we provided is based on the screening from Bloomberg. Investors are advised to do their own analysis on the individual companies before deciding to pick up any of the stocks.
The writer is a CFA charterholder
The world must wean itself from fossil fuels if it wants economic growth without the crippling effects of inflation. There are no viable alternatives except nuclear option but the world is now thinking twice after Fukushima. How? We are packed in a corner with no way out. Either we face the deadly effects of global warming or live with the threat of nuclear fallout. We are on a brink of a great human disaster that can wipe out millions of people in this decade. I shudder... I pray this can be avoided. My passport is ready and my family and I will run first.
Published March 19, 2011
Don't count the stock market out, there's value yet
There are blue chips with expected dividend yield of over 6%; that beats keeping money in the bank
By TEH HOOI LING
SENIOR CORRESPONDENT
WE ARE in very uncertain times now and the catalogue of issues is endless: the seemingly intractable sovereign debt problems and persistent high unemployment in the developed world; the financial aftermath of the devastation in Japan following the earthquake last week; rising food and commodities prices which are exacting a big toll on the lowest strata of the economy; widening income disparity, the gradual shift of economic centre of gravity from the West to the East; rapid urbanisation of hundreds of millions of people; climate change; the fast depletion of resources from this earth. The list goes on.
No one can tell for sure how things will pan out. There could be a lot of unknown unknowns just lurking around the corner. History may not provide much of a reference if we are moving into totally uncharted waters. Still, we shouldn't be paralysed into inaction just because there are many uncertainties out there. For one thing, inaction which involves the clinging on to dear cash may turn out to be a losing proposition given that the worth of cash gets eroded by inflation over time.
Yes, what has happened in the past may be totally irrelevant going forward. But there will always be certain things that continue to make sense. For example, if a company is able to create value and make profit, and there is a chance to participate in its business at a reasonably low cost, a rational person would and should consider doing it.
The next question then is, what is a reasonably low cost? For me, it would be one that would give me a significantly higher return than other available alternatives at the moment.
The price would also have to be low enough to give me some assurance that it does not have much room to go down further, and cause permanent loss to my capital. In this respect, history, for better or worse, provides us with some benchmarks to look at. Robert Shiller, professor of economics at Yale University, popularised a market valuation metric where the current market price is measured against the average earnings per share (EPS) of the last 10 years. This will even out the cyclicality of earnings.
Today, the ERP is at 7% - a reasonably good level from which the market had chalked up decent gains, going by the past. We were at similar levels back in July 2009, February 2008, December 2005 and January 2003.
I tested that out on the Straits Times Index, the one calculated by Datastream, which goes way back to 1973. In Chart 1, you can see that from 1983 till now, the STI trades between 10 times and about 35 times of its average past 10 years' EPS. We are now at 17.7 times earnings, or about one standard deviation below the average multiple that the index traded at in the past 40 years or so. Hence, at current levels, stocks can't be said to be expensive, but neither are they a screaming buy. We are now at levels last seen in mid-2003, early 1999, late 1997, and early 1991.
How about the equity risk premium (ERP)? This is a measure of the expected return of an equity investor over and above the risk free rate. I use the earnings yield (the inverse of price-earnings ratio) minus the one-year interbank rate as a proxy for ERP. The higher the ERP, the higher the supposed return for holding equities.
In Chart 2, you can see that the ERP shot through the roof - it went as high as 19 per cent - in March 2009, just before the capitulation of the market following the global financial crisis. That's the highest the measure has been in its 24-year history, and that also proved to be one of the biggest buying opportunities of all time.
Today, the ERP is at 7 per cent. Again, that's a reasonably good level from which the market had tended to chalk up decent gains, going by patterns in the past. We were at similar levels back in July 2009, February 2008, December 2005 and January 2003.
And finally, the dividend yields of a number of Singapore stocks are still expected to be juicy based on analysts' expectations. I downloaded the data from Bloomberg and categorised the stocks based on their market capitalisations.
