- "Significant changes in demographic trends are about to occur in the euro area,especially in those countries, like Ireland and Spain, where labour growth hasbeen a key determinant of strong economic performance in the decade beforethe recession. Less room for rising labour force participation rates will probablyalso reduce the labour growth contribution to trend GDP growth." - "More adverse demographic and labour market dynamics are likely tosignificantly reduce trend growth in these peripheral countries. And this maytranslate into an impact on aggregate euro area annual trend growth of ¼-½pp."
- Questions to be answered • "What is the impact for the financial markets if the US ‘doubledips’?" • "Is the global economy headed for inflation/deflation or stagnation?" • "Will the European economy face another financial crisis?" • "Will emerging markets be able to de-couple?" • "What is the future for China and Thailand over the next 5 years?"
- Action"The credit crisis that originated in the US has generated a rebalancing of global investments from the West towards the East. Over the past year, we see a growingimpact from Asia on the rest of the world. On quant factor investing, we highlight theperformance differences between developed and emerging markets in Asia." - Recent market specifics"The credit crisis that originated in the US has generated a rebalancing of globalinvestments from the West towards the East. Since October 2008, the MSCI ACAsia Pacific ex-Japan index has outperformed the MSCI regional indices in the US and Europe, and there has been a growing impact from Asia on the rest of the world.Over the past year, we have seen the continuation of the uptrend in weights of Asianmarkets, impressive fund inflows to the region, and increased fund-raising activitiesby IPO. These all reflect a shifting investment preference to Asian markets." - Changes in return attributions"We extend our return attribution analysis for Asia Pacific equities and estimatechanges in the stock returns attributable to four factors: the global market, country-,sector- and stock-specific factors, over the past year. We see the continuation ofthe rising global factor effect on Asia equities when the global market recoveredfrom the previous recessionary trough. Meanwhile, there is a significant decreasein the spread between country factor and sector factor effect in emerging Asia,signalling a converging characteristic of emerging Asia to the developed markets.Our analysis also suggests that the performance impact from Asia on the US/European markets has grown over the past few years, and it is almost the samelevel as that from US/Europe on the Asian markets." - Investment factors that work"Developments in financial market infrastructure, together with improved marketdepth, provide opportunities to invest in the region using quantitative approaches,in our view. We look at the factor performances in developed and emerging Asia,respectively. In the long run, the factor effectiveness in emerging Asia has been more consistent than that in developed Asia, especially for value investing andearnings-revision indicators. The differences are more evident when we look atdifferent market cycles. After the credit crisis, the utility of quant factors forinvesting continues look more promising in emerging Asia than that in developedAsia, with significant alphas generated from valuation devices such as E/P and B/P,and earnings revision indicators such as normalised earnings yield and revisionindex in emerging Asia."
- "US jobless claims data were weak, but incoming data suggest a double dip is stillunlikely. The US economic slowdown is certainly not due to malfunctioning creditmarkets. Mortgage yields are at all-time lows, and corporate debt yields are alsovery low." - "We believe the data need to turn significantly worse than what we and theconsensus expect for the Fed to decide to step up QE; if and when it does, it willneed to be overwhelming, probably accompanied by an inflation target." - "Beyond the US, disinflationary forces appear to be over globally, particularly asthere is upward pressure on food prices." - "In China, we expect authorities to remain on hold to balance risks, but even if theyease policy, we expect them to keep measures aimed at lowering housing prices."
- "Price moves remain diverse across the commodities complex. Market concerns onrecent softer macro-economic data have pressured crude oil prices, while agriculturalcommodities – grains and cotton in particular – have been relatively immune afterwitnessing recent supply-side production downgrades on adverse weather conditions.We dissect commodity investment trends in this month’s Commodity Investor withcommodity investments passing an important milestone in July with AUM surpassing$300bn for the first time, as commodity inflows bounced back and prices strengthened"
- "Social Security has provided at least some measure of economic security tothose who pay into the system, much as President Roosevelt envisionedwhen he signed the Social Security Act into law 75 years ago." - "At the time of Social Security’s inception in 1935, there existed very few publicprograms to provide Americans insurance against old age or disability. Onlyabout 3% of the elderly were receiving benefits under state plans, and onlyabout 5% were receiving company retirement pensions." - "Social Security has always been a pay-as-you-go system – the US Treasurycan’t tell the difference between a dollar of Social Security tax revenue and adollar from any other tax. The accounting convention of a Trust Fund reflectsthe fact that Social Security tax revenues have exceeded contemporaneousbenefit payments, with the excess funding other government spending." - "This year, however, Social Security is expected to fall into deficit, and it islikely to remain in the red through 2011, mainly because of highunemployment curtailing tax inflows. The Social Security Administration thenexpects three years of renewed surpluses (i.e., it assumes significantrenewed job growth)." - "In a few years, the program goes into deficit for the foreseeable future, mainlybecause of the surge in benefit payments to retiring (but not shy) babyboomers." - "To cover these structural shortfalls, higher payroll taxes, reduced benefits,increased retirement ages, or some combination will be required. And in theaftermath of the 2007-09 financial crisis, it is hard to envision a groundswell ofsupport for the George W. Bush-era privatization option."
