Daily Themes 2009

January

Daily Theme - 30 January 2009
Sterling weakness – who stands to benefit?

Daily Theme - 29 January 2009
Fed's quantitative easing - any credit due?

Daily Theme - 28 January 2009
Is the mortgage-backed securities rally over?

Daily Theme - 27 January 2009
Sizing up the US stimulus package

Daily Theme - 23rd January 2009
The bear facts

Daily Theme - 22 January 2009
Rather fail with honour than succeed by fraud

Daily Theme - 21st January 2009
If they are printing dollars why pay good money for them?

Daily Theme - 20 January 2009
UK policy - making quantative easing easier

Daily Theme - 16 January 2009
EUR becoming a problem

Daily Theme - 15 January 2009
Change begins at home

Daily Theme - 14 January 2009
Property yields - a value trap?

Daily Theme - 13 January 2009
Investment-grade credit - winning by default

Daily Theme - 9 January 2009
Equity valuations - the regional rankings

Daily Theme - 8 January 2009
Zero Bound

Daily Theme - 7 January 2009
Sector trends for 2009

Daily Theme - 6 January 2009
All eyes on lending

February

Daily Themes - 27 February 2009
Equity valuation in a non-equilibrium

Daily Themes - 26 February 2009
A little help from your friends

Daily Themes - 25 February 2009
Mortgages back in business - backed by the government

Daily Themes - 24 February 2009
Fed downgrades growth potential

Daily Themes - 20 February 2009
Bear market rallies

Daily Themes - 19 February 2009
The Eastern Question

Daily Themes - 18 February 2009
Silver Lining

Daily Themes - 17 February 2009
Putting the leverage machine in reverse

Daily Themes - 13 February 2009
A missed opportunity

Daily Themes - 12 February 2009
Braking China

Daily Themes - 10 February 2009
De-globalisation?

Daily Theme - 6 February 2009
Better late than sorry

Daily Theme - 5 February 2009
Warnings from history

Daily Theme - 4 February 2009
The economic impact of the stimulus

Daily Theme - 3 February 2009
Reykjavik-on-Thames?

March

31 March 2009 - Inflation envy
Our view that developed economies face a period of benign inflation – because of the large negative output gaps being accumulated during the current recession – is often challenged by our clients. One objection is that inflation is, deliberately or otherwise, under-reported in many economies and is already much higher than the official numbers suggest.

27 March 2009 G20 stimulus – so how have they done so far?
At their November 2008 summit in Washington, DC, the leaders of the G20 countries promised to ‘use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability’

26 March 2009 Reweighing the probabilities
In our 2009 Outlook , we presented three different scenarios for global growth, based on the effectiveness of monetary and fiscal policies. In our central scenario, those policies would gain traction and the world would experience ‘only’ a severe recession.

24 March 2009 PIPP – not just another acronym in the fight against toxic debt 
The US Treasury Secretary, Tim Geithner, has finally announced his plan to tackle what the Treasury calls legacy assets but most investors know as toxic debt.

20 March 2009 QE II – now the Fed buys Treasuries 
On Wednesday, the Federal Reserve (Fed) announced that it would expand its programme of quantitative easing (QE) by purchasing up to $300 billion of longer-term Treasury securities over the next six months.

19 March 2009 Global economy - tentative signs of stabilisation
During the UK’s early-1990s recession, Norman Lamont, then the Chancellor of the Exchequer, was ridiculed for saying that he had spotted ‘the green shoots of economic spring’ in October 1991, long before they were apparent to the average voter.     

18 March 2009 Equities rally - but where's the credit 
Equity markets often rally in the face of bad or even worsening economic news – as now. The key driver for share prices is whether the news is better or worse than investor expectations.

17 March 2009 Eurozone government bonds - what's in the spread? Spreads between the yields on the government bonds of all countries in the eurozone have widened significantly over the past year.

13 March 2009 Dividend yields - a house built on sand?
On 27th February, General Electric, the last surviving member of the original Dow Jones index, announced its first dividend cut since 1938.

12 March 2009 Where China leads, others will follow 
A consistent theme of our published research in recent months has been a view that headline inflation rates in a number of major economies are likely to turn negative in the first half of this year, fuelling concerns about deflation.

11 March 2009 Picking equity ideas in a deflationary environment
Selecting equity sectors that will outperform in a deflationary period is a bit like quantitative easing: it’s all theoretical, as the only historical parallel is Japan and that, for a variety of reasons, doesn’t really work. 

10 March 2009 Back to the 70s, but without the inflation
February's US labour market data (published 6 March) showed a sharp monthly decline in payrolls of 650,000.  The unemployment rate of 8.1% is still below 1982's 10.2%, the post-1945 peak, but it is increasing at a rapid clip.

6 March 2009 Quantitative easing - the UK takes the plunge
Unfortunately, cutting rates further is no longer a realistic option in the UK. So it’s no real surprise that the BoE officially announced the launch of a process of quantitative easing (QE) aimed at kickstarting the UK economy.

5 March 2009 Consumer prices can go down as well as up
Having fallen to just 0.1% year on year in January, the UK inflation rate – as measured by the Retail Prices Index (RPI) – is set to turn negative for the first time since the early 1960s when the February number is released later this month.

4 March 2009 Commodities in the credit crunch
Though we mainly focus on oil and gold, other commodities have seen equally dramatic moves over the past year.

