Research Watch
PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.
As the world's finest financial minds descend on Davos to discuss the world's ills, Credit Suisse doesn't seem to think anything's wrong – the bank has lifted its year-end market targets and is full of global optimism. Dave Rosenberg, on the other hand, says the bull argument still relies on three big ifs. Find out what the Year of the Dragon means for stocks, and what the Bible reveals about emerging markets in 2012. Check out the tree of gold as Iran pushes up the price. Warren Buffett unveils the latest super-safe asset; money market funds hint that Europe's debt crisis is coming to an end; and Kim Dotcom's very strange bail documents provide a taste of things to come. On video, the market-moving Joe Granville explains why he thinks the market will crash harder than anyone expects.
10 reasons markets will rally in 2012 '¦ “We recently raised our end-2012 S&P 500 target to 1400 from 1340 to reflect '¦
- US macro momentum has continued to surprise and the breadth of the economic recovery has been impressive.
- Euro-area. The ECB’s three-year long-term refinancing operation is a potential game changer. It’s printing money; could be exceptionally large; could drive the euro to levels required to stop the recession (c€/$ 1.10); is driving the three-year bond yield to levels consistent with temporary debt sustainability in Italy and Spain; and, critically, it is a form of debt mutualisation (as the haircuts applied to collateral are too low), yet one that is less emotive for the German public than QE '¦
- China: a move to modest easing with inflation clearly falling. New loans rose in December and M2 growth has accelerated to 17.3% from a recent low of 12.9% '¦
- Food prices continue to fall: this is important as food is a third of CPI in emerging markets and 14% in the US. This helps both disposable income and control emerging market inflation.
- Excess liquidity is very high.
- Equities look cheap against expensive bonds – although not in absolute terms.
- Equities remain one of the most attractively priced, long-term inflation hedges as we move towards synchronised QE.
- The second derivative of earnings momentum is getting no worse – and we think the bulk of the rise in profitability is structural.
- On the whole, positioning is still cautious.
- The tactical indicators are mixed and in parts still supportive (such as risk appetite, net long position of long/short hedge funds).”
(Credit Suisse, January 24)
The Big Ifs '¦ “Is there a bull case for equities? Well, after a 20% pop off last October’s lows, that would seem like a pretty strange question to ask. But what is most important is not looking through the rear-view mirror, but driving ahead by focusing on what is happening through the front window. With that in mind, we now need to build some assumptions to get to the bull case'¦
If'¦ This housing recovery story in the US has more legs than just balmy seasonal December weather; and
If'¦ China manages to navigate its economy to a soft landing instead of a hard landing; and
If'¦ Europe can hang in'¦
Then one can build the assumption that, if all goes well, the forward price/earnings multiple reverts to 15 times, where it was before the trapdoor opened up last spring '¦" (David Rosenberg via Pragmatic Capitalism, January 24)
Return of the dragon '¦ “Between 1900 and 2011, the nine previous dragon years [on China's astrological calendar] have seen America's Dow Jones Industrial Average price index increase by an average of 7.7% in real terms, the second-best historical record of the 12 zodiac animals. Such fortune may be short-lived however; next year's animal, the snake, has the second-worst historical record.”
(The Economist, January 23)
A biblical warning for emerging markets '¦ “The hypothesis of regular [emerging market] boom-bust cycles is supported by a long-standing scholarly literature '¦ But I would appeal to an even older source: the Old Testament – in particular, the story of Joseph, who was called upon by the Pharaoh to interpret a dream about seven fat cows followed by seven skinny cows. Joseph prophesied that there would come seven years of plenty, with abundant harvests from an overflowing Nile, followed by seven lean years, with famine resulting from drought. His forecast turned out to be accurate. Fortunately, the Pharaoh had empowered his technocratic official (Joseph) to save grain in the seven years of plenty, building up sufficient stockpiles to save the Egyptian people from starvation during the bad years '¦ For emerging markets, the first seven-year phase of plentiful capital flows occurred in 1975 to 1981, with the recycling of petrodollars in the form of loans to developing countries. The international debt crisis that began in Mexico in 1982 catalysed the seven lean years, known in Latin America as the 'lost decade' '¦ The second cycle of seven fat years was the period of record capital flows to emerging markets in 1990 to 1996. Following the East Asia crisis of 1997 came seven years of capital drought. The third cycle of inflows occurred in 2004 to 2011, persisting even through the global financial crisis. If history repeats itself, it is now time for a third 'sudden stop' of capital flows to emerging markets.” (Jeffrey Frankel, Professor of Capital Formation and Growth at Harvard University, via Project Syndicate, January 20)
Weighing Australia's gold market '¦
Click on image for a larger version.
