Archive for the ‘Stock Market’ Category
In an 108-page report, management consulting firm McKinsey projects a massive change in the geographical ownership of financial assets by 2020. The implications are profoundly disturbing.
From the Executive Summary:
Several forces are converging to reshape global capital markets in the coming decade. The rapid accumulation of wealth and financial assets in emerging market economies is the most important of these. Simultaneously, in developed economies, aging populations, growing interest in alternative investments, the move to defined-contribution pension schemes, and new financial regulations arechanging how money is invested. These forces point to a pronounced rebalancing of global financial assets in the coming decade, with a smaller share in publiclylisted equities.
- Today, investors in developed economies hold nearly 80 percent of the world’sfinancial assets—or $157 trillion—but these pools of wealth are growing slowly relative to those in emerging markets.
- The financial assets of investors in emerging economies will rise to as much as 36 percent of the global total by 2020, from about 21 percent today. But unlike in developed countries, the financial assets of private investors in these nations currently are concentrated in bank deposits, and keep little in equities.
- Several factors are reducing investor appetite for equities in developed countries: aging populations; shifts to defined-contribution retirement plans; growth of alternative investments such as private equity; regulatory changes for financial institutions; and a possible retreat from stocks in reaction to low returns and high volatility.
- Based on these trends, we project the share of global financial assets in publicly traded equities could fall from 28 percent today to 22 percent by 2020. That will create a growing “equity gap” over the next decade between the amount of equities that investors will desire and what companies will need to fund growth. This gap will amount to approximately $12.3 trillion in the 18 countries we model, and will appear almost entirely in emerging markets,although Europe will also face a gap.
- As a result, companies could see the cost of equity rise over the next decade and may respond by using more debt to finance growth. Only a tripling of equity allocations by emerging market investors could head off this drop in demand for equities—which will be difficult to accomplish in this time frame, given the remaining institutional barriers. The probable outcome is a world in which the balance between debt and equity has shifted.
The implications of this shift are potentially wide ranging for investors, businesses, and the economy. Companies that need to raise equity, particularly banks that must meet new capital requirements, may find equity is more costly and less available. Reaching financial goals may be more difficult for investors who choose lower allocations of equities in their portfolios. And, with more leverage in the economy, volatility may increase as recessions bring larger waves of financial distress and bankruptcy. At a time when the global economy needs to deleverage in a controlled and safe way, declining investor appetite for equities is an unwelcome development.
I’m not, but JPM has more clout than I do. Here’s the summary of its self-described “contrarian” case for U.S. equities.
Equities Rise Despite Uncertainty…
2011 is a year most investors would like to forget. Even though equity markets areessentially flat year to date, the S&P 500 saw a 300-point range (a 9% rally followed by a 22% drop, followed by a 20% rally). Multiple events contributed to this: Japanfloods, Arab spring, Peripheral Europe, and U.S. AAA downgrade. However, despitethis (Italian yields even broke above 8%), surprisingly U.S. equity markets are flatfor the year.
- We believe this is a testament to a combination of: 1) U.S. economic resilience;2) U.S. corporate financial strength and pricing power; and 3) severe relativeundervaluation of equities (supporting prices).
Eight Reasons to Be Contrarian (Optimistic)in 2012
The consensus view is that visibility remains murky with significant tail risks(European systemic crisis, China hard landing, U.S. fiscal tightening) and the outlook for equities is generally muted with only one strategist seeing equitiesin 2012 exceed the 1371 high of 3/11. However, we have eight reasons to beconstructive, as shown below.
1. J.P. Morgan Fixed Income Strategists are constructive for 2012 on High Grade, High Yield, MBS, ABS, and CMBS. Given equities are the junior piece of the capital structure, this is positive for equities.
2. Consensus is cautious about 2012.
3. The J.P. Morgan base case is for the Euro crisis to abate by 2H12 with Europe potentially exiting recession by mid-year. Historically, equities have bottomed 6-9 months ahead of a return to growth.
4. EBIT margins should expand 100-150bps in 2012, bolstering net profit margins by 60-90 bps to 10%, setting a new high for profit margins and driving 2012E/2013E EPS of $105/$110.