3 March 2009 UK interest rates - down and out
The coming week will see policy announcements from a number of central banks around the world, most notably the European Central Bank and the Bank of England. We forecast a cut in interest rates of 50 basis points from both.

April

30 April 2009 - Stress tests – more pain to come?
The IMF published its semi-annual Global Financial Stability Report last week, ahead of the US banks’ stress-testing results (due next Monday). Though acknowledging that the unprecedented policy response to the global economic crisis is gradually starting to boost market confidence, the IMF warned that the challenges to restoring financial stability remain significant.

29 April 2009 - From SARS to swine – the economic and market effects of pandemics
We are not epidemiologists, so anyone interested in a forecast of precisely how and indeed whether the current outbreak of swine flu centred on Mexico will spread should look elsewhere.

28 April 2009 - Credit issuance – the patina of normality
During the first quarter of 2009, primary issuance by high-grade corporates soared to around pre-crisis levels. This has been taken by some as a sign that credit markets are returning to normality, or even that they are facing a ‘bubble’ of excessive issuance prompted by unsustainable investor demand.

24 April 2009 - UK public finances – the worst is yet to come
The public finance forecasts in this week’s UK 2009 Budget make for dismal reading. In order to return to a sustainable fiscal balance, the next UK government – regardless of its political complexion – will have to contemplate a combination of stringent spending cuts and tax increases on a scale not currently under public discussion.

23 April 2009 - Green shoots of slower contraction, not recovery
Five weeks ago, we published a Daily Themes entitled, “Global economy – tentative signs of stabilisation”. The gist of this piece was that we were on the look out for green shoots of recovery. Over the past couple of weeks, press articles and politicians have started to trumpet signs of nascent recovery increasingly loudly. But, while there has certainly been some better data lately, it is important to keep things in perspective.

22 April 2009 - US bank stress tests – has anybody done their homework?
The US bank stress tests were introduced only ten weeks ago but seem to have already been overtaken by events. Practically every assumption seems to be under challenge, so the results, when announced on 4th May, will be like one of this season’s Grand Prix races: the subject of endless steward enquiries before the final winner is known.

21 April 2009 - UK Budget preview – a billion here and a billion there…
Tomorrow sees the presentation of the UK government’s 2009 budget. Because of the rapid increase in government spending in the years immediately before the current economic downturn, the public finances are in worse shape in the UK than in most other developed economies.

17 April 2009 - Earnings revisions – What is priced in?
First quarter earnings reports from a number of US blue chips – including the likes of Goldman, Intel, Citigroup and GE – have come in this week, to be followed by almost half of the S&P 500 companies over the next fortnight. Clearly, markets are braced for bad news, but exactly what are expectations and what is priced in to valuations?

16 April 2009 - The outlook for government bond yields A number of clients have asked about the likelihood of a significant rise in bond yields in the coming months. Our view is that, with credit growth still weak, capacity utilisation very low and major central banks still in the process of buying bonds, a cyclical bear market in bonds is not an imminent concern.

15 April 2009 - Re-building Chinese growth
The property market is key to the speed and scale of China’s recovery, we believe. But opinion is as sharply divided over the health of this sector as over the broader economic outlook, with signs of market stabilisation at odds with warnings from commentators that house prices will collapse.

9 April 2009 - Crunch time for the bear market
At the end of last week, the S&P500 was up 26% from its 666 low at the start of March. That makes it the second significant rebound of the current bear market (after the one at the end of 2008).

8 April 2009 - Taking stock of the recovery
Despite all the advances in terms of speed of manufacturing, transportation and ‘just in time’ management, manufacturing’s natural lags remain, with the intertwined trends of specialisation and globalisation resulting in supply chains stretched around the world.

7 April 2009 - House prices - still a one-way bet?
The last month has seen an improvement in the tenor of much of the economic data from the very low levels at the turn of the year. The housing market is no exception.

3 April 2009 - Fishing for a bottom – lessons from history
In a previous Daily Themes ( 23rd January: ‘The bear facts’ ), we warned investors about the risks of mistaking a short-term technical rebound for the start of a new, sustainable bull market.

2 April 2009 - G20 summit – “A little less conversation, a little more action please.”
Today’s gathering of world leaders in London to address the global financial crisis is likely to be long on conversation and short on action. Most of the substantive decisions have already been taken.

1 April 2009 - Tinkering with currencies
The temptation to tinker with one’s currency is almost irresistible for policy-makers. It offers ‘cost-free’ solutions to economic woes, as the benefits of increased competitiveness can be claimed while the ‘hidden’ costs of inflation and an increased risk premium for assets held by foreign investors are ignored.

May

29 May 2009 - Is the market running out of steam?
The S&P 500 touched its high for the current market rally at 929 back on 8th May, moving back to a more or less flat performance for the year after sinking to a low of 676 at the beginning of March. However, over the past three weeks, the US stock market has traded sideways (see graph below) in a very narrow band of barely 3% (from 883 to 910). That mirrors the behaviour of our proprietary investor sentiment indicator, which – after a strong recovery from very pessimistic levels back to optimistic territory – is also pausing and has even turned down of late, though very marginally. Could this herald a period of consolidation after a rebound that has seen US equities rise by 37% over two months?

