Demographic Blues

- "Significant changes in demographic trends are about to occur in the euro area, especially in those countries, like Ireland and Spain, where labour growth has been a key determinant of strong economic performance in the decade before the recession. Less room for rising labour force participation rates will probably also reduce the labour growth contribution to trend GDP growth."
- "More adverse demographic and labour market dynamics are likely to significantly reduce trend growth in these peripheral countries. And this may translate into an impact on aggregate euro area annual trend growth of ¼-½pp."

The long run, the short run and the in between: “How does the global economy rebalance itself?”

- Questions to be answered
• "What is the impact for the financial markets if the US ‘double dips’?"
• "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?"

Nomura Strategy Research August 2010

Erratum: The changing landscape of Asian markets – a quantitative view

- 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 growing impact from Asia on the rest of the world. On quant factor investing, we highlight the performance differences between developed and emerging markets in Asia."
- Recent market specifics "The credit crisis that originated in the US has generated a rebalancing of global investments from the West towards the East. Since October 2008, the MSCI AC Asia 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 Asian markets, impressive fund inflows to the region, and increased fund-raising activities by 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 estimate changes 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 of the rising global factor effect on Asia equities when the global market recovered from the previous recessionary trough. Meanwhile, there is a significant decrease in 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 same level as that from US/Europe on the Asian markets."
- Investment factors that work "Developments in financial market infrastructure, together with improved market depth, 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 and earnings-revision indicators. The differences are more evident when we look at different market cycles. After the credit crisis, the utility of quant factors for investing continues look more promising in emerging Asia than that in developed Asia, with significant alphas generated from valuation devices such as E/P and B/P, and earnings revision indicators such as normalised earnings yield and revision index in emerging Asia."

Nomura Quantitative Landscape 20100818

Watch out for the Fed backtracking

- "US jobless claims data were weak, but incoming data suggest a double dip is still unlikely. The US economic slowdown is certainly not due to malfunctioning credit markets. Mortgage yields are at all-time lows, and corporate debt yields are also very low."
- "We believe the data need to turn significantly worse than what we and the consensus expect for the Fed to decide to step up QE; if and when it does, it will need to be overwhelming, probably accompanied by an inflation target."
- "Beyond the US, disinflationary forces appear to be over globally, particularly as there is upward pressure on food prices."
- "In China, we expect authorities to remain on hold to balance risks, but even if they ease policy, we expect them to keep measures aimed at lowering housing prices."

Barclays Global Economics Weekly 20100820

Commodity review

- "Price moves remain diverse across the commodities complex. Market concerns on recent softer macro-economic data have pressured crude oil prices, while agricultural commodities – grains and cotton in particular – have been relatively immune after witnessing recent supply-side production downgrades on adverse weather conditions. We dissect commodity investment trends in this month’s Commodity Investor with commodity investments passing an important milestone in July with AUM surpassing $300bn for the first time, as commodity inflows bounced back and prices strengthened"

Barclays Commodities Weekly 20100820

75 Years of Social Security – Happy Anniversary?

- "Social Security has provided at least some measure of economic security to those who pay into the system, much as President Roosevelt envisioned when 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 public programs to provide Americans insurance against old age or disability. Only about 3% of the elderly were receiving benefits under state plans, and only about 5% were receiving company retirement pensions."
- "Social Security has always been a pay-as-you-go system – the US Treasury can’t tell the difference between a dollar of Social Security tax revenue and a dollar from any other tax. The accounting convention of a Trust Fund reflects the fact that Social Security tax revenues have exceeded contemporaneous benefit payments, with the excess funding other government spending."
- "This year, however, Social Security is expected to fall into deficit, and it is likely to remain in the red through 2011, mainly because of high unemployment curtailing tax inflows. The Social Security Administration then expects three years of renewed surpluses (i.e., it assumes significant renewed job growth)."
- "In a few years, the program goes into deficit for the foreseeable future, mainly because of the surge in benefit payments to retiring (but not shy) baby boomers."
- "To cover these structural shortfalls, higher payroll taxes, reduced benefits, increased retirement ages, or some combination will be required. And in the aftermath of the 2007-09 financial crisis, it is hard to envision a groundswell of support for the George W. Bush-era privatization option."