5. Corporates are likely to ramp up total cash return by asmuch as $250bn in 2012. For the past five years, corporates have represented 97% of the incrementalinflows into equities.
6. U.S. housing should see a further advance in its recovery in 2012, driven byexpanding household formation rates. Vacancies are at five-year lows and other factors are also supportive.
7. The 2012 U.S. election cycle should be positive for equities. Stocks havehistorically done well when an incumbent has had low approval ratings going into an election year (positive returns in seven of eight years).
8. China entering selective easing cycle sets the stage for a Cyclical upturn in EPS.
Establishing Year-End 2012 Target of 1430; Favor Cyclicals and FinancialsWe believe the S&P 500 will reach 1430 by the end of 2012. This based on a targetmultiple of 13.0x estimated 2013 EPS of $110. From any historical lens, this P/Emultiple appears conservative, representing an earnings yield of 7.7% (compared to JULI HG yield of 4.4%).We see Cyclicals and Financials outperforming, withFinancials as our top pick for 2012.
As everyone who pays attention to financial matters knows by now, S&P this afternoon put 15 eurozone governments on “CreditWatch With Negative Implications.” Click here for the details of its sovereign rating actions.
More interesting to me are two posts in the FT Alphaville blog that expand upon a section (beginning on page 61) of the Credit Suisse 2012 Global Outlook report. I addressed the first post earlier today. The second Alphaville post (“S&P plays Grim Reaper for the upcoming death of AAA“) was published after S&P issued its warnings:
[By warning governments that their ratings could be lowered] S&P surely also questions the AAA future of the EFSF. Many will also question the timing of any S&P announcement, coming shortly after Merkozy’s latest deal and with the “crucial” European summit a few days away. But…
Why is this (long overdue) realisation important? For one thing, as noted on FT Alphaville earlier on Monday, the universal pool of ‘risk-free’ investments has been contracting since 2008 anyway:
That in turn has caused a major run on the few remaining ‘safe assets’ out there.
A situation which in itself has fueled record low yields and negative repo rates on quality collateral, but rising yields, repo rates and hair cuts on ‘unsafe collateral’. Collectively, the two phenomena have choked up access to cheap secured funding. Regulatory moves to increase the amount of ‘quality collateral’ held unencumbered on banks’ balance sheets, as well as a general move towards central counterparty (CCP) trading relationships — all of which require more pledged collateral — have hardly helped to ease the collateral crunch.
Without enough ‘quality collateral’ to go round, some governments have even turned to synthetic alternatives to try and fill the gap.
But what does the end of risk-free really mean in this context?
We’d say the fact that there is no such thing as a principal protected investment anymore — no matter how pronounced the dash for the underlying security itself is. One way or another, the investor is now prepared for the fact that he may lose principal — either as a result of gambling in risky securities, or by paying a charge to be invested in less risky securities. [My emphasis]
You could say, the investment world has gone from a world of absolutes to a world of relative investments as and how they compare to cash deposits.
If you want to ensure that you’ll get your money back over time, you now have to pay up for the privilege of doing so via a possible negative yield. It’s the de facto depreciation of money in play. There’s no such thing as a safe investment and you can’t expect an interest rate unless you take a sizeable risk. [My emphasis]
On a relative scale, it doesn’t really matter which debt investment is considered the safest.
The difference between negative yielding debt and positive yielding debt is now about the difference in risk perception. The first sees the investor knowingly erode his wealth for the privilege of investing in the safest asset out there, the second sees the investor chance his wealth for the privilege of receiving a yield.
The first allows an investor to offset the wealth erosion effect via a lending fee, since the cash he receives can only be invested with exposure to greater risk. The second expects the investor to compensate the market (via a larger haircut payment) for the greater risk associated with lending cash against ‘unsafe assets’.
In the first, the investment is considered safer, or as safe, as cash deposits (after national insurance costs are factored in), while in the second, the investment is considered much riskier than cash deposits alone.
The riskier the asset, the larger the haircut.
