Appeasing the Bond Gods - New York Times
Needed: a new economic paradigm - Finacial Times
McDonald’s’ renminbi bonds - FT Lex
Is China Turning Japanese? - Foreign Policy
Watching China whizz by - Economist
Fidelity: retirement fund withdrawals rise in downturn - Reuters
China Swallows Obama Stimulus Meant for U.S. Economy: Andy Xie - Bloomberg
The impact of structural challenges to growth in advanced economies
- "The current debate between the proponents of austerity measures and those who favour additional stimulus is largely irrelevant because most of the socio-economic problems faced by advanced industrial countries are structural rather than cyclical."
- "Increased global competition, de-industrialization and a loss of control over innovation have undermined the ability of advanced industrial economies to sustain "normal" or historical levels of economic growth."
- "We believe a combination of structural long-term debt, deteriorating demographics, a backlash against immigration, spending cuts and stagnating incomes will lead to political gridlock and instability in developed economies, further undermining efforts to deal with slow economic growth."
- "The current global economic and political situation increases the likelihood of protectionism and trade tensions."
- "Economic power and geopolitical power are inextricably linked. We believe the decline in the geopolitical clout of advanced countries will carry negative implications for economic growth. Conversely, economic growth in developing countries will benefit from theirexpanding sphere of influence."
- "Investors have to be mindful of the increasing disconnect between economic growth and market performance at the national level."
- "Investment conclusions: Emerging markets will continue to outperform developed markets; U.S. markets will outperform most other advanced economies; Indian markets will outperform Chinese markets; Latin American investments are favoured over African ones; Commodities will outperform, as will investments geared to global mega-trends."
- "Increased global competition, de-industrialization and a loss of control over innovation have undermined the ability of advanced industrial economies to sustain "normal" or historical levels of economic growth."
- "We believe a combination of structural long-term debt, deteriorating demographics, a backlash against immigration, spending cuts and stagnating incomes will lead to political gridlock and instability in developed economies, further undermining efforts to deal with slow economic growth."
- "The current global economic and political situation increases the likelihood of protectionism and trade tensions."
- "Economic power and geopolitical power are inextricably linked. We believe the decline in the geopolitical clout of advanced countries will carry negative implications for economic growth. Conversely, economic growth in developing countries will benefit from theirexpanding sphere of influence."
- "Investors have to be mindful of the increasing disconnect between economic growth and market performance at the national level."
- "Investment conclusions: Emerging markets will continue to outperform developed markets; U.S. markets will outperform most other advanced economies; Indian markets will outperform Chinese markets; Latin American investments are favoured over African ones; Commodities will outperform, as will investments geared to global mega-trends."
NBC Global Investment Implications August 2010
The new “untouchables”
- Introducing our “musings on” series of reports "To move away from reactive writings on short-term issues, we’d like to introduce our new series of reports called “musings on”. In this series, we will write about long-term issues and try to think laterally. Some of our musings will have immediate market implications, but many, we suspect, may not. In our inaugural issue, we will contemplate on sectors that may face significant policy risks over the next few years as China undergoes structural reforms. We name them the new “untouchables” for effect and it doesn’t mean we won’t recommend them from time to time for other reasons."
- Untouchable No. 1 - monopolies "Many protected sectors are earning high ROEs and the government is going about changing that by capping salary growth, introducing private competition, limiting fee increases, and imposing additional taxes. Sectors vulnerable here include banks, energy and other resources, IPPs and telcos, by our assessment."
- Untouchable No. 2 – twin-high industries "I.e.,, high energy consuming and highly polluting industries e.g., steel, cement and metals. They benefited greatly from China’s investment-driven growth and have not paid their fair share of resources and environment costs. The government has rolled out a resources tax, cancelled tax rebates and concessionary tariffs, limited financing and shut down operations. It may also impose an environmental tax and a carbon tax, and raise environmental standards and charges."
- Untouchable No. 3 – property developers "Rightly or wrongly, many people in China are blaming developers for unaffordable houses and the government’s policies have turned increasingly hostile, e.g., cracking down on investment/speculative demand, expanding welfare housing programs, doubling land supply, collecting more taxes and restricting funding. Real estate taxes, property taxes and a capital gains tax may also be on the way."
- Untouchable No. 4 – public goods/services providers "The government has vowed to check their costs carefully to prevent excessive profits. This may undermine pricing power in a broad range of sectors, including fertilizer makers, drug makers, gas suppliers and distributors, IPPs, ports, airlines, airports and financial service providers."
- Untouchable No. 5 – the market "Untouchables No. 1-4 accounted for some 90% of market earnings in 2009."
- Untouchable No. 1 - monopolies "Many protected sectors are earning high ROEs and the government is going about changing that by capping salary growth, introducing private competition, limiting fee increases, and imposing additional taxes. Sectors vulnerable here include banks, energy and other resources, IPPs and telcos, by our assessment."
- Untouchable No. 2 – twin-high industries "I.e.,, high energy consuming and highly polluting industries e.g., steel, cement and metals. They benefited greatly from China’s investment-driven growth and have not paid their fair share of resources and environment costs. The government has rolled out a resources tax, cancelled tax rebates and concessionary tariffs, limited financing and shut down operations. It may also impose an environmental tax and a carbon tax, and raise environmental standards and charges."
- Untouchable No. 3 – property developers "Rightly or wrongly, many people in China are blaming developers for unaffordable houses and the government’s policies have turned increasingly hostile, e.g., cracking down on investment/speculative demand, expanding welfare housing programs, doubling land supply, collecting more taxes and restricting funding. Real estate taxes, property taxes and a capital gains tax may also be on the way."
- Untouchable No. 4 – public goods/services providers "The government has vowed to check their costs carefully to prevent excessive profits. This may undermine pricing power in a broad range of sectors, including fertilizer makers, drug makers, gas suppliers and distributors, IPPs, ports, airlines, airports and financial service providers."
- Untouchable No. 5 – the market "Untouchables No. 1-4 accounted for some 90% of market earnings in 2009."
Merrill Lynch China Musings on 20100813
Current Accounts and Demographics: The Road Ahead
- "Demographics are a major determinant of long-term current account trends."
- "Countries with a high proportion of ‘prime savers’ (those aged between 35 and 69) are more likely to run current account surpluses."
- "We show how demographic shifts have influenced global current account trends in the past 30 years, and what they imply for the next 20 years and beyond."
- "We have seen some rebalancing from the extremes in 2008 but the process is not yet complete."
- "Demographic shifts point to a cleaner split between emerging markets (mostly in surplus) and developed markets (mostly in deficit) in the future than is evident in the current, more complicated picture."
