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Marcuard's Market update by GaveKal Dragonomics
The financial crisis of 2008-2009 heralded a golden age for macro investors. As the wholesale market crash rendered the relative value judgments of stock pickers irrelevant, macro investors enjoyed a boom time—especially ones who had had the foresight to short US housing, global financials, or eurozone peripheral debt. Now, as the crisis recedes further into the rear view mirror, macro investors have struggled to adapt to a world in which established relationships have broken down, leaving in their place a multitude of puzzling contradictions.
Take for example this year’s sudden deceleration of China’s construction boom. As you would expect, this has hit iron-ore prices and Baltic freight rates (which are back to their 2008 lows). But despite this unappealing backdrop, the CRB commodity index is up 9% year-to-date while the Australian dollar is the world’s best performing major currency this year. Just as awkwardly for many macro investors, Japanese inflation has rebounded by more than 150bp on the back of the Bank of Japan’s aggressively reflationary policies. Yet JGB yields remain stuck to the floor and Japanese reflation plays are among the world’s worst performing trades so far in 2014. Meanwhile the yen, with gains of 2.7% against the US dollar and 4.1% against the euro, has confounded all predictions of a sustained bear market.
Then there has been the rally in US treasuries. With the Fed tapering, with loan growth in the US in double digits and with wages rising, most investors felt that 2014 would follow in 2013’s footsteps and deliver poor returns for bond portfolios. Instead, 30-year US treasuries have delivered among the highest returns of any asset class so far this year.
This breakdown in macro relationships that investors had come to take for granted is the over-arching issue. There are four key sub-issues:
• With China experiencing a combination of disappointing growth and limited room for maneuver on stimulus, Beijing will have little choice but to embrace more aggressive reforms. This means we should expect fresh surprises on the policy front—which in turn should unleash some interesting investment opportunities.
• Will Japan regain its reflationary mojo? The Topix has now risen for ten consecutive days, partly on the back of a promised corporate income tax cut. Will corporate tax cuts, combined with an ever-reflationary BoJ, lift Japanese equities from their place as this year’s worst performing major stock market to a more respectable position in the league table?
• Is inflation in the US set to accelerate? For structural reasons we have long held the view that deflation constitutes a bigger risk for most developed economies than inflation. But having said that, we recognise that US inflation data has been ticking higher recently and we have to ponder whether this is the start of a new trend. If it is, will it mark a profound change in the investment environment?
• One place where a pick-up in inflation is definitely not happening is euroland. Instead, inflation continues to make new lows, even in healthy economies such as Germany. Does this mean the ECB will now embrace unconventional monetary policies, and do so for as far as the eye can see? In the absence of aggressive continent-wide fiscal stimulus, an overly easy ECB may seem to most observers the only way to keep the euro-show on the road.
The answers to these questions should help dictate the path of financial markets over the coming quarters.