Both, nevertheless, see cash unwittingly re-collateralised. Too much cash relative to existing collateral equals a natural contraction and what might be described as a self-enforced move towards negative rates in assets perceived to hold value, against a self-enforced move towards higher rates (and haircuts) in assets deemed likely to depreciate.
Sure sounds like 1930s-style deflation to me.
Forecast summary from GS’s “US Portfolio Strategy 2012 Outlook”:
- Global economic growth will equal 3.2% in 2012 and 4.1% in 2013. Europe will be in a recession for most of 2012 and the status of the Euro is questionable. Our outlook remains strongest in Asia ex-Japan with GDP growth above 7% in both 2012 and 2013.
- The US economy will post its fifth consecutive year of stagnation with GDP growth of 1.5% in 2012 and 2.2% in 2013. Consensus estimates are higher at 2.1% and 2.7%, respectively. We expect unemployment will remain above 9% through 2013.
- Inflation will remain subdued with core CPI at 1.7% in 2012 and 1.3% in 2013. Fed Funds will remain unchanged at 0%-0.25% through 2013. We forecast 10-year Treasury yields will end 2012 at 2.5% and rise to 3.25% by year-end 2013.
- Earnings per share (EPS) will grow by 3% to $100 in 2012 and by 7% to $106 in 2013. Bottom-up consensus estimates equal $108 and $119. Different margin assumptions explain the gap between top-down and bottom-up forecasts.
- Profit margins will slip from a peak of 8.9% in 2011 to 8.7% in 2012. However, bottom-up consensus expects margins to reach a record high of 9.4% next year. Every 50 bp swing in net margins translates into roughly $4 per share in 2012 EPS.
- Valuation in the stagnating economic environment should remain flat with a forward P/E multiple of11.8X at year-end2012. Our dividend discount model (DDM) anchors our12-month target of 1250. Our uncertainty-based P/E multiple model suggests fair value of roughly 1210.
- Defensive sectors should outperform given the weak economic backdrop. We recommend investors overweight Consumer Staples, Telecom Services, and Information Technology; and Underweight Consumer Discretionary, Industrials, and Materials.
CNBC says that the release of this report on the European exposure of U.S. banks is what caused the equity market to weaken this afternoon. An excerpt:
Fitch believes that, unless the eurozone debt crisis is resolved in a timely and orderly manner, the broad outlook for U.S. banks will darken . . . The risks of a negative shock are rising and could alter Fitch’s stable rating outlook for U.S. banks . . . Any prolonged turmoil could negatively affect capital market-related revenues well into the future, not to mention the possible effects on loan portfolios and other revenue opportunities.
. . . Ratings of U.S. banks could be pressured if difficulties in Europe, combined with domestic economic challenges, result in significant incremental revenue pressure, combined with a reversal of positive asset quality trends. U.S. banks have been reporting improving asset quality in 2010 and to date in 2011. This positive trend could change course if contagion effects translate into a slowdown in general economic activity. The U.S. economy already faces continued pressure on real estate and persistently high unemployment, combined with fiscal pressures at the government level.
How insightful! If this was enough to send the market south, the equity market is on very shaky gound.
Consider these headlines, all from this evening’s ft.com:
US stocks build on strong economic data
US retail sales rise in October
US consumer sentiment at five-month high
US jobless claims fall to 390,000
Eurozone bonds hit by mass sell-off
Belgium bond yields rise sharply
Borrowing costs leap as contagion fears engulf Spain
Dutch hurt by downturn
For those with short memories, recall that the consensus view after the Lehman meltdown was that emerging economies had decoupled from developed economies. Reality — in the form of a sharp decline in exports to the U.S. and Europe — soon overtook what turned out to be nothing more than hope.
All signs indicate that Europe’s recession has begun and will intensify. American exports to Europe and the European operations of U.S. multinationals will suffer the same fate as did emerging economies three years ago.
Hope — the rising American stock market — will not spring eternal.
From the Economist’s Free Exchange:
I have to say, I’m puzzled. Recent developments in the euro zone seem incredibly negative to me. The probability of a reasonably orderly conclusion of the crisis appears to be falling. Yet equities aren’t dropping; indeed, they’re up from early September. Has the roadrunner sprinted off the cliff but not yet looked down? Or am I missing something?
