By Michael Hartnett, Chief Investment Strategist, BofA Merrill Lynch
In London recently, this was the feedback I got from clients.
All mouth and no trousers
There is a clear “sellers strike” in both equities and bonds right now; no-one wants to fight the Fed and risk assets are seen as impressively resilient to bad news (e.g. Monte de Paschi); in London there was more pushback to the idea of higher bond yields than higher equity prices; while the rhetoric is very bullish (“equities will rise 30% this year”) many argue investors are much less bullishly positioned in equity markets; hedge funds are in risk-on mode, while LO are reducing HY positions, raising equity weightings (though not fast enough in Japan) and some are experiencing inflows (industry data are likely to reveal another big week of equity inflows this week); there were notably few worries in London over the recent tax increases in the US.
“You know the best thing about London these days? No English people live there.” Anonymous, 2013
The safe haven bid has vanished. The favored trade is to sell “safe havens”, e.g. the Swiss franc, the DAX, Apple and other beneficiaries of the fear trade in recent years. London real estate, buoyed greatly by foreign buying in recent years, is another vulnerable “trophy asset” as structurally lower oil prices and wealth and reduced European instability is seen to reduce the bid. Some express these views through long Swiss equities/short DAX or long FTSE/short sterling trades.
It ain’t 1994
Interest rates are not seen as a big threat by the majority of clients. Very few expect a. the labor market to induce a big rise in yields, b. the Fed to allow yields to rise much above 2.5% and c. the economy or the debt situation in the US to permit a rise in yields to be large and permanent. Demographics and the regulatory background were also stated as reasons for low and stable rates. Inflation is possible, but unlikely. At a client dinner, no-one thought the 10-year Treasury yield would exceed 3% by year-end.
The Great Rotation
Clients think the Great Rotation is likely, just not this year. Cash is as likely to fund equity purchases as bonds and there was pushback to the view that the period of maximum ease was behind us: the Fed is still pumping; Japan just getting started. Put simply more clients believe its Jan 1993, than Jan 1994, and 2013 has a bullish, reflationary, high liquidity-higher growth outlook.
A steeper global yield curve is expected, and this is thought to be bullish for bank stocks. There are worries that a European policy mistake is being made, as the ECB balance sheet shrinks and causes a stronger Euro. But more than 2/3 clients believe the Euro would need to exceed 1.45 versus the US dollar before hurting the German economy.
FX War and Peace
There is debate and long-term worries about competitive currency devaluations. But the high levels of FX reserves in Emerging Markets provides comfort that recent Asian FX volatility is not a harbinger of a risk-off shock. Clients agreed with our view that currencies are the new “automatic stabilizers” and will appreciate wherever growth is good and vice-versa. We think that China is the only nation currently willing to tolerate a stringer currency, so Chinese export growth is key to watch n coming months. Weak exports could encourage the Chinese to seek a weaker currency which would be a much more threatening development in the infant FX war.
The Demographics of Japan sentiment
Older clients remain skeptical on the new government, new central bank and new policy mix; younger investors are much more bullish (the opposite of sentiment toward the US market in recent years). No hedge fund wants to miss the debasement of the yen, and the majority sees the Japanese equity market as the most likely best performer in H1. The recent melt-up in Japanese small cap stocks (TSEMOTHR INDEX) is testament to a capitulation into the market. JGB risk in Japan is seen as low. Indeed the mega-bull view is that Japan in 2013 will have the best performing equity market thanks to fiscal stimulus and yen depreciation, and the best performing bond market thanks to BoJ reflation/QE. We too are bullish Japan but view signs of improvement in real estate prices in Japan (and a good rise in JGB yields) as the crucial game-changer for secular investor sentiment toward Japan.
The lust for yield, the silent “peak oil” trade & the EM barbell
Managers of High Net Worth money noted that private clients are increasingly sellers of gold, have increasingly unrealistic expectations of expected returns from fixed income and are using margin to buy high yield bonds. The lust for yield continues.
Few investors seem to care about commodities (there was agreement that the secular bull market in commodities ended around around the same time Brazil, Russia and Qatar were announced as the hosts for the next three World Cups). But the were lots of questions as to why EM has underperformed YTD. Our view: sentiment became too bullish; profits have been taken in the massive EM consumer bull market in Mexico, Indonesia and Turkey and the money has not rotated to BRIC but rather a. cheaper large cap multinationals in Europe and the US that have exposure to the EM wealth theme and b. to Frontier markets in Africa, Middle-East and Cambodia/Laos/Myanmar.
Many investors are fascinated by Francisco Blanche’s view that WTI could fall to $50/barrel in coming years. A strong dollar-weak commodity backdrop is seen as less helpful for EM. We think the “peak oil” theme has played itself out convincingly across many equity markets and sectors in recent quarters (all the big outperformance in recent quarters has come from countries (e.g. Japan, peripheral Europe, India, Turkey) and sectors (e.g. consumer discretionary, banks) that do well when oil prices fall. This also suggests that the combo of rising yields and rising oil prices this year would be a big negative surprise to many.
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