Research Watch

Aussie banks and the next rally, the Fed on hold, zombies on CNBC, buy London and short China.

PORTFOLIO POINT: This is a sampling of this week’s best research notes. In a world of too much information, we hope our selection helps you spot the market’s key signals.

Australian banks may have been held up as industry leaders after surviving the financial crisis of 2008, but now the increasingly important international investing community won’t touch our Big Four. That’s according to a new note from Deutsche Bank, which warns that the stocks may soon lose their last group of supporters during the next risk-on rally. Speaking of market gains, economists at the New York Fed have outlined a fascinating front-running strategy that has accounted for almost every cent made in US markets in the last eight years, and also gains in at least six other major indices around the globe. As it turns out, you only need to mark eight pre-determined days into your calendar each year – find out which ones below. Meanwhile, Goldman Sachs runs the numbers on the imminent London Olympics, which could have implications for stock and property markets, and also puts Australia among the top five gold-winning countries based on econometric modelling. Analysts expect US rates to stay at zero until 2015, and UBS’s Reserve Bank 'tone’ index suggests Australia’s central bank is on hold for now, too. Elsewhere, China opens its doors to the world’s biggest hedge funds, as the nation’s smaller companies begin delisting from US exchanges. An appeal for calm over Libor, zombies on CNBC, and, on video, Jim Chanos’ guide to shorting China.

Will Australian banks fund the next rally?...

"Taking a closer look at market ownership, the importance of foreign investors is obvious, given they hold ~45% of the market ... Foreign investors’ aversion to Australian banks has increased over the past year or so, with their underweight position around record highs. In contrast, Australian households have moved further overweight banks, perhaps attracted by the high gross yield on offer. Domestic institutional investors (i.e., super funds, other funds) hold a historically high share of their portfolios in banks also. With domestic institutions overweight banks, there is the risk that bank shares could come under pressure if there was a move towards more risky stocks. For example, if Chinese growth picks up in the second half of 2012, as we expect, investors could rotate from banks into mining, given the attractive valuations in the latter group. If this were to occur, it is not clear that foreign investors would step in to fill the void ... [perhaps preferring] foreign banks, which are trading quite cheaply relative to history. (MSCI AC World Banks PE is 25% below average compared to Australian banks at 15% discount.)” (Deutsche Bank via Scribd, July 10)

The amazing pre-FOMC drift...

“The [first] chart shows average cumulative returns on the S&P 500 stock market index over different three-day windows. The solid black line displays the average cumulative return starting at the market’s opening on the day before each scheduled FOMC announcement to the market’s close on the day after each announcement. Our sample period starts in 1994, when the Federal Reserve began announcing its target for the federal funds rate regularly at around 2:15 p.m., and ends in 2011. (For a list of announcement dates, see the FOMC calendars.) The shaded blue area displays the 95% confidence intervals around the average cumulative returns'”a measure of statistical uncertainty around the average return. We see from the chart that equity valuations tend to rise in the afternoon of the day before FOMC announcements and rise even more sharply on the morning of FOMC announcement days. The vertical red line indicates 2:15 p.m. Eastern time (ET), which is when the FOMC statement is typically released. Following the announcement, equity prices may fluctuate widely, but on balance, they end the day at about their 2 p.m. level, 50 basis points higher than when the market opened on the day before the FOMC announcement. How do these returns compare with returns on all other days over the sample period? The dashed black line, which represents the average cumulative return over all other three-day windows, shows that returns hover around zero. This implies that since 1994, returns are essentially flat if the three-day windows around scheduled FOMC announcement days are excluded. '¦ While we do not find similar responses of major international stock indexes ahead of their respective central bank monetary policy announcements, we observe that several indexes do display a pre-FOMC announcement drift '¦ when each exchange is open for trading over windows of time around each FOMC announcement in our sample.” (David Lucca and Emanuel Moench of The New York Fed, July 11)

The Fed might be on hold until 2015...Goldman Sachs Group and Bank of America say a weaker-than-forecast June jobs gain in the US will lead the Federal Reserve to keep its benchmark interest rate at almost zero until the middle of 2015. The Fed, which has pledged to hold the rate low through at least late 2014, will amend its so-called forward guidance before deciding on a new round of bond purchases, according to the companies. Goldman Sachs and Bank of America are two of the 21 primary dealers that trade directly with the central bank. 'The “late 2014” formulation has now “aged” by six months since it was first adopted, but the economy still looks no better,’ Jan Hatzius, the chief economist at Goldman Sachs in New York, wrote in a report yesterday. The central bank may announce the change as soon as its next policy meeting July 31 to Aug. 1, Hatzius wrote.” (Bloomberg, July 9)

As the RBA sets the tone for August...