CreditSuisse US Economics Digest 20100819

Keep calm and carry on

- 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 do so, we have high confidence that 10-yr bunds will be the first non-Japan major to have a 1.xx% handle in a very few weeks. Leg one of the rally is done with shorts exited. If data continues to be weaker than the strangely buoyant consensus predicts, watch out for leg two: longs established & equity->FI reallocation, making for violent yield lurches lower. If this plays out, we can easy 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 longheld 2¼% 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 that challenging given that the liquidity trap becomes more embedded."
- UK: "There’s a new target for the rolling flattening of the curve; 5s10s. On a variety of measures 5s10s looks too steep, and should flatten in around 40bp from here as the lower for longer themes meet the duration grab."
- Scandinavia: "the Swedish recovery is steaming on at this point in time and this will probably be reflected in another set of strong confidence figures from Swedish households and corporates."
- Inflation-Linked: "The question of whether we are heading toward a Japanese liquidity trap or just back to a 2004-5 style European slump is a crucial decision for the economy bears. We suggest a strategy of longs in inflation hedged with longs in real yields (overweighting linkers in a breakeven trade). Italy now looks rich against France on breakeven and we think that a cheapening into supply makes a sensible play."
- Volatility: "The bullish flattening 2y forward 10s30s is our proposed trade to benefit from expected flattening of GBP curve. We expect this trade pays off well if the BOE initiate the second round of QE and follow the tradition of buying Gilts all through the curve."

RBS European Rates Weekly 20100820

Bringing Leases on Balance Sheet

- Proposed new accounting rules — "The IASB yesterday published an Exposure Draft on Leases, which would eliminate the current operating/financing lease distinction and bring all leases on balance sheet. The final IFRS is due in Q2 2011, with the new standard planned to take effect no earlier than 2013."
- Bigger balance sheets — "The ED proposes that lessees should report the present value 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 an interest charge on the liability. Lease cash flows would be reclassified in the cash flow statement."
- Effect on key metrics — "For many companies using leased assets, the proposed change would increase reported debt and gearing, increase Enterprise Value/Sales multiples, increase operating cash flow, and affect other valuation multiples. It would also reduce EPS of many companies on initial adoption of the new rules."
- Sector impact — "Retail, transport and leisure sectors would be particularly affected by the new rules."
- Company impact — "UK companies with significant operating lease exposure include Regus, Debenhams, DSG, Home Retail Group, Tui Travel, Kingfisher and Sainsbury. In the MSCI Europe ex UK index, the most affected companies include Iberia, Autogrill, Kesko, Accor, JCDecaux, Tui and Air France."

Decline in unit wage costs: What effects?

- "There has been a fall in unit wage costs due to the slowdown in wages and companies’ 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 a rise 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 real estate) assets."
- "In the first case (seen more in Japan), this development is negative for asset prices and investment; in the second case (seen in the United States currently, but also partially in Japan and in the future in the euro zone), it is positive (asset purchases by companies)."
- "In the first case, the fall in prices curbs the fall in real wages and improves competitiveness, but not in the second case: the consequences on asset prices and demand are therefore opposite, but for each there is a negative consequence."

Natixis Flash Economics 399 20100818

An Old Conundrum

- De-coupling — "Global government bond yields have fallen to multi-decade lows but 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 occasions when global bond yields and stock prices have diverged. Equities have been proven ‘right’ six times versus bonds two times. Divergence was unresolved twice."
- Bond Yields Expected to Rise — "This time, we expect the conundrum to be resolved through rising bond yields. Citi rate strategists suggest that a sustained global economic recovery and gloomy fiscal outlook should push yields up from their current historically low levels."
- What Should Equity Investors Do? — "Falling bond yields didn’t help stock prices rise so rising yields shouldn’t be a major headwind for equity investors. We think those expecting a rise in bond yields should consider buying Japanese equities (local currency) and global cyclicals like Diversified Financials, and consider selling global defensives like Telecoms."