Among big cap bluechip stocks, we can find more than 10 which are expected to deliver more than 6 per cent in dividend yield. That beats keeping money in the bank, and it outpaced the expected inflation rate for this year as well. Among the stocks are StarHub, Mapletree Logistics and Ascott Residence. There are also many smaller companies which are paying much more generous dividends. The caveat is of course the sustainability of their payouts.
Finally, just a reminder that the list we provided is based on the screening from Bloomberg. Investors are advised to do their own analysis on the individual companies before deciding to pick up any of the stocks.
The writer is a CFA charterholder
Buy Japan: Shifting Fund Flows Are LIke a Balancing Act
The Japanese stock market fell by 20% in the last 2 weeks. I went in to buy several ETF CFDs, the Schroder Japan Equity Fund and call options. Now I am up by 8%. I put in about SGD 20k, but because I leverage 5x, my exposure is around SGD100k. The rebound has already rewarded me with 8k, with an ROE of 40% in 3 days. Very good reward.The Japanese disaster was truly a heartache for all of us. My prayers are with them and I will contribute 10% of my returns to a charity of my choice, perhaps connected to helping the Japanese.
I don't think the bull cycle is over. I always thought this was a mid cycle correction and the disaster in Japan and the unrest in the Middle East triggered the sell down.
MONEY MATTERS
Shifting fund flows are like a balancing act
Flows from emerging to developed markets present good opportunity for long-term investors
By HAREN SHAH
THE tide of fund flows into the emerging markets is receding. The reverse is happening to the benefit of developed markets, which have experienced strong growth in recent months. But does this reversal of fortunes signal a long-term trend, an uncanny aberration or a necessary market correction?
We believe the recent fund flows out of the EMs and into the DMs are more a balancing act rather than a structural shift away from EMs. Inflationary pressures, rising interest rates and political uncertainties in the EM underpin the flowback.
For investors with a medium to long-term view, the flowback may represent good buying opportunities in select equity markets such as Hong Kong, South Korea and Taiwan in Asia. Brazil and Russia, too, particularly for commodity plays.
Fund flows
It was just last year that emerging market (EM) governments were lamenting the prospect of large fund flows into their economies and how these would distort their economies and affect their financial markets. It is only the first quarter of 2011, and how it all has changed. Rather than receiving inflows, EMs have experienced outflows, and most of the funds are reverting to developed markets (DM) like Japan, the US and parts of Europe.
This begs the question, is this the start of a new trend or is this just a normal adjustment to the vagaries of fund flows looking for value and safety?
In the last couple of years, EMs have been attracting inflows mainly due to the more robust growth prospects of these economies relative to DMs. The financial crisis further exaggerated the flows as interest rates remained low and investment prospects were not as attractive in the developed world.
Between 2008 and 2010, EMs saw significant inflows to the tune of US$130 billion while DMs saw outflows of US$350 billion. Moreover, with QE2 announced by the US Federal Reserve late last year, the expectation was that these funds would continue to flow into EMs as their growth prospects remained stronger, interest rates were heading higher and currencies were appreciating.
Inflationary pressures
A primary cause of the reversal in fund flows has been concerns about the build-up of inflationary pressures in the emerging economies. Many of them, especially in Asia and Latin America, have seen inflation surge due to strong growth and high commodity prices, especially food and energy.
This has resulted in interest rate hikes and property curbs to rein in these sharp price appreciations. Recent political tensions and events in Northern Africa and the Middle East have also not helped as risk aversion has further fuelled outflows from EMs. The risk premium on EM assets has risen as investors are concerned that the political problems could spread and affect growth prospects and ultimately corporate earnings. Oil price spikes and food inflation remain key concerns as these could lead to more unrest in EM countries.
EM equity markets attractive
EM equity markets have underperformed DM equity markets by about 10 per cent in this recent move over the past few months. Considering that EMs underperformed DMs by more than 31 per cent in their last period of underperformance in 2008, this raises the question of whether we could see such a magnitude of divergence this time around.
We suspect not, as the underlying fundamentals are currently much better. It should be noted that previous big pullbacks in EM equities occurred when global growth expectations were falling.
On the contrary, we are currently seeing global growth expectations being revised upward on the back of improving prospects in the US, Japan and core European countries.