"At the margin, the RBA was more upbeat than we had expected, returning our 'tone’ measure to neutral ... It is easy imagine the RBA on hold in August. Their present stance appears to be data-dependent, so they will likely need weak data to drive further easing. Given the better than expected Q1 GDP report, and the recently improved tone of interest rate sensitive sectors (house prices, retail sales, building approvals, car sales), core inflation ~0.7%q/q seems pretty sure to see the RBA keep their policy rate steady at 3.5%.” (Matthew Johnson and Andrew Lilley at UBS, via Aussie Macro Moments, July 11)

Buy London... “On average, hosting the Olympics increases the annual appreciation rate of local house prices by about 1 percentage point. Assuming the effect lasts for 10 quarters after the Games, the cumulative effect is 2.5ppt. '¦ All recent Olympic hosts have outperformed the MSCI World index in the 12 months following the Olympics. This is true of recent hosts regardless of the size of the economy or state of development, suggesting either the local market is boosted by the international profile of the Games, or is perhaps relieved to have the Games behind them. Given the below-average performance in the UK since the Olympic announcement, UK investors may hope for a continuation of this trend, looking forward to a positive year in equities following the London 2012 Games. '¦ Countries with superior growth environments and higher incomes are expected to win more medals, and there is also a marked host effect that will likely bump up the number of medals attained by Great Britain.”

(Goldman Sachs, July 2012)

Hedge funds descend on China... “China has given foreign hedge funds permission to tap its wealthy citizens inside the country for funds to invest overseas, according to people in the industry. The move represents another important step by China to open its capital account – a process that involves dismantling regulations separating China from international markets. '¦ The reform, called the Qualified Domestic Limited Partner programme, invites hedge funds to apply for licenses to register in Shanghai, two people said. One person said that only the world’s biggest hedge funds, with at least $10bn assets under management, would be allowed to participate at first. '¦ As well as creating a new channel for domestic capital to flow abroad, it would give Chinese institutions access to alternative investment strategies – from short positions to arbitrage – which they have lacked. '¦ Laurie Pinto, chief executive of North Square Blue Oak, a London-based investment bank that focuses on China, said that hedge funds were already queueing up to apply for licenses, even though the programme had not been formally announced.” (Financial Times, July 10)

As Chinese firms flee the US... “China Development Bank, the state-owned lender charged with strengthening the country’s competitiveness, is providing more than $1 billion to help smaller companies leave the US stockmarket. The nation’s biggest policy lender has offered funding so Fushi Copperweld, a Beijing-based wire maker listed on the Nasdaq Stock Market, can buy back its shares from the public, the company said last month. China TransInfo Technology said June 8 it would drop its US listing with CDB financing. '¦ While more than 60 Chinese companies joined US exchanges in the three years through 2011, only one listed this year after those with market capitalisations of less than $500 million lost 53% of their market value. The crash began in June 2011, when Muddy Waters, a short-selling firm, raised concerns about accounting and corporate-governance standards at Chinese companies by accusing Sino-Forest, a timber company that traded on the Toronto exchange, of exaggerating its assets. 'There’s this sort of stigma on Chinese listed companies,’ said Phil Groves, president of Hong Kong-based DAC Financial Management China, which assists investors with due diligence of China investments. 'These Chinese companies if they’re not really big they are essentially marooned on the US listing system, where the promised land of lots of further share issuances and debt financings aren’t happening.’” (Bloomberg, July 10)

What Libor scandal?... “Yves Smith calls the Libor scandal a 'huge deal’. And Robert Reich says this is the 'scandal of all scandals’. ... I know it’s popular these days to get mad at banks every time they do something even remotely wrong, but I have a feeling the media is making a mountain out of a molehill here. My reasoning is rather simple. If you compare the Fed Funds Rate and the overnight Libor rate you’ll find a 99.6% correlation between the monthly prices over the last 10 year period.

In other words, if these banks were colluding to manipulate rates then the world’s most important central bank was the key rate they were basing this grand 'manipulation’ off of – and the banks were doing a damn good job relaying the accurate overnight rate. Of course, central banks are in the game of manipulating rates. That’s their primary policy tool. So it’s not surprising that the world’s largest banks were basically keying their rates off the Fed Funds Rate. Either way, for a banking oligopoly these banks were doing a pretty good job submitting prices that were pretty much 100% in-line with the Fed Funds Rate. If they were 'manipulating’ the rate themselves then they suck at manipulating prices.” (Pragmatic Capitalism, July 7)

Zombies on CNBC... “Wow. I just did Squawk Box '” allegedly about my book, but we never got there. Instead it was one zombie idea after another '” Europe is collapsing because of big government, health care is terribly rationed in France, we can save lots of money by denying Medicare to billionaires, on and on. Among other things, people getting their news from sources like that are probably getting terrible advice about any kind of investment that depends on macroeconomics. But it’s amazing just how skewed the policy views are too.” (Paul Krugman, moments after appearing on CNBC, July 11)

Video of the Week: Chanos on China... Wall Street legend Jim Chanos delves deep into his short China thesis, how he got into this short theme and why he continues to believe the Chinese economy is due for a sizable decline.


(Opalesque.TV, July 9

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