28 May 2009 Leading indicators – providing positive feedback
Leading economic indicators are pointing to a brightening outlook. This improvement in the economic prospects has boosted investor confidence and capital markets. And rising stock markets have in turn raised consumer sentiment. All of which has led to some observers to point out that the recovery so far has been insubstantial, noting the self-referential nature of the improvement. While accepting the truth of these comments, we reject the conclusion. Economics is a social science. So, to ignore changes in sentiment, whether consumer or investor, is to ignore the importance of ‘animal spirits’, as described by John Maynard Keynes in 1936 in the aftermath of the Great Depression. 

27 May 2009 Corporate bonds - endorsing regime change?
The rally in corporate bonds over the past two months has by some measures been more extreme than that in equities. US high-grade corporate spreads are now at almost exactly the same level as when Lehman Brothers failed in mid-September, while the S&P 500 is still 25% down over the same period, even after its recent powerful rally. So has credit gone too far too quickly?

22 May 2009 - Grounds for optimISM? 
People familiar with our publications will have seen frequent references to the US Purchasing Managers’ Index from the Institute of Supply Management (ISM), which every month assesses companies’ views on topics such as new orders, production, employment, inventories and prices. This indicator has an excellent track record of giving early signals on the level of activity of the world’s largest economy and hence is closely monitored by economists and investment professionals.

21 May 2009 - Structural headwinds will shape the recovery
We first published a Daily Themes noting signs that the global economy might be stabilising two months ago ( 19 March 2009, ‘Global economy – tentative signs of stabilisation’ ). Two months on, and there is mounting evidence that the pace of contraction of the global economy has lessened, having been at its most intense in the first quarter. So this seems an opportune time to start to consider the nature of the recovery that lies ahead. 

20 May 2009 - Property – global recession, local recovery
Property markets are traditionally the most local of investment assets, as suggested by property investors’ mantra ‘location, location, location’. Yet the latest surveys show that local differences have been over-shadowed by the current recession and by the impact of a global liquidity crisis and credit crunch on an asset that has in the past relied heavily on debt funding.

19 May 2009 - Tilting at inflation windmills 
Some commentators and investors perceive a mechanistic relationship between the quantitative easing (QE) policies now being pursued by all the world’s major central banks and inflationary pressure. However, changes to the monetary base only affect broad money supply and inflation through the nexus of the commercial banks’ balance sheets – and they are currently being shrunk, not expanded.

15 May 2009 - EME returns = alpha + beta x DEV returns
Emerging equity markets have hit the headlines lately for their stellar performance not only in absolute terms but also relative to developed markets. According to MSCI, they are up 25% in dollar terms so far this year, while developed equities are perfectly flat. As usual in these cases, investors may start to wonder if things are different this time and emerging markets are decoupling.

14 May 2009 - UK housing market – firming foundations
This week’s survey from the Royal Institution of Chartered Surveyors is consistent with the message from lending data: the pace of house price declines will slow in the months ahead, but the market is not yet strong enough to sustain rising house prices.

13 May 2009 - Rebuilding the economy – the case for global infrastructure
With the world in recession and economic activity shrinking around the globe, it may seem a poor time to invest in infrastructure. Yet we would argue that cash-flow-producing real assets are an attractive addition to portfolios at present; economic stimulus packages, which include substantial funds for infrastructure investment, will support the sector; and infrastructure assets are now available at more attractive prices, offering the potential for strong returns.

12 May 2008 - UK public finances – the hard choices ahead
A favourite topic of discussion for clients, both inside and outside the UK, is the perilous state of the UK government’s finances. This concern is justified: the UK currently has a structural deficit of 5-10% of GDP. There are three solutions to the problem, and they are not mutually exclusive. We assess them individually and the combination we are likely to see.

8 May 2008 - Rally drivers required
On Wednesday, the S&P 500 broke decisively above the 900 level (closing at 919). That took it – and many other developed markets – back into positive territory for the first time this year. The current rally, which started in early March, has now lifted the S&P by 36%, making it the second significant rebound of this bear market (after the one at the end of 2008).

7 May 2009 - Previewing today’s US bank stress test results
After weeks of leaks and rumours, we will today hear the results of the financial stress tests regulators have been running on the 19 largest US banking groups. We expect the tests to result in $100-200 billion of capital actions – the amount of preferred stock that needs to be converted to common equity, plus any extra capital that needs to be raised.

6 May 2009 - Credit conditions - a slower tightening
A number of economic data releases over recent weeks have indicated that, though still not improving, the pace of economic decline in most sectors and regions is starting to slow. The release of April’s Federal Reserve Senior Loan Officers’ Survey indicates that one of the main restrictions on economic activity – the tightening of bank lending standards in the US – is also slowing.

1 May 2009 - UK property – both tenants and landlords still out in the cold?
After commercial property’s price declines, yields look attractive on an absolute as well as a relative basis. But how well will tenant demand hold up? And are yields attractive enough to cope with occupancy voids and rent decreases?