- "Emerging markets (EM) could continue to lend to developed markets (DM) on average."
- "Demographic forces may help keep global real rates low."
- "The development of EM capital markets may be important in offsetting demographic pressures for capital flows from the EM to the DM world."
- "Countries with a high proportion of ‘prime savers’ (those aged between 35 and 69) are more likely to run current account surpluses."
- "We show how demographic shifts have influenced global current account trends in the past 30 years, and what they imply for the next 20 years and beyond."
- "We have seen some rebalancing from the extremes in 2008 but the process is not yet complete."
- "Demographic shifts point to a cleaner split between emerging markets (mostly in surplus) and developed markets (mostly in deficit) in the future than is evident in the current, more complicated picture."
- "Emerging markets (EM) could continue to lend to developed markets (DM) on average."
- "Demographic forces may help keep global real rates low."
- "The development of EM capital markets may be important in offsetting demographic pressures for capital flows from the EM to the DM world."
GoldmanSachs Global Economics Paper 20100812
JPY intervention risk rising
- "The prospect of currency intervention to stem the appreciation of the yen has surfaced in the past week. In examining the market’s arguments, and comparing Japan’s situation with other major economies, we think the risk of intervention is real and rising."
- "Intervention is normally considered an option when markets can not be relied upon to adjust prices according to fundamentals. The main conundrum confronting the yen is that markets have favored the currency in both bad times and good.
• When the global recovery story was strong, the argument was that Japan stood to benefit from increased demand in Asia. This sounds logical except that, unlike other Asian stock markets, the Nikkei slides when the yen appreciates. The stronger yen not only hurts the operating profits at Japanese manufacturers, but are encouraging more companies to consider shifting production offshore.
• When risk aversion sets in, the yen becomes a safe haven currency. With 56% of Japan’s exports headed for Asia, does it make sense for the yen to appreciate while Asian currencies depreciate during this period? Probably not.
• A more plausible explanation for yen strength is the inability of the US economy to shake off post-crisis worries that it was headed towards a Japan-style deflation. Put simply, it is more reasonably a case of USD/JPY accompanying US bond yields lower. But the thing is, investors are seeking safety in US bonds, not Japanese bonds during periods of risk aversion."
- "In our view, markets should not be too quick to dismiss Japan’s complaint about the excessive strength in its yen. To be sure, in falling alongside US interest rates, a lower USD/JPY has dragged Japan’s equities lower. In reflecting US deflation risks, a stronger yen increases the odds of deepening Japan’s deflation woes. With China’s economy surpassing Japan this year, it does not make sense for the yen to bear the brunt of the currency adjustment on behalf of the yuan. In this regard, the yen has already delivered more than its fair share of appreciation since 2008."
- "Intervention is normally considered an option when markets can not be relied upon to adjust prices according to fundamentals. The main conundrum confronting the yen is that markets have favored the currency in both bad times and good.
• When the global recovery story was strong, the argument was that Japan stood to benefit from increased demand in Asia. This sounds logical except that, unlike other Asian stock markets, the Nikkei slides when the yen appreciates. The stronger yen not only hurts the operating profits at Japanese manufacturers, but are encouraging more companies to consider shifting production offshore.
• When risk aversion sets in, the yen becomes a safe haven currency. With 56% of Japan’s exports headed for Asia, does it make sense for the yen to appreciate while Asian currencies depreciate during this period? Probably not.
• A more plausible explanation for yen strength is the inability of the US economy to shake off post-crisis worries that it was headed towards a Japan-style deflation. Put simply, it is more reasonably a case of USD/JPY accompanying US bond yields lower. But the thing is, investors are seeking safety in US bonds, not Japanese bonds during periods of risk aversion."
- "In our view, markets should not be too quick to dismiss Japan’s complaint about the excessive strength in its yen. To be sure, in falling alongside US interest rates, a lower USD/JPY has dragged Japan’s equities lower. In reflecting US deflation risks, a stronger yen increases the odds of deepening Japan’s deflation woes. With China’s economy surpassing Japan this year, it does not make sense for the yen to bear the brunt of the currency adjustment on behalf of the yuan. In this regard, the yen has already delivered more than its fair share of appreciation since 2008."
DBS Asian Currency Research 20100818
BIS3: Some reprieve, with US banks OK on capital/liquidity
- BIS3: US Banks OK given softer standards, longer timeline "Proposed changes to BIS capital and liquidity standards have been a key source of uncertainty for Global Banks. Original proposals were vague but harsh, particularly as it related to liquidity requirements and timeline. BIS has now pushed back implementation dates for key items and softened some effects including deductions from Tier-1 Common, netting of derivatives, and liquidity requirements. We believe, US firms appear well armored in terms of capital/liquidity, with JPM strongest on relevant metrics. See tables on pg 3 for impact of key BIS3 capital/liquidity standards on US brokers/money center banks."
- JPM, GS, C well positioned for early capital deployment "Under our base case which assumes 2.5x Market Risk RWA (i.e. trading book) “inflation”, we believe the 4 big US dealers we cover appear sufficiently capitalized to meet BIS3, with JPM, GS, and C well positioned for early capital deployment in 2011, MS in 2012. Under BIS3 liquidity req. (Net Stable Funding ratio >100%), we est. C and JPM are already at or above 100% target while GS and MS are currently below it - though given NSF ratio isn’t mandated until 2018, they have ample time to reach target. Based on our analysis, C appears most liquid (105%), MS least (86%)."
- Scenario: Rising RWAs, Core Tier-1 target of 6,7,or 8% "Impact of RWA “inflation” on BIS3 CT-1 ratio (i.e. adjusted T-1 Common) hard to estimate as capital targets not set and US banks report RWA under BIS1. In our scenario analysis, we assume: Market Risk RWAs rise 2x-5x; counterparty credit risk RWAs rise 37.5%; a CT-1 target ratio of 6, 7, or 8%; no increased capital deployment; and roll forward RWA & earnings to 2012E. Results show JPM, C best positioned to withstand higher multiples of Market Risk RWA. Note though, C may face higher RWA “inflation” than peers (see below)."
- Stressed VaR to drive differences in RWA “inflation” "Comparing VaR across firms is treacherous given different methods of calculating it. However, comparing VaR reported at “peak” stress periods to Market Risk RWA, we can estimate how much of a firm’s RWA drives capital to support “normal risk” and how much reflects extra “cushion” for “tail risk”. Firms that currently fail to address “tail risk” face higher RWA “inflation”, we believe. Given VaR inconsistencies, we run 2 scenarios where we measure “tail risk” as a % of Market Risk (trading risk) and as % of combined Market and Credit Risk (cpty. credit risk). Based on our analysis, C appears weak on both metrics and could face higher RWA “inflation”. That said, given C’s excess CT-1, per our estimates, we believe it can withstand significant RWA “inflation” and still achieve min. CT-1 t argets. We also see potential for capital deployment at C, as early as 2011."
