- Europe’s leaders finally have a plan, of sorts
- This rally has more momentum than the last two
- Q2 performance favoured bonds, selective equity exposure
- Data slipping in US/EU but looking better in Emerging Markets
- Options market signals gold is oversold
Another footstep nearer a European banking union on Thursday and Friday and risk markets have reacted with gusto. Since this time last week, the MSCI world index has gained 4% and Euro-sensitive Eastern Europe 6.3%. Brent crude, which last Thursday evening was testing USD91pb, temporarily broke the USD98pb level on news that Europe has embarked on programme of clubbing bank liabilities and recapitalising banks. Good news if the details are enough to keep markets convinced that Europe is now dealing with its problems and separating banking sector risk for sovereign risk.
Interestingly, the NYSE Arca Gold Bugs Index is back above where it started the European Summit. Prices dived on the Thursday but have since recovered to suggest that markets still think that large-scale ECB intervention will be necessary. Thus we shall have to see the details of the summit package before venturing back into exposure to European risk markets. Nothing has changed in terms of capitalizing Europe’s bailout funds; Italy and Spain continue to be significant sources of bailout funding – for each other.
At beginning of a new quarter, returns on asset classes over the last three months have been quite varied. Star performers in asset class terms have been selected soft commodities (corn, wheat and soyabeans) and natural gas. US high yield bonds and the USD/G7 dollar index also showed positive returns. At the other end of the performance ledger come cotton, oil, silver and MSCI Latin American equities (leveraged to global growth). All have lost over 12% since 31 March. All MSCI indexes registered negative returns in Q2 as global growth expectations slipped and investors showed a clear preference for fixed income over equities. The US 10 year bond began Q2 fractionally above 2.2% and ended it a shade over 1.6% after a brief attempt on 1.4%.
In Emerging Markets, equities lost ground in all markets other than the Philippines. The archipelago nation continues to be a star performer in equities as it begins to benefit from better politics and increasing investment. It is one of only three Emerging Markets indexes that have registered an improving earnings outlook over the last couple of months. The BRICs have been the worst performing markets within the EM world: Brazil has lost 20.7% since end-Q1, Russia 17.5%, China 7.8 % (A shares) / 10.5% (H shares) and India 2.1%.
In the Frontier Markets world, the worst performance of Q2 came in Eastern Europe, where exposure to European banking sector problems is high, Saudi Arabia, which lost out because of falling oil prices, and Argentina where policy errors seem to come in lumps. African markets outside mining-sensitive South Africa continue to put in decent performance for niche players. Nigeria, where earnings expectations are being revised upwards, gained 6.9% in Q2. The end of the drought in Kenya and the fall in central bank policy rates that came with lower inflation led to a boost in local equities to the tune of 8.4%. Mauritius and Tunisia put on almost 2%.
Sector-wise, energy companies in Emerging Markets lost 18.3% in Q2 as oil prices fell hard. Materials dropped 13.3% while industrials and consumer discretionary fell 11%. All are high beta sectors in that prices go up and down by more than the overall market. It paid, on a relative performance basis, to be in defensive stocks in Q2 where betas were at the 70-90% level (consumer staples, healthcare and telecoms). In all cases other than financials and healthcare, the declines in Emerging Markets were greater in Q2 than experienced in the deeper and more sophisticated markets of the G7.
Looking ahead, it’s clear that markets want to believe that Europe is dealing with its problems and that growth expectations will not fall heavily. US numbers last week were softer than expected. The last estimate of Q1 GDP slipped on a downgrade of measured personal consumption although more forward looking indicators such as the Case-Schiller House Price index tend to indicate an improving outlook for the US consumer with diminishing balance sheet risk. But overall, the average economic surprise, relative to numbers expected by traders and analysts, was negative and marginally worse than one month ago.
European numbers always look bad these days, but stability seems to be returning to Emerging Markets – which after all make up most of the world’s important places. Data points coming out of China in the last few weeks show a marked improvement in the outlook for the world’s second largest economy. Our view at Emirates NBD has always been that the recent downgrade to Chinese growth expectations is a necessary evil given the state of local government finances after the stimulus measures of late 2008.
Even the former number two economy is looking better with probably the most dramatic increase in outlook of all the major economies. But politics in Japan have once again assumed centre-stage with today’s resignation of Democratic Party leader Ichiro Ozawa. Ozawa-san’s contribution to Japanese policy-making has always been immense and his departure many prove seminal. A huge fund-raiser for the DPJ, he allowed Japan to have two-party politics but at the same time his association with campaign financing scandal has left the country in a state of policy paralysis.
It may not come to anything, but Ozawa’s resignation may be the spur that forces Japan’s opposition to offer its population and investors something better.