Also, EM stocks are showing sharp improvements in earnings. So, from a valuations and 2011-12 earnings perspective, the recent underperformance and pullback in EM equities has increased their overall attractiveness.
Tighter monetary policies in Asia
Looking at Asia, the main concerns for investors have been inflation and the prospect of tighter monetary policies. So far, we have seen policy tightening across most Asian countries as governments try to cool price pressures. The fear here is that policymakers will misstep and cause growth to slow dramatically, thereby affecting corporate earnings.
This is of most concern in the region's two largest economies, China and India. Inflation in China, especially property prices, has resulted in the implementation of three policy rate hikes and significant banking reserve tightening measures. With signs that overall inflation is on an uptrend, the government appears very worried about social unrest.
Similarly, with inflation close to 10 per cent in India, there have been six policy rate hikes, with potentially more on the way. Such moves have made global investors nervous and prompted them to reverse their investment flows out of EM economies back to DM economies, where growth prospects and earnings outlooks are beginning to brighten. Nonetheless, we believe this is merely a short-term shift and that Asian stocks are likely to rerate once some of the uncertainties subside.
Against this backdrop, we believe the recent fund flow movements out of EMs and into DMs represent more of a rotation rather than a structural shift away from EMs. Macro concerns stemming from inflation, rising interest rates and political uncertainties will continue to resonate in EM economies.
But for investors who are taking a medium to longer-term view, this pullback may represent good buying opportunities in select markets such as Hong Kong, South Korea and Taiwan in Asia, while Brazil and Russia look like good prospects for the commodity play.
The writer is senior investment strategist, wealth management, Citi Asia Pacific
Disclaimer: Opinions expressed herein should be regarded solely as general market commentary, and may change without prior notice. Past performance is no guarantee of future results.
I don't think the bull cycle is over. I always thought this was a mid cycle correction and the disaster in Japan and the unrest in the Middle East triggered the sell down.
MONEY MATTERS
Shifting fund flows are like a balancing act
Flows from emerging to developed markets present good opportunity for long-term investors
By HAREN SHAH
THE tide of fund flows into the emerging markets is receding. The reverse is happening to the benefit of developed markets, which have experienced strong growth in recent months. But does this reversal of fortunes signal a long-term trend, an uncanny aberration or a necessary market correction?
We believe the recent fund flows out of the EMs and into the DMs are more a balancing act rather than a structural shift away from EMs. Inflationary pressures, rising interest rates and political uncertainties in the EM underpin the flowback.
For investors with a medium to long-term view, the flowback may represent good buying opportunities in select equity markets such as Hong Kong, South Korea and Taiwan in Asia. Brazil and Russia, too, particularly for commodity plays.
Fund flows
It was just last year that emerging market (EM) governments were lamenting the prospect of large fund flows into their economies and how these would distort their economies and affect their financial markets. It is only the first quarter of 2011, and how it all has changed. Rather than receiving inflows, EMs have experienced outflows, and most of the funds are reverting to developed markets (DM) like Japan, the US and parts of Europe.
This begs the question, is this the start of a new trend or is this just a normal adjustment to the vagaries of fund flows looking for value and safety?
In the last couple of years, EMs have been attracting inflows mainly due to the more robust growth prospects of these economies relative to DMs. The financial crisis further exaggerated the flows as interest rates remained low and investment prospects were not as attractive in the developed world.
Between 2008 and 2010, EMs saw significant inflows to the tune of US$130 billion while DMs saw outflows of US$350 billion. Moreover, with QE2 announced by the US Federal Reserve late last year, the expectation was that these funds would continue to flow into EMs as their growth prospects remained stronger, interest rates were heading higher and currencies were appreciating.
Inflationary pressures
A primary cause of the reversal in fund flows has been concerns about the build-up of inflationary pressures in the emerging economies. Many of them, especially in Asia and Latin America, have seen inflation surge due to strong growth and high commodity prices, especially food and energy.