- JPM, GS, C well positioned for early capital deployment "Under our base case which assumes 2.5x Market Risk RWA (i.e. trading book) “inflation”, we believe the 4 big US dealers we cover appear sufficiently capitalized to meet BIS3, with JPM, GS, and C well positioned for early capital deployment in 2011, MS in 2012. Under BIS3 liquidity req. (Net Stable Funding ratio >100%), we est. C and JPM are already at or above 100% target while GS and MS are currently below it - though given NSF ratio isn’t mandated until 2018, they have ample time to reach target. Based on our analysis, C appears most liquid (105%), MS least (86%)."
- Scenario: Rising RWAs, Core Tier-1 target of 6,7,or 8% "Impact of RWA “inflation” on BIS3 CT-1 ratio (i.e. adjusted T-1 Common) hard to estimate as capital targets not set and US banks report RWA under BIS1. In our scenario analysis, we assume: Market Risk RWAs rise 2x-5x; counterparty credit risk RWAs rise 37.5%; a CT-1 target ratio of 6, 7, or 8%; no increased capital deployment; and roll forward RWA & earnings to 2012E. Results show JPM, C best positioned to withstand higher multiples of Market Risk RWA. Note though, C may face higher RWA “inflation” than peers (see below)."
- Stressed VaR to drive differences in RWA “inflation” "Comparing VaR across firms is treacherous given different methods of calculating it. However, comparing VaR reported at “peak” stress periods to Market Risk RWA, we can estimate how much of a firm’s RWA drives capital to support “normal risk” and how much reflects extra “cushion” for “tail risk”. Firms that currently fail to address “tail risk” face higher RWA “inflation”, we believe. Given VaR inconsistencies, we run 2 scenarios where we measure “tail risk” as a % of Market Risk (trading risk) and as % of combined Market and Credit Risk (cpty. credit risk). Based on our analysis, C appears weak on both metrics and could face higher RWA “inflation”. That said, given C’s excess CT-1, per our estimates, we believe it can withstand significant RWA “inflation” and still achieve min. CT-1 t argets. We also see potential for capital deployment at C, as early as 2011."
Merrill Lynch Banks Multinational Universal 20100812
A little help from my FED
- Do you need any money? Extending Quantitative Easing “to help support the economic recovery”. "The Fed addressed market expectations of reinvesting principal paydowns in the Treasury market in today’s statement. Yesterday, we highlighted that the failure to do so could result in shrinkage of the portfolio of around 15%, an implicit tightening the Fed now acknowledges it does not intend to allow. Notably, the NY Fed clarified the location of those purchases in the 2 to 10 year curve - precisely where the strongest rally in the Treasury curve has occurred since the end of June. That suggests much of today’s action was anticipated though clearly not all as the belly of the curve (5 and 10 years) outperformed today declining in yield by around 8 and 7 basis points respectively."
- Yields – the magic 4%. "In the euro credit market, flows have historically been dictated more by spread-based investors. However, in recent years, there has been a growing participation from investors that focus on yield: retail investors, insurance companies, and institutional investors managing absolute return funds. To meet return targets, investors will need to extend in duration, buy lower-rated cyclicals, or dip into BBs. We highlight bonds in the European space which are yielding over 4%."
- BIS3: Some reprieve, with US banks OK on capital/liquidity. "BIS3: US Banks OK given softer standards, longer timeline. Proposed changes to BIS capital and liquidity standards have been a key source of uncertainty for Global Banks. Original proposals were vague but harsh, particularly as it related to liquidity requirements and timeline. BIS has now pushed back implementation dates for key items and softened some effects including deductions from Tier-1 Common, netting of derivatives, and liquidity requirements. We believe, US firms appear well armored in terms of capital/liquidity, with JPM strongest on relevant metrics. See tables on pg 3 for impact of key BIS3 capital/liquidity standards on US brokers/money center banks."
- FOMC: Shift back into neutral. "Fed announces reinvestment plan. In an effort to “help support the economic recovery,” the Federal Open Market Committee (FOMC) announced plans to maintain the current size of its balance sheet by reinvesting the principal payments from its mortgage portfolio into longer-term Treasuries. This action is best thought of a return to a neutral stance for policy, in which mortgage runoffs are not passively tightening policy — rather than the first step toward an inevitable restart of outright asset purchases. The outlook for growth and inflation would need to deteriorate materially for the Fed to move to actively expanding their balance sheet further, in our view."
- Productivity declines for the first time since 2008. "Hours jump as output slows. Nonfarm business sector productivity fell an annualized 0.9% in the second quarter as output advanced 2.6% while employee hours jumped 3.6%. Employee hours have now increased for three consecutive quarters and the second quarter increase in labor input is the largest since 2006. The recent surge in hours worked suggests that the backdrop for employment is improving as employers have exhausted the current staff. The median of analysts’ expectations was for a productivity gain of 0.1%. Productivity growth in the first quarter was revised from a preliminary increase of 2.8% to 3.9%. The upward revision is due to an increase in output as hours worked was unchanged. Over the past four quarters, productivity increased 3.9%. For the four quarters ended 2009Q2, productivity increased 2.5%."
- China: Trade surplus widened on slower imports in July. "Bottom Line: China’s trade growth is softening in 2H. China’s export growth softened to 38.1% YoY in July from 43.9% in June, mainly on a higher comparison base. The reading was stronger than expected, suggesting external demand had held up well. On the other hand, import growth declined sharply, on a rapid fall of YoY growth in import prices and sequential slowdown of the Chinese
economy. As a result, trade surplus widened significantly in July from June."
- Yields – the magic 4%. "In the euro credit market, flows have historically been dictated more by spread-based investors. However, in recent years, there has been a growing participation from investors that focus on yield: retail investors, insurance companies, and institutional investors managing absolute return funds. To meet return targets, investors will need to extend in duration, buy lower-rated cyclicals, or dip into BBs. We highlight bonds in the European space which are yielding over 4%."