- Overview: "We are oozing with bond bullishness. Nothing has changed.The cycle is playing out exactly as we expected. If (a big if) it continues to doso, we have high confidence that 10-yr bunds will be the first non-Japan majorto have a 1.xx% handle in a very few weeks. Leg one of the rally is done withshorts exited. If data continues to be weaker than the strangely buoyantconsensus predicts, watch out for leg two: longs established & equity->FIreallocation, making for violent yield lurches lower. If this plays out, we caneasy see 10-yr bunds as the first non-Japan major market to have a 1.xx%handle in a very few weeks." - Euro Area: "Deteriorating US lead indicators can take us through our longheld2¼% 10y Bund target. Ignore German strength and trade a test of 2.0%.The curve mechanics to get to this level on a recession are not thatchallenging given that the liquidity trap becomes more embedded." - UK: "There’s a new target for the rolling flattening of the curve; 5s10s. Ona variety of measures 5s10s looks too steep, and should flatten in around 40bpfrom here as the lower for longer themes meet the duration grab." - Scandinavia: "the Swedish recovery is steaming on at this point in timeand this will probably be reflected in another set of strong confidence figuresfrom Swedish households and corporates." - Inflation-Linked: "The question of whether we are heading toward aJapanese liquidity trap or just back to a 2004-5 style European slump is acrucial decision for the economy bears. We suggest a strategy of longs ininflation hedged with longs in real yields (overweighting linkers in a breakeventrade). Italy now looks rich against France on breakeven and we think that acheapening into supply makes a sensible play." - Volatility: "The bullish flattening 2y forward 10s30s is our proposed tradeto benefit from expected flattening of GBP curve. We expect this trade pays offwell if the BOE initiate the second round of QE and follow the tradition ofbuying Gilts all through the curve."
- Proposed new accounting rules — "The IASB yesterday published an ExposureDraft on Leases, which would eliminate the current operating/financing leasedistinction and bring all leases on balance sheet. The final IFRS is due in Q22011, with the new standard planned to take effect no earlier than 2013." - Bigger balance sheets — "The ED proposes that lessees should report the presentvalue of expected lease payments as an asset and liability on the balance sheet.Operating lease expense would be replaced by amortisation of the asset and aninterest charge on the liability. Lease cash flows would be reclassified in the cashflow statement." - Effect on key metrics — "For many companies using leased assets, the proposedchange would increase reported debt and gearing, increase Enterprise Value/Salesmultiples, increase operating cash flow, and affect other valuation multiples. Itwould also reduce EPS of many companies on initial adoption of the new rules." - Sector impact — "Retail, transport and leisure sectors would be particularlyaffected by the new rules." - Company impact — "UK companies with significant operating lease exposureinclude Regus, Debenhams, DSG, Home Retail Group, Tui Travel, Kingfisher andSainsbury. In the MSCI Europe ex UK index, the most affected companies includeIberia, Autogrill, Kesko, Accor, JCDecaux, Tui and Air France." Citigroup_Valuation_&_Accounting_20100818
- "There has been a fall in unit wage costs due to the slowdown in wages andcompanies’ efforts to improve productivity in Japan and the United States,and we are starting to see the same development in the euro zone." - "A fall in unit wage costs can have two effects: • if profit margins do not change, there will be a fall in prices, leading to arise in real interest rates; • but there may also be a continued rise in prices and in company earnings;companies can deleverage, but also end up accumulating financial (or realestate) assets." - "In the first case (seen more in Japan), this development is negative for assetprices and investment; in the second case (seen in the United Statescurrently, but also partially in Japan and in the future in the euro zone), it ispositive (asset purchases by companies)." - "In the first case, the fall in prices curbs the fall in real wages and improvescompetitiveness, but not in the second case: the consequences on assetprices and demand are therefore opposite, but for each there is a negativeconsequence."
- De-coupling — "Global government bond yields have fallen to multi-decade lowsbut equity markets don’t seem to care. While global stock prices have rallied 8%over the last few weeks, global bond yields have fallen 25 basis points." - Equities Winning 6-2 — "Over the last 11 years, there have been 10 occasionswhen global bond yields and stock prices have diverged. Equities have beenproven ‘right’ six times versus bonds two times. Divergence was unresolved twice." - Bond Yields Expected to Rise — "This time, we expect the conundrum to beresolved through rising bond yields. Citi rate strategists suggest that a sustainedglobal economic recovery and gloomy fiscal outlook should push yields up fromtheir current historically low levels." - What Should Equity Investors Do? — "Falling bond yields didn’t help stock pricesrise so rising yields shouldn’t be a major headwind for equity investors. We thinkthose expecting a rise in bond yields should consider buying Japanese equities(local currency) and global cyclicals like Diversified Financials, and considerselling global defensives like Telecoms." Citigroup_Global_Equity_Strategist_20100818
- "The global crisis has further enhanced the relative growth prospects of emerging markets (EM) capitalmarkets. Advanced economies’ capital markets will continue to make up the bulk of global financialassets, developed markets (DM) deleveraging and EM leveraging notwithstanding. Emerging Asia has notonly the largest capital markets, but also the most developed markets in the EM space. From theperspective of global investors and, even more so, financial services providers, some (segments) of therapidly growing EM financial markets can only be accessed with some difficulty and tapping into theirgrowth requires a well-thought-out, focused strategy. This fact notwithstanding, the “opportunity costs”of not building exposure to – or a platform in – the EM will be increasing over time."
