Broadgate: Weekly Briefing 18/2
18 February 2013
The Equity Bull Market
Global equity prices this year have added to their late 2012 gains, with many stock markets hitting new cyclical highs.
Some market participants are now claiming that complacency has set in and, thus, stocks are primed for a tumble. While equities are becoming overbought on a short-term basis, the Macro Research Board Risk Appetite Indicator is still positive on a 6-12 month horizon, and expects stock bulls to be well rewarded, while bond bulls face a disappointing year ahead.
Retail investment flows and sentiment gauges have a good record of flagging equity market turning points, as extremes occur just as the tide is set to turn. To this end, a surge of inflows to stock mutual funds in the US during January has raised the fear that the bull run is nearing an end.
Over the past year, there have been near-record outflows from equity funds, while bond funds have received near record inflows over the same period. While there has clearly been a lift in sentiment recently, one month does not make a trend and it is premature to claim investors are now excessively optimistic and thus “fully invested”. Rather, the Macro Research Board Risk Appetite Indicator has risen only to neutral levels, implying that there are no technical roadblocks to higher equity prices.
The equity advance should be choppier than in recent months with markets becoming overbought, but valuations remain compelling (and still very negative for government bonds). Moreover, the fundamental backdrop is slowly improving, with US and emerging economies regaining momentum, and global manufacturing surveys recovering to positive territory in January.
Monetary policies around the world will remain hyper-accommodative until the global economic expansion is decisively back on track. Therefore, there is a compulsive argument that investors should consider staying cyclically positive on stocks, especially relative to bonds.
Asian stocks rose after the Bank of Japan maintained its asset-purchasing programme before its governor steps down next month. An unexpected contraction in Japan’s economy fuelled speculation policy makers will boost efforts to end deflation.
The MSCI Asia Pacific Index climbed 0.3 percent to 133.64 on Wednesday in Tokyo. About four shares advanced for each three that fell. Hong Kong’s market reopened on Thursday while China, Taiwan and Vietnam remain shut for the Lunar New Year.
“Once the new governor takes over, we’ll see an acceleration of the pace of monetary easing,” said Shane Oliver, Sydney-based head of strategy at AMP Capital Investors Ltd. “Valuations remain reasonable and monetary policy will remain accommodative. We’re starting to transition into a phase where global growth picks up and that transfers through to earnings.”
Bank of Japan Governor Masaaki Shirakawa and his colleagues left monetary policy unchanged, while raising their assessment for the economy. Shirakawa and his two deputies step down on 19 March.
EU Transaction Tax
The European Union will propose a far-reaching tax on financial transactions which could be collected worldwide as soon as 1 January next year by the 11 nations that have so far signed up to participate.
The plan by the EU in Brussels, to be outlined shortly, invokes “residence” and “issuance” ties to firms in participating countries, in a bid to prevent traders from escaping the levy by trading outside the tax’s zone. The plan says that to escape the proposed tax entirely, firms in other nations would have to entirely cease financial-services business with the 11 EU nations involved.
The proposal marks a new stage in the EU’s efforts to raise revenue from the financial sector and curb what it sees as a “patchwork” of local levies. Like a prior, failed proposal for all 27 EU nations, Thursday’s plan would set a rate of 0.1% for stock and bond trades and 0.01% on derivatives trades.
The EU estimates the arrangement could raise EUR 30 billion (USD 40 billion) to EUR 35 billion per year. It would need approval by the 11 participants to proceed. All EU nations can sit in on the talks and have the option to join.
The proposals would exclude certain types of trading from the scope of the tax: day-to-day transactions by individuals and non-financial firms; primary offerings of stocks and bonds; and trades with central banks, the European Stability Mechanism and other official institutions. According to EU documents, it also would exclude trades in units of collective investment funds along with certain restructuring operations.
Repurchase agreements would be included, though they would be taxed differently from trades with an outright buyer and seller.
The plan also would include pension funds. The EU intends to argue that a well-designed tax could make pension funds safer by encouraging them to make untaxed purchases on the primary market and hold securities to maturity.
When EU ministers last month allowed the 11 willing nations to proceed with transaction-tax negotiations, the spillover effects on pension funds were a concern.
The Netherlands will wait before deciding whether to sign up, said Dutch Finance Minister Jeroen Dijsselbloem, who leads the group of euro-area finance ministers. “One of the criteria for us is our pension funds,” he said. “It’s very important that these pension funds are not harmed by a new tax.”
A weighted majority of EU finance ministers backed the measure in a Brussels meeting last month. The U.K., home to the Europe’s largest financial centre, abstained along with Malta, the Czech Republic and Luxembourg. The Confederation of British Industry said yesterday that the tax plan’s extended scope will require extensive review.
“The Commission’s FTT proposals are now significantly different from its initial plans, so the impact on growth and jobs must be assessed before proceeding,” Matthew Fell, CBI director for competitive markets, said in a statement.
While the U.S. will study the proposal, it doesn’t support the European financial transactions tax, according to a U.S. Treasury Department spokeswoman. The tax would harm U.S. investors who bought affected securities, a concern that Treasury officials have raised with their European counterparts, the spokeswoman said.