- BIS3: Some reprieve, with US banks OK on capital/liquidity. "BIS3: US Banks OK given softer standards, longer timeline. Proposed changes to BIS capital and liquidity standards have been a key source of uncertainty for Global Banks. Original proposals were vague but harsh, particularly as it related to liquidity requirements and timeline. BIS has now pushed back implementation dates for key items and softened some effects including deductions from Tier-1 Common, netting of derivatives, and liquidity requirements. We believe, US firms appear well armored in terms of capital/liquidity, with JPM strongest on relevant metrics. See tables on pg 3 for impact of key BIS3 capital/liquidity standards on US brokers/money center banks."
- FOMC: Shift back into neutral. "Fed announces reinvestment plan. In an effort to “help support the economic recovery,” the Federal Open Market Committee (FOMC) announced plans to maintain the current size of its balance sheet by reinvesting the principal payments from its mortgage portfolio into longer-term Treasuries. This action is best thought of a return to a neutral stance for policy, in which mortgage runoffs are not passively tightening policy — rather than the first step toward an inevitable restart of outright asset purchases. The outlook for growth and inflation would need to deteriorate materially for the Fed to move to actively expanding their balance sheet further, in our view."
- Productivity declines for the first time since 2008. "Hours jump as output slows. Nonfarm business sector productivity fell an annualized 0.9% in the second quarter as output advanced 2.6% while employee hours jumped 3.6%. Employee hours have now increased for three consecutive quarters and the second quarter increase in labor input is the largest since 2006. The recent surge in hours worked suggests that the backdrop for employment is improving as employers have exhausted the current staff. The median of analysts’ expectations was for a productivity gain of 0.1%. Productivity growth in the first quarter was revised from a preliminary increase of 2.8% to 3.9%. The upward revision is due to an increase in output as hours worked was unchanged. Over the past four quarters, productivity increased 3.9%. For the four quarters ended 2009Q2, productivity increased 2.5%."
- China: Trade surplus widened on slower imports in July. "Bottom Line: China’s trade growth is softening in 2H. China’s export growth softened to 38.1% YoY in July from 43.9% in June, mainly on a higher comparison base. The reading was stronger than expected, suggesting external demand had held up well. On the other hand, import growth declined sharply, on a rapid fall of YoY growth in import prices and sequential slowdown of the Chinese
economy. As a result, trade surplus widened significantly in July from June."
Merrill Lynch Situation Room 20100810
Brazil drills deep for petrodollars
- "Such has been the flow of good news about his country’s vast energy resources that President Lula da Silva of Brazil has already declared God to be “a Brazilian”. The discovery of what could be up to 100bn barrels of oil lying deep under the Atlantic promises to transform the nation’s economy and bring millions of people out of poverty. But when in July the president opened the taps on his country’s first commercial deep-sea oil production platform, the sheer scale of the challenge facing Brazil was starkly underlined by the offshore catastrophe further north in the Gulf of Mexico."
ABNAmro Energy Monthly August 2010
Dry bulk shipping costs hinting at double-dip recession?
- "The post-recession rally and subsequent collapse this year of the Baltic Dry Index, which measures the cost of transporting dry bulk goods by sea, is puzzling. A stronger performance by the index in Q2 seemed to support the views of those who believed that the emerging markets had escaped the financial crisis relatively unscathed, and would lead the rest of the world, including the advanced economies, into recovery. But the recent extraordinary crash in bulk carrier charges has left many wondering if a double dip recession is already upon us, and if it will be severe enough to drag down the economies of emerging markets too."
ABNAmro Metals Monthly August 2010
Will the resilience of the German labour market be long-lasting?
- "The German labour market’s resilience to the crisis has been exemplary, as the unemployment rate is at its lowest level since 1993 and continues to decline."
- "This performance shows the combined impact of several factors. Thus, out of the current three percentage point gap between the German unemployment rate (7.0%) and that of the euro zone (10.0%):
• 0.3 percentage point is explained by changes in the labour force in Germany, where demographic effects have had an favourable impact since the rise in the participation rate - which was spurred on by the Hartz reforms - ended;
• 1.2 percentage point is explained by the employment policy (0.3 percentage point by the reinforcement of support measures for job seekers and 0.9 by the easing of the terms for short-time work);
• apart from the success of short-time work, the German stimulus package has had a limited impact on employment (5,000 jobs created in construction);
• 0.8 percentage point is explained by the lack of destruction of jobs in construction, since there has not been any real estate bubble recently in Germany."
- "All in all, the "implicit" outperformance of German employment is "only" 0.7 percentage point of unemployment, in particular thanks to the jobs created in non-market services."
- "Demographic effects and the lack of a real estate bubble have made this performance long-lasting. However, it will subside as the employment policy runs out of steam, i.e. by around one percentage point over the next two years."
- "This performance shows the combined impact of several factors. Thus, out of the current three percentage point gap between the German unemployment rate (7.0%) and that of the euro zone (10.0%):
• 0.3 percentage point is explained by changes in the labour force in Germany, where demographic effects have had an favourable impact since the rise in the participation rate - which was spurred on by the Hartz reforms - ended;
• 1.2 percentage point is explained by the employment policy (0.3 percentage point by the reinforcement of support measures for job seekers and 0.9 by the easing of the terms for short-time work);
• apart from the success of short-time work, the German stimulus package has had a limited impact on employment (5,000 jobs created in construction);
• 0.8 percentage point is explained by the lack of destruction of jobs in construction, since there has not been any real estate bubble recently in Germany."
- "All in all, the "implicit" outperformance of German employment is "only" 0.7 percentage point of unemployment, in particular thanks to the jobs created in non-market services."
- "Demographic effects and the lack of a real estate bubble have made this performance long-lasting. However, it will subside as the employment policy runs out of steam, i.e. by around one percentage point over the next two years."
Natixis Flash Economics 397 20100811
Readings
Physics Envy in Finance - Rick Bootstaber
Economising on Liquidity is Deflation’s Antidote - A Wealth of Labour
For China, it’s diversify, diversify, diversify - FT Alphaville
Summer spikes - Free Exchange
Tensions Rise in Greece as Austerity Measures Backfire - Spiegel Online
Aggregate Demand Forecasts Are Falling - Macro and Other Market Musings
What is Happening with Bond Prices? - J. Bradford Delong
What should we do about national debt, and when? - McClatchy
Economising on Liquidity is Deflation’s Antidote - A Wealth of Labour
For China, it’s diversify, diversify, diversify - FT Alphaville
Summer spikes - Free Exchange
Tensions Rise in Greece as Austerity Measures Backfire - Spiegel Online
Aggregate Demand Forecasts Are Falling - Macro and Other Market Musings
What is Happening with Bond Prices? - J. Bradford Delong
What should we do about national debt, and when? - McClatchy
India and China: New Tigers of Asia, Part III
- "The huge surplus in the working-age populations in India and China has forced the world economy to recognize the countries’ roles in the global competitive dynamic. Both markets are increasingly integral to the business strategies of multinational companies and are viewed as structural drivers for global productivity. By 2020, we forecast India’s GDP will cross the US$6trn mark while China’s will surpass US$20trn, driven by the powerful combination of favorable demographics, structural reforms, and globalization. We expect the two economies to be the dominant growth stories for the next 20 years."