(Trustable Gold, January 25)
Gold is still the 'reserve’ currency '¦ “Earlier this month, Iran and Russia replaced the US dollar with their national currencies in bilateral trade. This came after Iran replaced the dollar in its oil trade with India, China and Japan '¦ [Now], European Union governments have agreed to fire back and place a ban on all new contracts to import, purchase or transport Iranian crude oil '¦ [But] there is another important sector being targeted by the sanctions. EU governments also agreed to freeze the assets of Iran’s central bank. More importantly, [the EU] placed a ban on all trade in gold and other precious metals with Iran’s central bank and public entities '¦ While the sanctions may be targeted at Iran’s nuclear financing, the move serves as a reminder to investors that precious metals are alternative reserve currencies used in the absence of the US dollar. Recent data shows that Russia and China are likely to continue business with Iran outside of the US dollar, which will help support gold and silver prices. In addition to trade agreements, Russia has reduced their US Treasury holdings over 50% from October 2010, while China has reduced their holdings to the lowest level in over a year.” (Wall St Cheat Sheet, January 23)
Confessions of a Davos spouse '¦ “The World Economic Forum kicked off in Switzerland this week and '¦ Anya Schiffrin (wife of Joseph Stiglitz) is back with a few tips for her fellow Davos Wives '¦ 'A lot of untoward groping goes on after hours and that is discussed quietly rather than openly '¦ There are always a lot of men who become 'geographically single’ when they arrive, and even the nerdiest expert in anti-malarial bed nets or obscure financial instruments fancies himself a player the moment he steps foot in the Zurich airport. Late at night, these men can be found eyeing the local talent, and there are rumours of at least one baby being born nine months after a night of passion at Davos’.” (DealBreaker, January 23)
Behold, Buffett bonds '¦ “Warren Buffett’s Berkshire Hathaway Inc. (BRK/A) issued $US1.7 billion of bonds to refinance debt sold to help pay for its acquisition of Burlington Northern Santa Fe. Berkshire, which bought the railroad for $US26.5 billion in 2010, sold $US1.1 billion of five-year notes and $US600 million of 10-year debentures '¦ The five-year notes yield 100 basis points more than similar-maturity Treasuries and the 10-year debt pays a spread of 137.5 basis points '¦ Berkshire is ranked Aa2, the third-highest level of investment grade, by Moody’s Investors Service and AA by Standard & Poor’s, one step higher. It was downgraded from AAA by S&P on February 4, 2010, the day it announced the bond offering to pay for the Burlington Northern acquisition.” (Bloomberg, January 24)
Europe gets used to life support '¦ “The ECB last month lent banks an unprecedented €489 billion ($US637 billion) for three years. Analysts said they expect demand to be just as high at a second auction on February 29 because the stigma associated with using the facility is dissipating and the list of what assets can be used as collateral in exchange for the loans will be extended '¦ 'The ECB is still deciding what will constitute acceptable collateral,' Marchel Alexandrovich, an economist at Jefferies International in London said. 'If criteria are loosened enough, then demand for cheap money will undoubtedly swell up and we may well see a figure in excess of €1 trillion' at next month’s operation. Credit Suisse analyst William Porter said he expects banks to borrow slightly more than in December, about €500 billion, because lenders won’t want to be put at a competitive disadvantage when their peers can borrow cheaply from the ECB. 'This will remove some of the refinancing risk the banks face and the markets are reacting positively after a bit of a delay '¦ But the more fundamental question is how “long can you run a banking system like this?”' (Bloomberg, January 24)
But it might be waking up by itself '¦ “There are more and more signs that the plumbing of the European financial system is starting to work. The latest, as FT reports, is that money market funds are once again buying European bank paper: 'Last year, money market funds were sellers of many European banks’ short-term commercial paper as worries grew about the repercussions of a possible European sovereign default. That was a critical factor in market anxiety, as the highly rated funds’ $US2.7 trillion in liquid assets are a key source of dollar funding. Money market funds bought French bank paper with maturities as long as one month, as well as small amounts of Spanish bank paper, according to bankers. The funds also bought longer-dated UK, Dutch and Scandinavian bank paper, up to six-month maturities.' By the end of last year, the ECB was essentially the only game in town when it came to bank funding. While the ECB still basically backstops the whole thing, others are at least willing to enter the game again. (Business Insider, January 22)
Kim Dotcomedy '¦ The German national, previously known as Kim Schmitz, has had his bail application denied in the district court at North Shore. From the court document, a taste of courtroom colour to come:
(FT Alphaville, January 25)
Video of the Week: Joe Granville predicts a 50% market plunge '¦ The notorious market timer is back with a very big call.
(Bloomberg, January 24)