June

30 June 2009: Financial system health check
One of the main reasons we expect the recovery in western economies – when it comes – to be anaemic is that credit growth will be constrained by a banking system that has been stabilised but is not strong enough to support robust credit growth. As Bank of England Governor Mervyn King said in his recent Mansion House speech, ‘stress tests designed to assess the viability of banks are very different from tests of the capacity of the banking system to finance a recovery.’ 26 June 2009: No rush for the exit

26 June 2009: No rush for the exit Since the better-than-expected US payrolls numbers for May were published on 5th June, markets – whether for bonds, equities or commodities – have become increasingly worried that the US Federal Reserve (Fed) will start the process of raising interest rates from emergency levels and reversing quantitative easing sooner than expected. However, given the Fed’s forecast for the path of the economy, this concern seems unwarranted.

25 June 2009: Bond yields - finding a level
Government bond yields have been particularly volatile over the past 12 months. In the second half of 2008, US yields roughly halved from 4% to a historical low of 2%, as investors started pricing in a significant risk of a rerun of the Great Depression. Yet they have doubled again since the start of the year, as green shoots of recovery have emerged. So, looking through the recent volatility, what should long-term equilibrium levels be for government bond yields?

24 June 2009: Raising the gold standard
Gold has always represented a store of value, and the key driver of the price is investor demand. As emergency policies adopted by governments around the world gain leverage against the threat of global depression, we here review the outlook for gold in the new environment. Our central case favours riskier assets, although we see clear risks and headwinds to growth. However, the success of policies aimed at boosting growth will necessarily increase the risk of inflation, against which gold is a useful hedge.

19 June 2009: Reviewing the case for a new equity bull market
With riskier assets – and equities in particular – posting significant rebounds over the past three months, it’s legitimate for investors to ask if this marks the start of a new bull market for such assets. Also, as many investors will not have bought into equities on 9th March, when they touched their lows for the current bear market, it is reasonable to wonder whether they have missed their chance to re-enter equity markets. In this extended Daily Themes, we analyse the facts in order to address the key questions investors should be asking right now.

17 June 2009: Commodity markets update
Commodity markets update If, as we forecast, the economic upturn starts in the second half of the year, the recovery is effectively under way already. Hence, we are keen to increase our exposure to economically sensitive assets which are geared into the economic cycle, such as commodities. But many commodities’ prices have already doubled this year, so do they still offer value?

16 June 2009: Despite hurting savers, rate cuts are still benefiting UK households
Even allowing for the interest lost by savers, UK households’ cash flow is getting a welcome boost from falling interest rates. Along with declining consumer spending, this has allowed households to channel more of their post-tax incomes into rebuilding their savings. Had it not been for rate cuts easing the interest burden and freeing up cash for savings, consumer spending – which is down 2.8% year on year – would have experienced an even sharper fall.

12 June 2009: PEs - no barrier to further equity gains
Back at the start of March, when developed equity markets reached their trough, valuation indicators such as the 12-month trailing price-earnings ratio (PE) almost touched a new 40-year low. Since then, equity markets have rebounded by 35%, pushing PEs higher again. Given valuation’s importance to equities’ prospects for the long term, has it changed from a significant support to a headwind over the past three months?

11 June 2009: UK housing market update – firmer foundations
The UK housing market is showing signs of attempting to form a bottom. This week’s DCLG house price index for April showed that the pace of decline of house prices has decelerated considerably as the year has progressed, with the three-month/three-month rate of decline slowing from -5% last December to just -1% now. Though still negative, that is a vast improvement. Rising demand, thanks to increased affordability, and a gently thawing mortgage market mean that the worst is behind the UK housing market, and it is now time to start considering when prices will rise again.

10 June 2009: Leading indicators are increasingly positive
The OECD composite leading indicators for April 2009, which have just been released, are showing a higher aggregate value, for the second successive month. With the OECD citing an increasing number of economies as at a ‘possible trough’ rather than a ‘slowdown’, our own analysis of the rate of change of the CLI suggests a clear turning point.

09 June 2009: FX markets and the rally – the dollar goes off-piste
The dollar’s recent weakness has been held up by many commentators as a reflection of investors’ concerns about the US government’s ability to fund its deficit. Regardless of the fact that the US current-account deficit is actually shrinking – reducing the US’s dependence on external financing – the dollar’s weakness against sterling does not fit this picture. 

05 June 2009: ISM - a taste of things to come?
As forecast in a previous Daily Themes ( 22nd May, ‘Grounds for optimISM?’ ), Monday’s data release for the US Purchasing Managers’ Index from the Institute of Supply Management (ISM), which assesses companies’ confidence every month, improved further, from 40.1 to 42.8. That helped the S&P 500 to rise 2.6% on the day. Following this release, we here update our forecast for the ISM, translate that into expectations for US growth and assess how much is now priced into stock markets.

04 June 2009 : The outlook for convertible bonds
Convertible bonds are likely to post positive returns over the next 12 months as equity markets keep recovering in fits and starts and as liquidity, which evaporated from the convertibles market after the collapse of Lehman Brothers, continues to return.

03 June 2009 : Calculating the probability of recovery
So how close are we to a recovery, and what does that mean for investors? To help us understand where we are at present, we use a statistical probit model, which looks at the capacity utilisation of the US economy. For this model, ‘Recovery’ is defined as when output growth is faster than capacity growth, so that the economy is not only growing but expanding fast enough for unemployment and spare industrial capacity to be declining.