- "This report is the third part of our India and China: New Tigers of Asia series. Part I, published in July 2004, assessed the long-term outlook for the two economies during a period of rapid globalization. We highlighted how the rise of India and China is the most significant economic force in the world economy and that their growing presence will continue to change the rules that underpin the structure of global manufacturing and services output."
- "In Part II, published in June 2006, we focused on the challenges the two economies faced to maintain their growth trajectories beyond the then current boom. In that report, we highlighted that India had the potential to catch up to China’s economic growth rates over a 10-year period. Indeed, India is now not far from doing so."
- "In Part III, we focus on the long-term growth outlook in India. We believe that, over the next two years, India should start matching China’s economic growth, barring another global crisis, clearly reaping the rewards of very positive demographics and an increasingly dynamic economy."
- "We will continue to see both these economic powerhouses develop and reform as their respective models or stages of growth evolve as they create wealth and see their demographics change. The drive and dynamism both these economies provide to the world has and will become ever more important as they continue to develop and engage more intricately with the global economy."
- "This report provides some terrific insights into that evolution and the longer-term comparative factors driving the success of both economies. We now increasingly have a genuine double act from China and India in terms of dynamic economic growth engines willing and enthusiastic to engage with the global economy. This can only be beneficial for the continued growth and stability of the region and the world economy as a whole."
- "This report is the third part of our India and China: New Tigers of Asia series. Part I, published in July 2004, assessed the long-term outlook for the two economies during a period of rapid globalization. We highlighted how the rise of India and China is the most significant economic force in the world economy and that their growing presence will continue to change the rules that underpin the structure of global manufacturing and services output."
- "In Part II, published in June 2006, we focused on the challenges the two economies faced to maintain their growth trajectories beyond the then current boom. In that report, we highlighted that India had the potential to catch up to China’s economic growth rates over a 10-year period. Indeed, India is now not far from doing so."
- "In Part III, we focus on the long-term growth outlook in India. We believe that, over the next two years, India should start matching China’s economic growth, barring another global crisis, clearly reaping the rewards of very positive demographics and an increasingly dynamic economy."
- "We will continue to see both these economic powerhouses develop and reform as their respective models or stages of growth evolve as they create wealth and see their demographics change. The drive and dynamism both these economies provide to the world has and will become ever more important as they continue to develop and engage more intricately with the global economy."
- "This report provides some terrific insights into that evolution and the longer-term comparative factors driving the success of both economies. We now increasingly have a genuine double act from China and India in terms of dynamic economic growth engines willing and enthusiastic to engage with the global economy. This can only be beneficial for the continued growth and stability of the region and the world economy as a whole."
Morgan Stanley India and China New Tigers of Asia Part III 20100813
Physical oil market tightening even as economic recovery softens
- WTI timespreads point to a tightening physical oil market even as oil prices slide on concerns over the economic recovery "WTI timespreads have largely recovered from the liquidation of speculative long positions in May, with 1st-60th month WTI timespreads rising as much as $10/bbl to trade between -$8.00 and -$10/bbl since mid July. Further, WTI timespreads remain resilient, actually strengthening by $0.11/bbl as WTI prices fell from $80.25/bbl to $75.39/bbl this week."
- Discharge of floating storage suggests that the oil supply-demand balance is in deficit, even as onshore inventories continue to rise "Recent shipbroker reports suggest that floating storage drew by 40-45 million b/d in June and July, to its lowest level in over 18 months. Using the more conservative estimate of the June-July discharge suggests that the draw at sea has more than offset the build on shore, which the IEA estimates at 21 million barrels. Consequently, we believe that total world inventories including floating storage declined counter-seasonally in June and July, even as onshore inventories continued to build, with oil demand exceeding supply by 600 thousand b/d on a seasonally-adjusted basis."
- Increased downside risk from US and Chinese economic policy "We continue to expect the WTI forward curve to flatten in 2H10, lifting prompt WTI prices into the $85-$95/bbl range that long-dated WTI prices have traded in since October of last year. However, the anticipated tightening of Chinese economic policy is having an impact on Chinese oil demand, with notable weakness in the recent July data. Further, US fiscal policy looks set to shift from a boost to a drag on economic growth, which led our US economists to revise down their 2011 US GDP forecast recently to 1.9% from 2.5%. While we anticipate that Chinese economic policy will loosen in coming months, and the US Fed will likely return to quantitative easing, the downside risk from economic policy in the United States and China to our WTI crude oil price forecast has increased."
- Discharge of floating storage suggests that the oil supply-demand balance is in deficit, even as onshore inventories continue to rise "Recent shipbroker reports suggest that floating storage drew by 40-45 million b/d in June and July, to its lowest level in over 18 months. Using the more conservative estimate of the June-July discharge suggests that the draw at sea has more than offset the build on shore, which the IEA estimates at 21 million barrels. Consequently, we believe that total world inventories including floating storage declined counter-seasonally in June and July, even as onshore inventories continued to build, with oil demand exceeding supply by 600 thousand b/d on a seasonally-adjusted basis."
- Increased downside risk from US and Chinese economic policy "We continue to expect the WTI forward curve to flatten in 2H10, lifting prompt WTI prices into the $85-$95/bbl range that long-dated WTI prices have traded in since October of last year. However, the anticipated tightening of Chinese economic policy is having an impact on Chinese oil demand, with notable weakness in the recent July data. Further, US fiscal policy looks set to shift from a boost to a drag on economic growth, which led our US economists to revise down their 2011 US GDP forecast recently to 1.9% from 2.5%. While we anticipate that Chinese economic policy will loosen in coming months, and the US Fed will likely return to quantitative easing, the downside risk from economic policy in the United States and China to our WTI crude oil price forecast has increased."
GoldmanSachs Energy Weekly 20100816
Looking for clearer upside catalysts into year end
- Wheat has surged higher, but key commodities remain fragile "Commodity returns rose over the last month led by sharp gains in the agricultural complex owing to weather-related supply shocks in wheat. Additional key commodities also broke out to the upside of recent ranges in late July, driven primarily by a shift in policy tone in China, key financial uncertainties abating post European bank stress tests and the passage of US financial reform and generally positive corporate earnings, all of which boosted sentiment in risky markets. However, sentiment remains fragile and concerns about economic growth have dominated again in recent days, leading to some retracement across assets from multi-month peaks."