EM capital markets growth prospects after the global crisis

- "The global crisis has further enhanced the relative growth prospects of emerging markets (EM) capital markets. Advanced economies’ capital markets will continue to make up the bulk of global financial assets, developed markets (DM) deleveraging and EM leveraging notwithstanding. Emerging Asia has not only the largest capital markets, but also the most developed markets in the EM space. From the perspective of global investors and, even more so, financial services providers, some (segments) of the rapidly growing EM financial markets can only be accessed with some difficulty and tapping into their growth 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."

DeutscheBank Talking Point 20100820

Near-term setbacks in store

- Short view: Running ahead of fundamentals "We look for Q3 to be relatively weak and stress that (further) setbacks in prices should be expected; price rises could be seen toward year-end as markets realise that the global economy is not heading for a worst-case scenario. Also, a weaker dollar and positive sentiment 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 slipping further on compliance only a small deficit to be seen this year. This should leave forward demand 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 likely bubble in the Chinese construction sector. We have left our longer-term base metals forecasts largely unchanged but now pencil in marked softness in Q3. We see aluminium and 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 stocks and that spill-over to soybeans and corn should be limited. Correction in store and limited 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 industrial metals before locking in prices of copper and aluminium. Clients who are net sellers of wheat could in our view do well in fixing current price levels in the grain. On oil, we suggest awaiting a decline to below USD74/barrel for Brent before locking in expenses."

DenDanske Commodities Monthly 20100819

EUR/GBP: return to June low?

- "Comments by ECB council member and 2011 candidate president Weber on the possible extension of unlimited liquidity until year-end have not gone unnoticed, casting a shadow of 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 risk beating a retreat, the success of Japanese officials to temper the decline in USD/JPY can be questioned and indicates that the cross may be settling in a range around 85.0. The perceptible weakening of the US economy in Q2 is showing signs of spilling over in Q3 and means the USD is set to remain a safe haven magnet along with the CHF. Unrevised UK Q2 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 mixed performance for GBP vs other G10 currencies. GBP/USD fell 0.4% to 1.5532, having slipped below 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 still looms, though reluctance to push the cross lower on a sell-off in stocks indicates that investors have become more wary of intervention ahead of the next BoJ meeting. The CHF topped 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 on the 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 dampen speculation of the MPC soon resuming its asset purchase programme. The MPC minutes showed the committee voted 8-1 in August to keep BR and the APF on hold. Discussions included both an easing and modest tightening in policy. ECB member Weber stated his preference 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 mean additional Fed measures and stimulus spending cannot be ruled out."
- "No change in theme. Bullish seasonals and weak US macro data helped gilts to extend their stellar performance, with 10y gilt yields dropping below 3% and EU 30y yields falling below 3%. For 10y gilts, the 2.93% low of 2009 is now within striking distance. Even as investors question bond valuations, there could be further downside for yields and swaps if UK data sours. 5y swaps dropped to 2.07%. The 2y/10y swap spread tightened to 182bp, with cash compressing to 234bp. The 10y swap spread held at +5."

LLoydsTSB FX Strategy Weekly 20100820


Creating liquidity out of illiquidity - FT Alphaville
Why Bond Volatility Is Acting Abnormally - Minyanville
How Scary Are Municipal Finances? - Morningstar
The Baltic Dry Index Has Exploded Higher- Money Game
Pressed to Act, Bank of Japan Sees Few Ways to Lift Demand - New York Times
The Taylor Rule And The “Bond Bubble” - Paul Krugman