02 June 2009 : The US and China – sticking together
The cost to the public sector of supporting the ailing private sector has been huge. In the US, the current tally of stimulus and bail-out packages stands at around $4.2 trillion. Even in the world of government finances, this is a massive effort: fighting the Second World War cost the US government ‘just’ $3 trillion, in 2008 dollars. Investors’ focus has therefore recently shifted from the credit-worthiness of banks to that of governments.

July

31 July 2009 - Earnings growth argues for emerging equities

In previous Daily Themes (such as Equities – earnings hold the key, 3rd July), we touched on the importance of medium-term profit growth when assessing equity markets’ valuations. Today, we delve into the subject in more detail and analyse the latest trends. In calculating equity market valuations, investors usually look at price-earnings ratios (PEs) and dividend yields. Those indicators are a good starting point. But, when investing in a stock, you are buying the right to a share in a company’s future profits and dividends. So you should consider not only reported earnings but also future earnings growth. You may be willing to pay a high price relative to reported earnings if you expect earnings to soar.

29 July 2009: Give the US fiscal package time to work
Friday will see the publication of the first estimate of US second-quarter GDP. The economy is likely to have contracted at an annualised pace of around 1.5%. That is a vast improvement on both the first quarter’s 5.5% contraction and the 6.3% contraction in the final quarter of 2008 – but a contraction nevertheless. As the US economy continues to contract even after February’s passage of the $787 billion fiscal stimulus package, some commentators are claiming that the stimulus is not working and are even calling for another package. Such calls are premature. The existing package is back-end-loaded and needs to be given more time to work.

24 July 2009: Equity market performance – crunching the numbers
Over the past week or so, equity markets seem to have resumed their upward trend, thanks to a good start to the earnings season in the US and supportive economic news flow. In this Daily Themes, we take a step back to assess how much markets have lost peak to trough since 2007, how far they have rebounded from the trough and how much further they would need to rise to reach their 2007 peak. We also analyse whether any trend may be emerging.

23 July 2009: Bernanke declares mission accomplished, war continues
Ben Bernanke, Chairman of the US Federal Reserve (Fed), took the opportunity of his regular report to Congress to declare that a collapse of the global financial system has been averted. This still leaves the US economy in the deepest recession since the Second World War, with US interest rates at effectively zero and the Fed having resorted to quantitative easing (QE). Our inference from the testimony was that the Fed foresees keeping rates at current emergency levels until confirmation that economic growth is robust and unemployment is falling – implying that rates may not increase until 2011. If this does not happen, the most likely alternative is that inflation is not as dead as markets currently assume and that rate rises have to happen before unemployment is clearly falling.

21 July 2009: UK Fiscal Nightmares
Sorting out the public finances is one of the biggest challenges – if not the biggest – facing the UK economy over the coming years. In April’s Budget, the UK Treasury set out its forecasts for the economy and the public finances over the next five years. Even under its relatively optimistic growth scenario, the recession and mopping up after the financial crisis leaves behind a lasting legacy, with the debt-to-GDP ratio more than doubling to 76% by fiscal year 2013.

17 July 2009: Equity valuations – the regional breakdown
After a strong rebound in March and April, equity markets have paused for breath over the past two months. During that period, equity analysts have been revising down their earnings expectations for the coming 12 months, albeit at a lower pace of late ( ‘Earnings season – signs of stabilisation?’, Daily Themes, 10th July 2009 ). So where does this leave forward valuations for developed and emerging markets?

16 July 2009: Global macro-economic outlook – growth, but not as we knew it
The global economy is starting to pull out of a recession unprecedented in the post–World War II era, but the stabilisation is uneven, and the recovery is set to be sluggish. Financial conditions have improved since the start of the year, thanks to government intervention, and recent data releases suggest that the rate of decline in economic activity is moderating, though how much varies from region to region.

15 July 2009: European commercial property – a long way back
After widely divergent performances from individual European commercial property markets in 2008, 2009 is set to be uniformly down. Although we expect stabilisation next year, returns are likely to be broadly flat in 2010. For growth to return, we would look for unemployment to peak and signs that interest rates need to be raised as activity picks up – for the eurozone, that is forecast to be 2011. So investors will either have to take a long view or seek exposure via Real Estate Investment Trusts (REITs), where shares stand at a discount to asset value.   

10 July 2009: Earnings season – signs of stabilisation?
Last week ( ‘Equities – earnings hold the key’, Daily Themes, 3rd July 2009 ‘), we argued that a recovery in companies’ profits will be increasingly needed to propel stock markets higher. With Alcoa announcing its results this week, the second-quarter (Q2) earnings season will officially open. It will culminate in the two weeks starting 20th July, when almost half of the S&P 500 stocks will report. But what exactly are current market expectations?

9 July 2009: Plumbing the depths of the UK recession
This recession is proving to be much more severe for the UK economy than those of the early 1970s and early 1990s. Its profile has more in common with the early-1980s recession. But, unlike that V-shaped recession, the recovery from this one is set to be more gradual, because of consumer de-leveraging, credit constraints and the need for fiscal restraint.   

8 July 2009: China’s economy emerges with credit
Our cautiously bullish view on China this year has proved far too cautious, as the economy has outperformed expectations. With the ‘four trillion yuan budget’ underpinning growth and a pumped-up money supply jump-starting the property market, economic growth is heading back towards the government’s 8% target rate, despite the weakness of export markets. We remain optimistic on the outlook and see China as continuing to expand its role as an engine of growth for the global economy.   