- Short view: Running ahead of fundamentals"We look for Q3 to be relatively weak and stress that (further) setbacks in prices should beexpected; price rises could be seen toward year-end as markets realise that the globaleconomy is not heading for a worst-case scenario. Also, a weaker dollar and positivesentiment in equity markets should provide support to commodities." - Energy: Demand recovery fizzling out"We are increasingly worried about oil demand in the near term and with Opec slippingfurther on compliance only a small deficit to be seen this year. This should leave forwarddemand cover at elevated levels and we expect oil to test the lower end of the USD70-80/barrel range in Q3. Brent to average USD79 this year and USD87 in 2011." - Base metals: Look for Q3 correction"Base metals are highly sensitive to the business cycle and vulnerable to focus on a likelybubble in the Chinese construction sector. We have left our longer-term base metalsforecasts largely unchanged but now pencil in marked softness in Q3. We see aluminiumand copper going below USD2,000 and USD7,000 per tonne, respectively. Further out,we continue to see value in base metals, notably copper." - Grains: Wheat spike but spill-over to be limited "Within grains, the recent wheat spike has surprised us but we highlight still huge stocksand that spill-over to soybeans and corn should be limited. Correction in store andlimited potential for prices to rise in 2011." - Hedging recommendations: Consumers should await correction "We recommend that clients on the consumer side should wait for a setback in industrialmetals before locking in prices of copper and aluminium. Clients who are net sellers ofwheat could in our view do well in fixing current price levels in the grain. On oil, wesuggest awaiting a decline to below USD74/barrel for Brent before locking in expenses."
- "Comments by ECB council member and 2011 candidate president Weber on the possibleextension of unlimited liquidity until year-end have not gone unnoticed, casting a shadowof the ST outlook for the EUR. In a market short of liquidity and marked by a retreat of risk,Weber’s comments may hasten the decline in EUR/USD from the August highs. With riskbeating a retreat, the success of Japanese officials to temper the decline in USD/JPY canbe questioned and indicates that the cross may be settling in a range around 85.0. Theperceptible weakening of the US economy in Q2 is showing signs of spilling over in Q3 andmeans the USD is set to remain a safe haven magnet along with the CHF. Unrevised UKQ2 GDP data next week may add fuel for a return in EUR/GBP to the June lows." - "UK macro data continued to impress but ran into aversion for risk, resulting in a mixedperformance for GBP vs other G10 currencies. GBP/USD fell 0.4% to 1.5532, having slippedbelow 1.55 for the first time since July 27. GBP/EUR ended the week virtually flat at 1.2226,but potential for a move to the upside appears to be building. EUR/USD dropped 0.4%and USD/JPY stalled above 85.50, logging a drop of 0.65%. A test of the Nov-09 low stilllooms, though reluctance to push the cross lower on a sell-off in stocks indicates thatinvestors have become more wary of intervention ahead of the next BoJ meeting. The CHFtopped the G10 table with solid gains vs the USD and EUR." - "Early indications show that momentum from UK Q2 GDP is carried over into Q3 at least onthe consumer spending side. Retail sales rose a stronger than forecast 0.9% m/m in July,posting a third successive gain. June data were revised upwards. This will dampenspeculation of the MPC soon resuming its asset purchase programme. The MPC minutesshowed the committee voted 8-1 in August to keep BR and the APF on hold. Discussionsincluded both an easing and modest tightening in policy. ECB member Weber stated hispreference to extend unlimited liquidity until year-end. US economic data continued to disappoint.Reports of a jump in weekly claims to 500k and a fall in the Philly Fed survey to -7.7 meanadditional Fed measures and stimulus spending cannot be ruled out." - "No change in theme. Bullish seasonals and weak US macro data helped gilts to extendtheir stellar performance, with 10y gilt yields dropping below 3% and EU 30y yields fallingbelow 3%. For 10y gilts, the 2.93% low of 2009 is now within striking distance. Even asinvestors question bond valuations, there could be further downside for yields and swapsif UK data sours. 5y swaps dropped to 2.07%. The 2y/10y swap spread tightened to182bp, with cash compressing to 234bp. The 10y swap spread held at +5."