This has resulted in interest rate hikes and property curbs to rein in these sharp price appreciations. Recent political tensions and events in Northern Africa and the Middle East have also not helped as risk aversion has further fuelled outflows from EMs. The risk premium on EM assets has risen as investors are concerned that the political problems could spread and affect growth prospects and ultimately corporate earnings. Oil price spikes and food inflation remain key concerns as these could lead to more unrest in EM countries.
EM equity markets attractive
EM equity markets have underperformed DM equity markets by about 10 per cent in this recent move over the past few months. Considering that EMs underperformed DMs by more than 31 per cent in their last period of underperformance in 2008, this raises the question of whether we could see such a magnitude of divergence this time around.
We suspect not, as the underlying fundamentals are currently much better. It should be noted that previous big pullbacks in EM equities occurred when global growth expectations were falling.
On the contrary, we are currently seeing global growth expectations being revised upward on the back of improving prospects in the US, Japan and core European countries.
Also, EM stocks are showing sharp improvements in earnings. So, from a valuations and 2011-12 earnings perspective, the recent underperformance and pullback in EM equities has increased their overall attractiveness.
Tighter monetary policies in Asia
Looking at Asia, the main concerns for investors have been inflation and the prospect of tighter monetary policies. So far, we have seen policy tightening across most Asian countries as governments try to cool price pressures. The fear here is that policymakers will misstep and cause growth to slow dramatically, thereby affecting corporate earnings.
This is of most concern in the region's two largest economies, China and India. Inflation in China, especially property prices, has resulted in the implementation of three policy rate hikes and significant banking reserve tightening measures. With signs that overall inflation is on an uptrend, the government appears very worried about social unrest.
Similarly, with inflation close to 10 per cent in India, there have been six policy rate hikes, with potentially more on the way. Such moves have made global investors nervous and prompted them to reverse their investment flows out of EM economies back to DM economies, where growth prospects and earnings outlooks are beginning to brighten. Nonetheless, we believe this is merely a short-term shift and that Asian stocks are likely to rerate once some of the uncertainties subside.
Against this backdrop, we believe the recent fund flow movements out of EMs and into DMs represent more of a rotation rather than a structural shift away from EMs. Macro concerns stemming from inflation, rising interest rates and political uncertainties will continue to resonate in EM economies.
But for investors who are taking a medium to longer-term view, this pullback may represent good buying opportunities in select markets such as Hong Kong, South Korea and Taiwan in Asia, while Brazil and Russia look like good prospects for the commodity play.
The writer is senior investment strategist, wealth management, Citi Asia Pacific
Disclaimer: Opinions expressed herein should be regarded solely as general market commentary, and may change without prior notice. Past performance is no guarantee of future results.
Sunday 13 March 2011
Do You Think It's Over?
I have not written much about the markets for some time. I am too lazy to write. Since a month back, we've seen unrest in the Middle East, the overthrow of the Egyptian president, the massive earthquake and tsunami in Sendai... To me, all these are noise.
I think we are about to enter the third and final stage of the bull rally, the one where inflation in the US finally hits above 2.5%. It should happen by June 2011 and interest rates will rise swiftly. How long have we got thereafter? Perhaps a year more. If we're lucky 2 more years. Yes, it's hard to believe that despite all the turmoil, I think the bull rally will last. But I believe that's how the cookie will crumble.
By 2012 / 13, the US should hit a stagflationary stage, where GDP growth barely surpasses 2% and inflation hits 3% and above. Stocks will flounder. Residential property in Singapore will correct at least 30% but the government will make some emergency measures to prop it up.
Time to hedge your portfolios, buy some commodities.
I think we are about to enter the third and final stage of the bull rally, the one where inflation in the US finally hits above 2.5%. It should happen by June 2011 and interest rates will rise swiftly. How long have we got thereafter? Perhaps a year more. If we're lucky 2 more years. Yes, it's hard to believe that despite all the turmoil, I think the bull rally will last. But I believe that's how the cookie will crumble.
By 2012 / 13, the US should hit a stagflationary stage, where GDP growth barely surpasses 2% and inflation hits 3% and above. Stocks will flounder. Residential property in Singapore will correct at least 30% but the government will make some emergency measures to prop it up.
Time to hedge your portfolios, buy some commodities.
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