3 July 2009: Equities – earnings hold the key 
A few weeks ago, we argued that valuations should not be a headwind for equity markets in the short term (‘PEs – no barrier to further equity gains’, Daily Themes 12th June 2009). Nevertheless, if, as we expect, the pace of growth in Western economies is subdued even once the recovery starts, that could cast a shadow on the medium-term prospects for stock markets.

1 July 2009: UK commercial property - recovery postponed?
Some of the recent news from the UK commercial property market appears encouraging. Yields, for instance, are at levels which have historically been attractive, with the average hitting 8%. Data on the economy has also improved, with a recovery expected to start by the end of the year. Indeed, property shares, a good lead indicator of the direct ‘bricks & mortar’ market, have bounced by more than 40% from their nadir. And yet the property market remains under significant stress, making us reluctant to signal the ‘all clear’.

August

28 August 2009 - US budget deficit – death and taxes
New budget projections from the Obama administration show that, despite undershooting original estimates this year, deficits are set to persist indefinitely. This is a key factor behind longer-term concerns about the US dollar, as well as our forecasts of a trend of weaker economic growth. The need to tackle these deficits suggests higher taxes, but it also brings into focus the administration’s desire for healthcare reform, which would include constraints on the projected open-ended growth of federal healthcare spending.

27 August 2009 - Are new equity market lows likely before the end of the year?
For equity markets to hit new lows before the close of 2009 the economic data would have to be particularly bad. In fact, the news flow would have to be ugly enough for the market to begin pricing in a depression even worse than the one feared back in March – when it was priced for a three-year US downturn. Given that the US recession has probably already ended, this seems unlikely. Indeed, in the months ahead, the market's balance of risks around a sub-par recovery may actually shift from the downside to the upside. This would help propel equities on to further gains between now and the end of the year.

21 August 2009 - Getting credit for the recovery
The latest banking surveys indicate that the availability of credit, though improving, remains tight. The flow of credit is a key factor for economic growth. But, despite the best efforts of central banks to support the banking system, bankers are still showing a marked reluctance to lend. The cycle has definitely turned, as revealed by the surveys for the second quarter in the US, the eurozone and the UK, but the tightening of loan conditions last year still represents a considerable barrier, and loan growth remains very weak. This suggests that quantitative easing (QE) measures are likely to be retained and inflation expectations should be subdued until credit becomes more easily available.

14 August 2009 - A productive recovery
US productivity leapt by 6.4% in the second quarter of this year. That contrasts markedly with the historical trend of productivity growth deteriorating or even reversing during a recession. The implications of this rise in productivity are positive for corporate profitability and therefore equities but negative for employment and hence consumers. US non-farm productivity rose 6.4% quarter on quarter, which was ahead of expectations. While output fell 1.8%, this was outweighed by the 7.5% cut in total hours worked. That led to a sharp drop of 5.8% in unit labour costs, as wage inflation remains subdued.

7 August 2009: The nature of UK house price bottoms
Last week, the Nationwide reported that UK house prices rose in July, for the third month running. Although the other major house price series have not turned as sharply, house prices seem to be in a bottoming process, driven by a steep rise in new buyers’ enquiries and a shortage of supply. Nevertheless, we are unlikely to be at the start of a sustained period of strong house price rises. History suggests that house price bottoms tend to be gradual processes – an outcome made all the more likely by the combination of pent-up supply and credit constraints.

6 August 2009: Earnings quality – a regional convergence?
In previous Daily Themes (such as ‘Earnings growth argues for emerging equities’, 31st July), we have analysed the relative attractions of developed and emerging markets in terms of valuation and potential for medium-term earnings growth. Today, we focus on their quality of earnings.

September

29 September - It will be 'leaning, not cleaning' for central bankers
The financial crisis of the past two years has proved an extremely painful experience both for investors and for the wider economy. As a result, central bankers are reassessing the wisdom of letting asset price bubbles form and then cleaning up when they burst, rather than trying to stop them inflating in the first place. Simple measures of credit and price momentum can be used to identify the warning signs of a bubble. Yet, despite their recent strong rally, equities are unlikely to be seen as a bubble to lean against by central bankers.

24 September 2009 : Time for a reality check on growth
As the activity numbers continue to surprise on the upside and point towards a strong start to the recovery, forecasts for 2010 GDP growth are likely to rise further. This process should support the prices of riskier assets in the final quarter of the year. But, if – as we expect – the pace of growth fades during 2010, as the headwinds stemming from de-leveraging re-assert themselves, the environment may become less favourable.

23 September 2009: Upgrading UK commercial property
We believe that UK direct commercial property has turned the corner and is now set to deliver positive investment returns. With clear signs that the UK economy is recovering, we have greater confidence that investing on yields which are attractive in both relative and absolute terms will deliver returns over the short and the long term. We have therefore upgraded our recommendation to positive, for the first time since 2007.

18 September 2009: The phase of the cycle points to further risk asset outperformance
The current mixture of improving economic activity but enough spare capacity to mean that monetary policy will remain loose for a considerable period, is one in which investors should continue to favour equities and corporate bonds over government bonds. Investors should also bias the equity portion of their portfolios towards emerging markets rather than developed markets.