- Improved data will likely be required to sustain rising prices "Current soft economic data, combined with increasingly mixed signals from the commodity markets, is likely to continue to generate choppy commodity price action in the near term. In particular, although commodity demand indicators remain generally supportive, growth in Chinese implied oil demand fell sharply in July, observed oil inventories in the developed economies continue to build on a seasonally-adjusted basis and the decline in metals exchange inventories has slowed. While we expected some softness in 3Q2010, we believe that improvement in this data will likely be required before upward commodity price pressure can be sustained."
- We remain constructive on key commodities heading into year end "We maintain that high and rising emerging market demand levels against limited supply growth are likely to increasingly tighten balances, lending support to key commodities during 4Q2010. We expect upside to be greatest for crude oil, copper, zinc, platinum and gold. However, given market price action over the past month we are lowering our 12-mo returns forecasts for base metals to 15% from 25% and for agriculture to -10% from -1.0%. These revisions lead us to lower our 12-mo forecasted return for the S&P GSCI Enhanced Total Returns Index to 19% from 21.6%."
- Improved data will likely be required to sustain rising prices "Current soft economic data, combined with increasingly mixed signals from the commodity markets, is likely to continue to generate choppy commodity price action in the near term. In particular, although commodity demand indicators remain generally supportive, growth in Chinese implied oil demand fell sharply in July, observed oil inventories in the developed economies continue to build on a seasonally-adjusted basis and the decline in metals exchange inventories has slowed. While we expected some softness in 3Q2010, we believe that improvement in this data will likely be required before upward commodity price pressure can be sustained."
- We remain constructive on key commodities heading into year end "We maintain that high and rising emerging market demand levels against limited supply growth are likely to increasingly tighten balances, lending support to key commodities during 4Q2010. We expect upside to be greatest for crude oil, copper, zinc, platinum and gold. However, given market price action over the past month we are lowering our 12-mo returns forecasts for base metals to 15% from 25% and for agriculture to -10% from -1.0%. These revisions lead us to lower our 12-mo forecasted return for the S&P GSCI Enhanced Total Returns Index to 19% from 21.6%."
GoldmanSachs Commodity Watch 20100814
Mid-Quarter Update: Bond and Equity ‘Connect’
- Staying the Course — "Our Q3 trading range thesis is intact; the sharp pullback in GEMs in recent days should not turn into a rout. After some consolidation at or just below current levels – the seasonals are not good for August and September – we expect a breakout to new highs and strong gains for emerging markets in Q4."
- Good Quarter — "Emerging markets are having a good quarter. At one stage in early-August, MSCI GEMs were up by over 10%. EMEA and Latin America (both now up 9.8% in Q3) have led the way, while Asia (+4.8%) has lagged; GEMs (+6.8%) have outperformed AC World (+6.1%). Both emerging market currencies (+1.9%) and bonds (+6.6%) have delivered positive returns."
- Worrying about Bonds — "The latest symbol of the ‘wall of worry’ is the collapse of US bond yields to 2.6% (10-years). Since March 2010, nominal yields are down by 120bp but real yields have barely moved (-10bp) as inflation has fallen sharply."
- Bond/Equity ‘Disconnect’ — "At US yields below 6%, equities tend to fall when yields fall (correlation between US bonds and equities of +0.84 since the start of 2007). However, since early-July, US equities have rebounded as bond yields have fallen – a ‘disconnect’."
- Emerging Markets’ ‘Connect’ — "The bond/equity link in GEMs is the exact opposite. The correlation between equities and bond yields is -0.84, given that debt yields are typically the main driver of equity prices; equities like low yields, so there is no ‘disconnect’ in GEMs. This relationship should only break down if ‘double-dip’ fears cause a new bout of risk aversion, so pulling equities lower."
- Resolution — "Our global strategy team sees the bond/equity disconnect being resolved via lower bonds not lower equities. This outcome should not threaten emerging markets as long as yields do not rise too far."
- Regions/Countries — "We remain cautious near-term and look to add beta around end-Q3. We stay Overweight in the more defensive Asia and continue to prefer EMEA (Neutral) to Latin America (Underweight). We raise to Overweight Peru, Czech Republic and Egypt (from Underweight) and Poland (from Neutral). We cut Thailand and Turkey to Neutral and Malaysia and Mexico to Underweight."
- Sectors — "We upgrade Utilities to overweight, based mainly on attractive valuations, underperformance in the third quarter and the sector’s low beta status. We reduce slightly our Overweights in IT, Industrials and Materials. We make several changes to our Model Portfolio of stocks".
Citigroup Global Emerging Markets Strategy 20100816
- Good Quarter — "Emerging markets are having a good quarter. At one stage in early-August, MSCI GEMs were up by over 10%. EMEA and Latin America (both now up 9.8% in Q3) have led the way, while Asia (+4.8%) has lagged; GEMs (+6.8%) have outperformed AC World (+6.1%). Both emerging market currencies (+1.9%) and bonds (+6.6%) have delivered positive returns."
- Worrying about Bonds — "The latest symbol of the ‘wall of worry’ is the collapse of US bond yields to 2.6% (10-years). Since March 2010, nominal yields are down by 120bp but real yields have barely moved (-10bp) as inflation has fallen sharply."
- Bond/Equity ‘Disconnect’ — "At US yields below 6%, equities tend to fall when yields fall (correlation between US bonds and equities of +0.84 since the start of 2007). However, since early-July, US equities have rebounded as bond yields have fallen – a ‘disconnect’."
- Emerging Markets’ ‘Connect’ — "The bond/equity link in GEMs is the exact opposite. The correlation between equities and bond yields is -0.84, given that debt yields are typically the main driver of equity prices; equities like low yields, so there is no ‘disconnect’ in GEMs. This relationship should only break down if ‘double-dip’ fears cause a new bout of risk aversion, so pulling equities lower."
- Resolution — "Our global strategy team sees the bond/equity disconnect being resolved via lower bonds not lower equities. This outcome should not threaten emerging markets as long as yields do not rise too far."
- Regions/Countries — "We remain cautious near-term and look to add beta around end-Q3. We stay Overweight in the more defensive Asia and continue to prefer EMEA (Neutral) to Latin America (Underweight). We raise to Overweight Peru, Czech Republic and Egypt (from Underweight) and Poland (from Neutral). We cut Thailand and Turkey to Neutral and Malaysia and Mexico to Underweight."