Yes, I know that recent U.S. economic data, while nothing to write home about, has been stronger than was expected a month or so ago, eliminating, for the time being at least, fears that our economy is on the edge of recession. But — and it’s a big but — the eurozone crisis, including eurozone economic data, is worsening, with no end in sight. Presumably, we learned a thing or two about contagion in 2008. To be bullish on our stock market, not to mention on European markets, you’d have to believe that contagion works in only one direction: from the U.S. to Europe, as in 2008, but not from Europe to the U.S. That belief would rank very high on the list of all-time heroic assumptions.
Presumably, institutional investors — and it is they, not the retail crowd, that are driving the markets — earn their fees for (correctly) anticipating the future. In this retired Wall Street analyst’s eyes, they’re being incredibly myopic. Their argument — to the extent they have one — is that corporate earnings are doing just fine, thank you very much. Even more impressively, profits are rising within the context of an uncertain and less than stellar economic and political macro environment. But this can’t last; eventually, the macro environment will win. Take your pick: will it be (1) a Lehman moment in the eurozone, or (2) the failure of the congressional supercommittee to agree on anything, or (3) heightened uncertainty in next year’s presidential contest?
When the bloom comes off the profit rose, there’ll be nothing left to support the bull case. A waterfall decline will then ensue.
UPDATE — I’m not alone. From Athelstan in the FT Alphaville Long Room:
Disclaimer: I trade U.S. energy equities and debt both long and short at a hedge fund.
Everywhere I look, discord dominates. Equity and credit markets are at odds on the outcome of the EU. IMHO, it is a matter of months before the charade cascades into chaos. Equities soar with endless bids, yet try to sell a few million of the average high yield energy issuance and buyers fade. Brokers pull bids and size shrinks.
The Euribor-OIS hovers between 89 and 99 bps, the highest ever, 2008/9 aside. European financial institution funds on deposit with the Fed and ECB are nearing non-2008/9 highs. The ECB steps in daily when the Italian spread to the average of Germany, France, Holland exceeds 400 bps (450 bps is the LCH Clearnet margin increase trigger). The S&P 500 and the DAX change over 100 bps every day for nearly 3 straight months. Volatility is stratospheric, not as measured by the VIX, but by the pure aggregate magnitude that every global asset has changed value by since July.
Money is darn near free the world over, yet everywhere you look there is a liquidity crisis that is not and can not be solved with ever cheaper rates. As though U.S. home owners are going to buy more homes because the Fed has gotten the rate from 4.5% to below 4%. When you are strapped for cash, it isn’t the rate that matters.
We are in the early stages of a global liquidity crisis that can’t be solved with Fed printing presses. The world began deleveraging in 2007 and hasn’t stopped yet. It cannot stop until we hit bottom, wherever that is. We are entering the phase where we are trapped by liquidity itself because there is nothing left to do.
I suspect it ends with global velocity of money being halved or something horrendous like that. Where credit is tight and actual equity is needed. Growth in developed worlds will stagnate and growth in developing worlds will feel to them like a recession. The never ending risk bid in oil will fade. Correlations will have to break down so that risk takers can be certain that they are making a distinct bet and not a global bet through what they thought was a discrete asset.
It has long been true that massive and repetitive volatility signals uncertainty. That volatility can only end through exogenous intervention that seeds certainty, or when prices fall enough to over-discount the unknown for long enough to be clear that it is over-discounted, not merely for 1 day as on 10/4/11.
Unfortunately, Jesus is unlikely to make a new pilgrimage and I don’t believe Aliens want to take our global debt from us. So until then, I fear only much lower prices worldwide will cause the end of the beginning of this global margin call.
The equity market is usually the last to get it. My advice is to stay out of the fray until the dust settles. As you can see by global hedge fund net/gross exposure levels, they are the lowest since 2008 and have only been and stayed this low one other time: pre-2008/9 crash. Hedge funds are saying the worst is yet to come.