4 September 2009: Chinese markets - speculation versus investment
The setback in the Chinese stock market has put the spotlight on to investors’ concerns about the sustainability of China’s growth record. While understanding these concerns, they should be viewed in terms of a still-developing economy’s efforts to support growth in the face of global recession and the risk of a depression. Overall, we are optimistic, recognising that the Chinese economy has recovered well and continues to offer attractive investment potential. Yet the nature of future growth and the domestic Chinese market suggests there will be further swings in sentiment which will provide additional trading opportunities.

3 September 2009: In search of a flattening yield curve  
The slope and shape of the yield curve is closely watched by many economists as it can provide some insight into future economic performance. Steep curves tend to lead to expansion while negatives ones can presage a slowdown. But what are the prerequisites that would lead central banks to allow the yield curve to flatten? A yield curve shows the relationship between yields and maturity dates for government bonds at a given moment in time. From looking at almost 30 years of data, it’s apparent that the slope currently is close to historical highs in the UK, the US and Germany. In the US, the spread between two and ten-year yields is the widest since 2004, while the two-year yield is still close to its historical lows. Unusually, the slope is very steep in all three economies at the same time.

October

28 October 2009: Output gaps and asset class returns
Last week we looked at how the large amount of excess capacity in the economy is enabling central banks to keep interest rates at emergency lows to support the embryonic recovery. Today we analyse the link between excess capacity and the performance of equities, bonds and property. A large amount of excess capacity is typically positive for government bond returns, particularly short dated bonds, but negative for house prices. Equity returns are much more sensitive to the pace of economic growth rather than spare capacity.  

27 October 2009: Quantitative easing made easier
Last week’s surprise announcement that the UK economy contracted for the sixth consecutive quarter in Q3, increases the chance that the Bank of England will expand its quantitative easing (QE) programme in November. The aim of QE is to inject money into the economy in order to revive nominal spending, which has declined by 4.5% since the middle of 2008. The Bank is injecting money by purchasing UK government bonds and, to a far lesser extent, corporate debt from the private sector. When it pays for those assets with money it has created electronically, it boosts the amount of central bank money held by banks. Hopefully the level of deposits held by firms and households also increases, stimulating both spending and the economy. The three key channels through which QE bolsters the economy are explained below and summarised by the flow diagram overleaf.

22 October 2009: Mind the (output) gap
The large amount of excess capacity in the economy is enabling central banks to keep interest rates at emergency lows to support the embryonic recovery. Indeed, there is so much slack in the economy that rates are unlikely to rise until the second half of next year. But because the recession may have reduced the economy’s productive potential there is a risk, albeit a small one, that central banks end up taking too much comfort from unreliable measures of excess capacity and keep rates too low for too long.

21 October 2009: Agricultural commodities – a change in climate
Agricultural commodity prices have been broadly flat this year, after falling by nearly a half from their peak last year. We take a more positive view for next year as some negative trends appear set to reverse. Since climate change is also an increasingly important driver of agricultural prices, we quote a study which provides some forecasts for the potential impact of the anticipated rise in global temperature. Primarily, we view agricultural commodities as a hedge against inflation. Therefore, looking further ahead, while performance has been weak in a deflationary environment, we see a positive outlook as inflationary pressures return.

14 October 2009: Bonds and equities – an apparent conundrum
It is a generally recognised rule of thumb that when equities perform well, that government bonds go down and vice versa. This is the basis of traditional asset allocation, with its foundations in fundamental economic drivers of capital markets. So the last two months where we have seen good returns from government securities and even better returns from equities, have caused some consternation amongst market commentators. However, a closer examination of the correlation between bonds and equities shows that there are separate drivers at work for each asset. This does not mean that the current situation can persist indefinitely, but neither is it ‘irrational’ nor will it change until the market expectations for these underlying drivers change.

13 October 2009: The path of true recovery never did run smooth
If serious policy errors – such as the macro policy tightening and financial system neglect that caused Japan’s lost decade in the 1990s and the premature tightening that caused the 1937–38 reversal of the US’s recovery from the Great Depression – can be avoided, the major economies should stay on their recovery path over the coming years. Yet, while remaining on an average up-trend, that path is likely to prove bumpy.

06 October 2009: Mind the financing gap
Despite weak private-sector demand for credit in the major developed economies, surging government bond issuance means that credit demand is likely to exceed the amount of credit the de-leveraging banking system will be able to supply in 2010. Besides constraining growth in developed economies, the process of bringing the supply of credit into line with demand will lead to some combination of upward pressure on bond yields, downward pressure on exchange rates and even further quantitative easing.

01 October 2009 : Cyclical trends provide opportunity in European small caps
Small-capitalisation stocks are more geared than large caps to the economic cycle and so are potentially attractive in the current environment of global recovery. Looking at regional markets, Europe is cyclically linked to the global economy and has a well-capitalised small-cap equity market. This appears an attractive combination particularly at this phase of the economic cycle, as is demonstrated by historical data from previous cycles.

November

26 November 2009: Asian property markets roar ahead
Many Asian property markets are now at new highs. Thanks to significant fiscal and monetary stimuli, Asian economies have quickly recovered from the sharp recession at the end of 2008. With the property market’s 2007-08 boom-bust still fresh in investors’ memories, many remain nervous about the prospects of a property bubble reforming. We see little evidence of this yet, and forecast that strong Asian economic growth will combine with cheap funding, as pegged exchange rates effectively import the Fed’s loose monetary policy, to drive the region’s property markets higher.

