Bob's World: Investing Liquidity
A few thgts 1st:
1 - UK Rating Action - The research grp put out a cmmt last week post the S&P shift on the UK. The key takeaways from my side: A) The UK WILL have a multi-yr austerity government soon, the only question is when. We WILL see higher taxes, far less public spending, higher unemployment etc. The UK has no more fiscal room left, so from here on in its ALL abt the politics and policy is ALL abt whether thru BoE QE we have much more appetite to further debase GBP. And B) I really suspect the UK action is also a case of S&P using the UK as a guinea pig (in terms of assessing mrkt reaction) ahead of something they may do on the US, in say 3 to 6 mths time. The US has a tad more room than the UK fiscally, but ultimately the issues (austerity vs currency debasement) are the same.
2 - Investing in risk only on the basis of 'liquidity' led to the crash of 01/02/03 (where we blew up corporate balance sheets with debt), as well as the current crash of 07/08/09 (where we blew up consumer balance sheets with debt), to which the pavlovian response has been to blow up government balance sheets with debt. JUST 'excess' liquidity is a terrible reason to invest in risk on any meaningful investment horizon - 'trading' is a different matter. But in both these contexts I hear a lot of the same tired out arguments. Investing just because retail are buying has never been a strategy I would want to follow. And as for trading, YET AGAIN I am hearing a lot of the 'I'm just playing momentum, and will be smart enough to get out in time ahead of the turn' trading strategy. Have the events of the last few years taught us NOTHING?!?!
3 - To support the pure liquidity led risk rally - to give it legs, to make it sustainable - we need to see real and sustained improvements in private sector demand, in earnings and in incomes. Kevin and I see no evidence of this, if anything we see more evidence of the opposite. It is also now clear that we are either at or close to the limits of fiscal 'support' so it is uncertain how much more debt even the public sectors can credibly get away with. At the same time, it is clear that at the moment the only 'solution' policymakers in Anglo-Saxon can come up with is more of the same that got us into the debacle we are faced with, namely the reflationist policy of PRINT/BORROW/SPEND/BUY MORE RUBBISH WE DON'T NEED/PUSH THE PROBLEMS INTO 'TOMORROW' & PRAY IT GETS BETTER - its all abt avoiding taking the adjustment/the hit. As such, all this really means to me is that if the WEAK H2 09 scenario does play out as we having been saying all year, then we SHUD expect a quantum increase in the scale/levels of QE the FED and BoE may be forced to undertake, as this will be the only way, absent a real and sustained pick up in the private sector (which we CAN'T see at all) to create nominal growth.
4 - The risk here is that we are creating/storing up huge tail risks in the form of significant FX gap risks (esp. re the USD/GBP), and/or significant Rates gap risks (esp. re USTs and Gilts). Since early 2007 the Credit mrkt has been the driver/lead indicator for markets. As the policy response has been to load up all the risks & debt onto public sector, going forward THE LEAD DRIVERS WILL BE FX & RATES MARKETS, in terms of levels, direction and volatility, and NOT the Credit or indeed Equity markets. IN OTHER WORDS, just focusing on what S&P and/or the Crossover index is doing is NOT going to be enough.
5 - So, if I look at all of this together, all I can see ahead are higher VOLS in both markets and the real economies of the world, a higher risk free rate, higher hurdle rates to investment, and more selectivity around capital allocation and investment.....this means Risk Premia MUST be higher....in this context do NOT focus on Q4 08 comps - this is utterly bogus. DO the comps with 04/05/06/07 - hey presto, you get a much uglier picture for where we are at and where we are going. Higher risk premia means LOWER PEs.....combined with profit outlook which is basically flat on 08 for 09 and 2010 at least, this means STOCKS ARE TOO HIGH.
Turning naturally to markets at this juncture:
1 - The min-May turn I talked abt earlier this mth is happening. I expect it to last another fortnight or so, looking for stocks to be another 5 to 10% lower (S&P down at 800/780), XO up above 800/into the high 800s, and I am looking for the sell-off in govvies to abate and turnaround, giving us lower govvie yields - the off the run 10yr BUND more than hit my 3.5% target, and it shud rally back into the 3.30s at least.
2 - As before however, the mini-May sell-off is not one to chase too hard, as I see over June and into July another move higher in stks, tighter in credit, higher in govvie yields, all 'vaguely' supported by data and definitely spun and cheer-led to the max. It is this move better in risk assets into July, when I expect to see the S&P at the highs of earlier this yr, which will blow out all residual shorts/bears, and suck in all the lagging bulls. This is the move which takes positioning, sentiment, expectations and valuations to 'bubble' territory again. AT THIS POINT, and assuming the data tells us nothing substantive and new re private sector demand, private sector earnings and income grwth, I will be looking to get UBER bearish for H2 09.
3 - For H2 09, I am BEARISH equities (looking for a 30/40% sell-off from coming June/July 'highs') --> S&P target - 950 in July, 550 in the back-end of 09. Credit will RELATIVELY outperform equity, but if stks are off 30/40% in H2 09, Credit on an absolute basis WILL be wider and, as the risk of a seizure in dealer 'bids'/market liquidity dry-up is likely going to be very high, we could see some outsized spread gaps, driven more by 'technicals' rather than fundamentals (a partial unwind of the biggest concensus trade of the moment - that IG corp. bonds are the best 'long' around). Within Credit I see HY suffering far more than IG in H2 09, as HY will suffer from weaker technicals AND weaker fundamentals, but as I say, gaps moves wider in IG are entirely possible. I am looking for S10 XO up at 1500 (adding back Bassell) and S11 XO up at 1250. I am looking for IG12 in the US well above 200. IG, incl. big bank senior will outperform HY, HY will see new wides, IG will maybe revisit the wides on the corp side but overall we may not see new wides.
Into July I expect to see govvie yields back up at current highs, perhaps even higher, esp in the US/UK - 10yr USTs up at 3.75??? Overall, I stick with the theme that the ECB will be the most independent and least likely to debase, with the US at the other end. Thus for H2 and beyond, buying 10yr Bunds at 3.5%/3.75% (!) will I think be very rewarding, as I see Bunds doing very well in the expected H2 risk sell-off (2-handle on yields?). Overall I favour EURO (esp. German) govvies over USTs/Gilts. I think the Anglo-Saxon media enjoying bashing Europe. From a long-term growth angle this might have merit (although I am dubious even on this, esp. on a 'real' basis as opposed to NOMINAL) but what is clear is that we shud all trust the ECB to protect the value of our cash far more than the Fed. I think the 10yr Bund/UST relationship can go from +10/15bps, too perhaps MINUS 50/MINUS 100bps (Bunds thru USTs) over the next 3 qtrs. In FX, my call is for much higher VOLS over H2 09, and overall I look for a much weaker USD. On a multi-yr basis, Gold an CRUDE remain key back-book 'longs'.
hat tip Credit Analyst Sphere: Related Content
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