- Sectors — "We upgrade Utilities to overweight, based mainly on attractive valuations, underperformance in the third quarter and the sector’s low beta status. We reduce slightly our Overweights in IT, Industrials and Materials. We make several changes to our Model Portfolio of stocks".
Which macroeconomic equilibrium in the United States and the euro zone?
- "We try to characterise the macroeconomic equilibrium over the next few years in the United States and the euro zone. After the crisis, we are likely to see:
• a significant need for household deleveraging due to the persistent imbalances in their balance sheets, leading to sluggish household demand;
• a reduction in fiscal deficits;
• need for companies that want to reduce their debt leverage to increase their profitability via a squeezing of wage costs instead of via rapid growth in their turnover; accordingly, distortion of income sharing at the expense of wage earners, which will reinforce the weakness of household demand and boost company earnings. The resulting effects on stock markets will be ambiguous;
• the main source of growth is therefore likely to be exports and related investments;
• due to the weakness of domestic demand and the distortion of income sharing at the expense of wage earners, domestic inflation will remain very low, and monetary policy will hence remain expansionary. This points to low risk-free nominal interest rates;
• the international environment can be expected to move in the same direction for several years: high level of global savings, rise in commodity prices deferred for several years by the crisis, and low inflation given the labour reserves in emerging countries. Emerging countries will probably not become inflationary or stop generating excess savings before the end of the decade."
- "All in all, we expect an under-employment equilibrium (Keynesian unemployment equilibrium) in the United States and the euro zone for a few years, with fiscal policy becoming more restrictive and monetary policy remaining expansionary, resulting in the normal characteristics of such an equilibrium: unemployment, lack of inflation and low interest rates. The distortion of income sharing will shift the burden to wage earners, while corporate profitability will be robust despite tepid growth."
• a significant need for household deleveraging due to the persistent imbalances in their balance sheets, leading to sluggish household demand;
• a reduction in fiscal deficits;
• need for companies that want to reduce their debt leverage to increase their profitability via a squeezing of wage costs instead of via rapid growth in their turnover; accordingly, distortion of income sharing at the expense of wage earners, which will reinforce the weakness of household demand and boost company earnings. The resulting effects on stock markets will be ambiguous;
• the main source of growth is therefore likely to be exports and related investments;
• due to the weakness of domestic demand and the distortion of income sharing at the expense of wage earners, domestic inflation will remain very low, and monetary policy will hence remain expansionary. This points to low risk-free nominal interest rates;
• the international environment can be expected to move in the same direction for several years: high level of global savings, rise in commodity prices deferred for several years by the crisis, and low inflation given the labour reserves in emerging countries. Emerging countries will probably not become inflationary or stop generating excess savings before the end of the decade."
- "All in all, we expect an under-employment equilibrium (Keynesian unemployment equilibrium) in the United States and the euro zone for a few years, with fiscal policy becoming more restrictive and monetary policy remaining expansionary, resulting in the normal characteristics of such an equilibrium: unemployment, lack of inflation and low interest rates. The distortion of income sharing will shift the burden to wage earners, while corporate profitability will be robust despite tepid growth."
Natixis Flash Economics 396 20100809
The correlation between equities and bonds in the euro zone: How many regimes?
- "We study the factors determining the correlation between equities and bonds. At first sight, it is reasonable to think that:
• a rise (fall) in growth or a fall (rise) in risk aversion will lead to a rise (fall) in both share prices and long-term interest rates, implying a positive correlation between equities and interest rates;
• a rise (fall) in commodity prices - not linked to growth - will lead to a fall (rise) in share prices and to a rise (fall) in interest rates, meaning there would be a negative correlation between equities and long-term interest rates;
• a very expansionary (restrictive) monetary policy will lead to a fall (rise) in long-term interest rates and to a rise (fall) in share prices, and hence a negative correlation between equities and long-term interest rates."
- "We therefore have one regime (linked to growth and/or risk aversion) with normally a positive correlation between equities and long-term interest rates and two regimes (commodity prices, monetary policy) with normally a negative correlation between equities and long-term interest rates."
- "In the past we have seen:
• a regime of positive correlation between equities and interest rates (end-1998 to early 2004, end-2006 to 2010) linked to growth and risk aversion;
• a regime of negative correlation between equities and long-term interest rates (1996 to early 1998, end-2004 to the first half of 2006) linked to monetary policy."
- "Periods of sharp fluctuations in commodity prices (end-2007 - early 2008) have for the time being been too short to lead to an identifiable regime of negative correlation. However, such a regime must be included in the list of possibilities in the future."
• a rise (fall) in growth or a fall (rise) in risk aversion will lead to a rise (fall) in both share prices and long-term interest rates, implying a positive correlation between equities and interest rates;
• a rise (fall) in commodity prices - not linked to growth - will lead to a fall (rise) in share prices and to a rise (fall) in interest rates, meaning there would be a negative correlation between equities and long-term interest rates;
• a very expansionary (restrictive) monetary policy will lead to a fall (rise) in long-term interest rates and to a rise (fall) in share prices, and hence a negative correlation between equities and long-term interest rates."
- "We therefore have one regime (linked to growth and/or risk aversion) with normally a positive correlation between equities and long-term interest rates and two regimes (commodity prices, monetary policy) with normally a negative correlation between equities and long-term interest rates."
- "In the past we have seen:
• a regime of positive correlation between equities and interest rates (end-1998 to early 2004, end-2006 to 2010) linked to growth and risk aversion;
• a regime of negative correlation between equities and long-term interest rates (1996 to early 1998, end-2004 to the first half of 2006) linked to monetary policy."
- "Periods of sharp fluctuations in commodity prices (end-2007 - early 2008) have for the time being been too short to lead to an identifiable regime of negative correlation. However, such a regime must be included in the list of possibilities in the future."
Natixis Flash Economics 395 20100806
Real estate tightness counterbalances net loosening in commercial and industrial
- "Credit standards loosen for both large and small firms, but this is mostly the result of competition rather than robust loan demand"
- "Prime loan standards loosened, but overall residential loan demand remains weak"
- "Willingness to extend consumer installment loans is at the high end of the past decade"
- "Prime loan standards loosened, but overall residential loan demand remains weak"
- "Willingness to extend consumer installment loans is at the high end of the past decade"
BBVA US Banking Watch 20100817
Agency MBS: Outlook for Agency MBS Basis
- "Over the past two weeks, agency MBS had significantly underperformed Treasuries. The sharp underperformance of the MBS universe could be gauged from the fact that the dollar prices of FN 4.5s have appreciated by only 6+ ticks and those of FN 5.5s and 6.0s have declined by close to 22-24 ticks even as the 10-year Treasury Futures contract had appreciated by 2-08 and the 5-year Treasury Futures contract had appreciated by 0-31+ over the past two weeks (Figure 1).1 This sharp underperformance of agency MBS had occurred even as implied volatility of interest rate options (both Gamma and Vega) had declined by 3-7 bps over this time period, which is unlike prior episodes of mortgage spread widening when MBS spread widening was typically associated with a spike in implied volatilities."