25 November 2009: end of year report card
In the process of compiling our 2010 Outlook document, which will be published in a few weeks time, we have dusted off last year’s Outlook and reviewed which of the main investment calls we got right and, just as importantly, which we got wrong. We are proud of the things we got right. Conversely, where we have misjudged things, we adapted our strategic stance as new data comes to light.

20 November 2009: Financially stressful
Financial stress, as captured by the Kansas City Fed’s index, has fallen considerably since hitting historic highs in the immediate aftermath of the collapse of Lehman Brothers in September 2008. However, the financial system still demonstrates signs of stress. Despite declining sharply since the dark days of last autumn, financial stress remains almost as high as it was during the recessions of the early 1990s and early 2000s.

Encouragingly, the reduction in financial stress that we have seen suggests that lending conditions will improve further and the recovery in the US economy will gather pace. Nevertheless, the US Federal Reserve (the Fed) is very unlikely to raise interest rates until financial stress falls markedly further and stays there.

19 November 2009: Inflation risks
This week’s release of unexpectedly high UK inflation figures for October has reignited the debate over the risks of runaway inflation. We do not believe that the recent rise in RPI inflation is indicative of a higher inflationary trend. Rather, we see this as reflecting a temporary boost as last year’s large falls in petrol prices, interest rates and house prices drop out of the annual RPI calculation. We believe that quantitative easing is more likely to generate asset price inflation than goods price inflation. Investors’ increasing appetite for risk allied with negative real yields, are driving them into financial assets.

06 November 2009: Diversification is bad for the US dollar
While the announcement that the Reserve Bank of India (RBI) had bought 200 tons of gold from the International Monetary Fund (IMF) spurred gold to hit new highs, it was bad news for the US dollar. India paid $6.7bn to swap the dollars into gold. This accounted for some 2% of its total foreign exchange reserves. Although the trend to diversify away from the US dollar as the only reserve currency is clear, the process is likely to be slow. We see the potential for the US dollar to stage a counter rally next year.

05 November 2009: Market sentiment – time for a change?
Back on the 21st October, the S&P 500 Index touched an intra-day high for the current rally of 1,101, having risen 65% from its bottom of 666 in early March. But, over the past two weeks, the US market has begun to tire, with the index consolidating by 6.5% to 1,030 on Monday, right on the support trend line (graph below). That mirrors the behaviour of our proprietary investor sentiment indicator, which, after a strong recovery from very pessimistic levels to optimistic territory, has now retraced to a more neutral level. But while it may fall further in the short term, we believe it is unlikely to herald a significant change in investors’ appetite for risk.

04 November 2009: The fog of economic battle
The fog of economic battle Monday saw the release of the stronger-than-expected UK Manufacturing Purchasing Managers’ Index (PMI) for October. This suggests that when the Composite PMI is released later today it will, unlike the official GDP data, continue to signal that the economy has emerged from recession. Analysis of historical revisions to GDP data indicates that over time, the official data will be revised so that it looks more consistent with the PMI evidence. Inconsistent economic data is the norm around turning points. While this does not make the Bank of England’s task any the easier when it meets to set monetary policy tomorrow, we continue to expect that the Bank will decide to extend its quantitative easing programme.

December

11 December 2009: Budgeting for the UK
The Pre-Budget Report contained a relatively modest series of measures, most of which will take effect in 2011. This reflects the reality that the UK economy was still contracting in the third quarter and, while it should be back to growth by the end of this year, only a modest recovery is forecast for 2010. We summarise the main changes in order of their planned introduction and the associated forecasts for growth and the budget deficit.

4 December 2009: Budgeting for the UK
The pre-budget report on Wednesday 9th December will present a position that is, at least, no worse than at the time of the previous Budget in April. However, the position will still be dismal. The budget deficit stands at over 12% of Gross Domestic Product (GDP) and the stock of public debt has risen to its highest level relative to GDP for over forty years. The problem is that, with the economic recovery having only just started, it is no time to withdraw the fiscal stimulus from the economy. We would therefore expect a combination of some very modest stimulus to support growth with some promises on how the deficit will be addressed – to be redeemed by the new government following the elections which are due by next May. But these pre-budget forecasts and the debate that follows will shape investors’ expectations and be a key driver for bond yields and sterling.

1 December 2009: The news from Dubai
Dubai World’s debt moratorium has triggered a mixed reaction. This reflects the nature of the event. Markets were apparently surprised that a troubled-debtor company and its effectively bankrupt subsidiary stopped repayments. However, the real surprise was that the controlling shareholder, the Dubai government, and the United Arab Emirates (UAE) did not stand behind these debts. But the failure of financial authorities to support the troubled debtor does not threaten to trigger another Lehman-style ‘systemic crisis’. Instead, it represents the next stage of the process. Emergency government interventions that bailed out everyone for fear of unintended consequences, have been replaced by the normal workings of the debt market in the aftermath of a recession and credit crunch. Case-by-case assessments mean that lenders will share the pain of this next stage. Here are the headwinds, which we have repeatedly forecast, to the economic recovery of indebted countries, blown up as a sandstorm. Growth has returned to the global economy, but so has credit risk, as the central banks step back from the provision of money to all and sundry.