Demand for Gold
Gold demand rose 3.8 percent in the fourth quarter as Indian purchases jumped, narrowing the first drop in annual usage in three years, the World Gold Council said. India remained last year’s biggest buyer, ahead of China.
Global demand gained to 1,195.9 metric tons in the quarter, the most ever for an October-to-December period, from 1,151.7 tons a year earlier, as Indian consumption surged 41 percent, the London-based industry group said today in a report. Jewellery usage rose 11 percent to the highest since the first quarter of 2011, leaving total demand for 2012 down 3.9 percent at 4,405.5 tons. That’s still 15 percent more than the five-year average.
Purchases in India, which the council had expected to be replaced by China as the top buyer, rose toward year-end on seasonal buying and expectations of higher import duties, it said. While holdings in gold-backed exchange-traded products reached a record in December as prices posted a 12th straight annual gain, the metal failed to set an all-time high for the first time since 2007. China’s economic growth accelerated for the first time in two years in the fourth quarter.
“The real driver was the rise in jewellery, and within that you saw India being key” in the fourth quarter, Marcus Grubb, managing director of investment research at the council, said. “China’s economy is now re-accelerating quite strongly into January and February. Both Indian and Chinese demand will be higher in 2013.”
Gold for immediate delivery traded at USD 1,644.65 an ounce in London on Wednesday, down 1.8 percent this year. Prices averaged a record USD 1,717.86 in the fourth quarter, up 2.1 percent from a year earlier and 3.9 percent higher than the third quarter. They averaged an all-time high USD 1,669 in 2012, boosting the value of last year’s demand to USD 236.4 billion, the most ever.
Spotlight on Current Fund Manager Sentiment
Confidence in a strong global economic outlook has consolidated while investors have indicated that they see support from current equity valuations after the recent rally, according to the Bank of America Merrill Lynch Fund Manager Survey for February.
A net 59 percent of investors believe the global economy will strengthen in the year ahead, in line with the reading in January, which marked four consecutive months of rising sentiment. The outlook for profits has improved with a net 39 percent of the panel saying that profits worldwide will improve in the coming 12 months, up from a net 29 percent in January. The desire for higher capital expenditure is strong with 48 percent of investors saying that capex is the best use of corporate cash – the highest reading since April 2011.
Investors have indicated that they continue to perceive value in equities in light of strong market performances of early 2013. A net 13 percent of global investors still say that equities are under-valued. At the same time, a net 82 percent say bonds are overvalued, the second-highest level recorded by the survey with the highest coming at the peak of the European sovereign bond crisis in 2012.
Risk appetite has also remained steady month-on-month. Average cash balances in portfolios remain at 3.8 percent, though the net percentage of investors overweight cash has fallen to 2 percent this month from 8 percent in January, the lowest reading since February 2011.
“The continued high level of optimism is a concern and markets may be vulnerable to bad news, but valuation support suggests any correction should be short and shallow, and our core ‘Great Rotation’ theme remains in play,” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research. “Investors are striking a balance between the optimism over growth and caution over investment decisions. Investors have so far resisted taking an exuberant stance,” said John Bilton, European investment strategist.
Allocations towards equities have held at the highs reached in January. A net 51 percent of asset allocators remain overweight global equities. Within equities, sectoral allocations highlight a bias towards a measured easing of risk appetite with a shift towards defensive assets.
Pharmaceuticals, a traditional defensive sector, has returned to the number one sectoral pick for global investors, having been third in the pecking order a month ago. The proportion of investors overweight the sector rose to 27 percent from 11 percent in January.
Cyclical sectors become less popular. The biggest month-on-month faller was Technology, which saw a negative 12 percentage point swing in the number of investors overweight the sector. Materials also suffered a double-digit fall in the percentage of overweights. The number of respondents overweight Technology, Industrials and Energy also fell.
Japanese equities continue to benefit from a positive shift in sentiment by global investors. A net 7 percent of asset allocators say they are overweight Japanese equities this month, up from a net 3 percent in February. In December, a net 20 percent were underweight Japanese equities.
Local sentiment and risk appetite appears strong. A net 29 percent of Japanese investors responding to the Regional Fund Manager Survey say they are underweight cash, up from a net 5 percent one month ago. Automotives, Technology and Banks are the three most popular sectors domestically.
Global investors have indicated that their positive view towards Japan will continue. A net 21 percent of the panel says that the outlook for corporate profits in Japan is more favorable than for anywhere else, up from a net 4 percent in January. Accordingly, a net 9 percent says that Japan is the region they would most like to overweight. Two months ago, a net 17 percent said Japan was the region they most wanted to underweight.
This positive outlook comes at a time when investors see the yen as weakening, despite the fact that the currency is close to fair value based on the IMF’s definition of currency valuation. Four out of ten respondents to the global survey say that USD/JPY rising to 100 is likely to happen before a U.S. debt downgrade, a Spanish bailout or gold breaking through USD 2,000 per ounce.
An overall total of 251 panelists with USD 691 billion of assets under management participated in the survey from 1 February to 7 February.
The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.
Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.