Global Economics : Priced for Perfection - Joachim Fels
Our latest estimate of fundamental fair value for 10-year US Treasury yields stands at 5.0%, based on our MSFAYRE model, still some 35 basis points above current 10-year yield levels. The model also tells us that the current 10-year yield of 4.65% is consistent with a fed funds rate of 4% and actual core inflation and inflation expectations a touch lower than they are now — in other words, bonds look to be currently priced for perfection.
We believe inflation expectations will respond to global pressures and dollar depreciation, pushing bond yields up. The Fed rate cut and a fall in actual and expected inflation have pulled our fair value estimate down by some 30 bp. Bond yields have risen some but should continue to rise further to their fair value of 5%. Why? Current economic conditions resemble a midcycle slowdown rather than a recession.
Our fair-value estimate suggests that Treasuries still look expensive, and we expect yields to rise towards their fair value in the next several quarters. Already, 10-year yields have priced in a fed funds rate of 4%, which would take the Fed to neutral according to estimates from our natural rate model. Being bullish on bonds at current levels then implies a hard landing for the US economy, with the Fed being forced to slash rates below neutral.
GEMS Equity Strategy : Multiple Expansion — Where Next? - Jonathan Garner
The next leg of the EM bull market will be driven largely by an expansion in multiples, we believe, in line with a rerating in global equities. For the most part in the rally since 2003, earnings growth has been a key driver of performance: On average, EPS growth has contributed 84% of the yearly price returns for the MSCI EM. We expect P/E expansion to assume a greater role in driving performance from here.
MSCI EM has already started to benefit from multiple expansion. China’s substantial re-rating has been a prime driver of the multiple expansion for the overall asset class. In the last 18 months, MSCI China’s trailing P/E increased by 125%. Russia, in contrast, has had the largest multiple contraction of the top eight markets. The multiple expansion of the MSCI EM as a whole in this period has been 16%. Countries that have the greatest potential for multiple expansion and that are overweighted in our country allocation model include Russia, Turkey, Hungary, Israel and Malaysia.
At the sector level, consumer discretionary, industrials and financials have re-rated the most this year. In contrast, EPS growth has been the primary driver of
performance in materials, energy and utilities. Those sectors which should benefit most from multiple expansion and which we continue to favour on a fundamental basis are energy and materials.
Historically, P/E expansion has been an important driver at this stage of the cycle. It should be all the more so in light of the recent reflationary actions by central banks. These are intended to boost credit availability, but the short-term effect will also be to raise the price of real assets. The liquidity increase should quickly be intermediated into financial assets perceived to offer defensive growth, such as Asian and EM equities and oil, mining and industrial stocks. These measures add fuel to an EM bull market that was structurally intact, in our view.
Currencies : Demographic Trends and the Financial Markets - Stephen L. Jen
Demographic trends have important economic and financial implications. Without remedial action, global ageing in the developed world tends to raise the level of real interest rates, flatten the yield curves, benefit equities at the expense of bonds, and lower the value of the dollar.
Declining fertility and mortality rates. These two trends have been the primary factors behind the demographic trends (slow population growth and ageing structure) in much of the developed world. With the exception of China, much of the developing world is still enjoying a ‘demographic dividend,’ as their youth populations continue to grow rapidly.
Ageing exerts fiscal burdens that could lead to higher borrowing costs. The levels of real interest rates could be distorted by the lower potential growth rates, lower tax intake, and higher fiscal outlays associated with an ageing population.
Population ageing could also twist the shape of the yield curve. Notwithstanding the point above, decelerating potential growth rates imply higher short-term interest rates and lower long-term interest rates. Conversely, young and growing populations tend to bias the slope of the yield curve upward.
Ageing in the developed world may favour equities over bonds. While the popular notion among academics is that retirees prefer safe assets (i.e., bonds over equities), longevity risk could force retirees to take on more investment risk, as it already has in Japan. While pension funds still hold more bonds than equities, the share of the latter has been rising rapidly.
The US demographic trend is not friendly to the dollar.
Unless the US raises its savings rate at a faster pace than that of dis-saving by the rest of the world, a resurgence in its current-account deficit would not be good for the dollar.
US Economics - How Much More Work Does the Fed Have to Do? - Richard Berner
Fed officials left the door wide open to further easing last week but gave little guidance either on the economic outlook or on the path of monetary policy. Yet their intentions are clear: They will respond as needed to forestall downside risks to economic activity.
We expect another 50 bps of easing by early next year, with the Fed having “front-loaded” stimulus so far. Risks seem balanced around that baseline: The uncertain collateral damage from the housing downturn implies downside risks to rates. But the Fed could also do less, partly reflecting healing markets.
Expect weaker growth in earnings. Investors should continue to expect steeper yield curves, elevated volatility, a weak dollar, and weakening earnings growth. That backdrop may challenge equities. In my view, the jump in breakeven inflation so far signals the reflationary impact of policy on commodity prices, rather than a near-term inflation pickup.
Markets face three risks: Rising defaults may upset the benign outlook for both credit and equities. Inflation might fall faster than expected. Conversely, although the chance seems small, investors should consider that the economy could pick up sooner than expected.