- "As regular readers are well aware of, our strategy team has been recommending a long-term underweight on the MBS basis versus Treasuries for 2H’10, primarily because of our expectation of the Federal Reserve not reinvesting paydowns on its existing MBS holdings back in the MBS. This would represent a significant net supply of agency MBS to the rest of the market and spreads will have to widen for this excess supply to be absorbed by private investors. However, even we are somewhat surprised at the pace of spread widening over the past two weeks."
- "Below we present an assessment of some of the macro-factors that are likely to drive agency MBS spreads over the next several weeks and outline our short-term and long-term trade recommendations on MBS basis:
• Issue #1: Reinvestment of MBS paydowns received by the Fed in Treasuries
• Issue #2: Elevated prepay uncertainty due of the possibility of streamlined refinancing
• Issue #3: Low absolute yield levels and relatively cheap MBS valuations
• Issuer #3: Servicers"
- "As regular readers are well aware of, our strategy team has been recommending a long-term underweight on the MBS basis versus Treasuries for 2H’10, primarily because of our expectation of the Federal Reserve not reinvesting paydowns on its existing MBS holdings back in the MBS. This would represent a significant net supply of agency MBS to the rest of the market and spreads will have to widen for this excess supply to be absorbed by private investors. However, even we are somewhat surprised at the pace of spread widening over the past two weeks."
- "Below we present an assessment of some of the macro-factors that are likely to drive agency MBS spreads over the next several weeks and outline our short-term and long-term trade recommendations on MBS basis:
• Issue #1: Reinvestment of MBS paydowns received by the Fed in Treasuries
• Issue #2: Elevated prepay uncertainty due of the possibility of streamlined refinancing
• Issue #3: Low absolute yield levels and relatively cheap MBS valuations
• Issuer #3: Servicers"
Nomura Special Topics 20100813
Japanese equity valuations should rise as double-dip concerns fade
- Japanese equity prices excessively discount concerns about global economic outlook: "In our opinion, Japanese equities have excessively priced in concerns about the global economic outlook and a double dip for the Japanese economy. We think this provides an opportunity for investors, particularly value investors with a long-term horizon."
- Little risk of double dip for Japanese economy: "If the Japanese economy were to slide into recession, this would likely be caused by recession in the US or the world economy. We see little risk of the US economy moving into recession unless some kind of major shock occurs. Some argue that the concerted switch to fiscal tightening by major economies could provide a substantial shock. However, our calculations of the impact of policy stimulus withdrawal, as well as past examples of fiscal tightening, indicate that fiscal tightening is unlikely to be so severe as to trigger a recession."
- Japanese economy headed for self-sustained recovery: "We expect the Japanese economy to regain momentum after slowing up to 2011 Q1. We think this momentum will be driven by (1) a rebound in capex, (2) the positive implications of this for employment, incomes and consumption, and (3) firm exports on the back of sustained strong growth in emerging economies."
- Scope for upward adjustment in Japanese equities, which price in fall in FY11 profits: "We think that equity markets price in a scenario whereby the improvement in Japanese corporate earnings loses momentum in the lead-up to FY11, and profits decline in FY11. This suggests to us that market participants may be factoring in a recession for the Japanese economy. Our analysis suggests there is little risk of the Japanese economy sliding into recession. Once the excessive pessimism fades, we think Japanese equities will see an upward adjustment in their low valuations."
- Japanese economy-sensitive stocks at or near lows: "We believe Japanese economy-sensitive (high-beta) stocks are trading at or near lows. As long as there is no recurrence of the financial crisis, we see limited scope for further underperformance by high-beta stocks. Among high-beta stocks, we recommend overweighting sectors sensitive to emerging economies (trading companies, construction machinery). From 2011, we anticipate an almost simultaneous upward adjustment in “capex” and “consumer durables” sectors as well as “domestic demandsensitive” sectors. Meanwhile, valuations look high for "emerging economy growth" sectors (robots/pneumatic equipment, healthcare, cosmetics/toiletries) following strong share price performance in 2010 H1. In the near term, we think "emerging economy-sensitive" sectors could take over as the main driver of high-beta stocks."
- Little risk of double dip for Japanese economy: "If the Japanese economy were to slide into recession, this would likely be caused by recession in the US or the world economy. We see little risk of the US economy moving into recession unless some kind of major shock occurs. Some argue that the concerted switch to fiscal tightening by major economies could provide a substantial shock. However, our calculations of the impact of policy stimulus withdrawal, as well as past examples of fiscal tightening, indicate that fiscal tightening is unlikely to be so severe as to trigger a recession."
- Japanese economy headed for self-sustained recovery: "We expect the Japanese economy to regain momentum after slowing up to 2011 Q1. We think this momentum will be driven by (1) a rebound in capex, (2) the positive implications of this for employment, incomes and consumption, and (3) firm exports on the back of sustained strong growth in emerging economies."
- Scope for upward adjustment in Japanese equities, which price in fall in FY11 profits: "We think that equity markets price in a scenario whereby the improvement in Japanese corporate earnings loses momentum in the lead-up to FY11, and profits decline in FY11. This suggests to us that market participants may be factoring in a recession for the Japanese economy. Our analysis suggests there is little risk of the Japanese economy sliding into recession. Once the excessive pessimism fades, we think Japanese equities will see an upward adjustment in their low valuations."
- Japanese economy-sensitive stocks at or near lows: "We believe Japanese economy-sensitive (high-beta) stocks are trading at or near lows. As long as there is no recurrence of the financial crisis, we see limited scope for further underperformance by high-beta stocks. Among high-beta stocks, we recommend overweighting sectors sensitive to emerging economies (trading companies, construction machinery). From 2011, we anticipate an almost simultaneous upward adjustment in “capex” and “consumer durables” sectors as well as “domestic demandsensitive” sectors. Meanwhile, valuations look high for "emerging economy growth" sectors (robots/pneumatic equipment, healthcare, cosmetics/toiletries) following strong share price performance in 2010 H1. In the near term, we think "emerging economy-sensitive" sectors could take over as the main driver of high-beta stocks."
Nomura Japan Investment Strategy 20100813
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