Research Watch

The “great rotation”, Soros on the euro, a looming correction, Goldman’s bearded leader, and hedge fund fisticuffs.

Summary: This week’s Research Watch includes a range of investment snippets, including the “great rotation”, why deleveraging may still rule, Soros on the euro, a looming correction, Goldman’s bearded leader, and hedge fund fisticuffs.
Key take-out: The shift from bond funds into equities is on the cards, but it is probably over a year away.
Key beneficiaries: General investors. Category: Portfolio management.

There has been a great deal of talk about a ‘Great Rotation’ from bonds into equities in recent weeks, and now Bank of America Merrill Lynch’s chief investment strategist is out with a handy chart illustrating exactly how it might work. However, Citigroup says the paradigm shift is probably still a year away, and Gary Shilling argues the deleveraging era could run another five. Meanwhile, George Soros and Deutsche Bank are backing the euro, but Marc Faber warns of a “1987 redux” in the seemingly stabilised economic zone. Also this week, PIMCO may be building a bond disaster, four notes on Lloyd Blankfein’s new beard, and researchers at New York University have come up with a sneaky tactic to avoid the fallout from negative company announcements. On video, hedge fund titans Bill Ackman and Carl Icahn go head to head on CNBC, in a segment Jim Cramer calls the greatest moment in financial TV — ever.

Your guide to the Great Rotation...
Graph for Research Watch

(Michael Hartnett, Bank of America Merrill Lynch’s chief investment strategist, January 29)

Although you might need to wait another year...

Citi’s Tobias Levkovich … says a ‘Great Rotation’ scenario that many envision in 2013 – wherein investors pull money from bond funds and ‘rotate’ it into equities – is probably over a year away. … Levkovich writes that the data on equity flows so far in January that has been driving the buzz about the ‘Great Rotation’ doesn’t really paint that clear of a picture: ‘The data on US equity mutual fund flows have been mixed based on different tracking sources. Indeed, one mutual fund flow data provider reported outflows during January while others suggested there were significant weekly inflows.’ Furthermore, though many are talking about a ‘1994 scenario’ – a mad rush for the exits in the bond market – Levkovich doesn’t really think that is plausible. Investors usually take a longer view, writes Levkovich, and that means a big rotation out of bonds may not happen for another year: ‘Note, we suspect that investors will need to be convinced by five-year return numbers showing equities outperforming bonds and that means it may take another year for the rotation to develop (since the tough 1Q09 will have to be “anniversaried” away). We have heard some suggest that individual investors will exit the fixed income asset class once bond funds suffer losses, but we would remind readers that the tech bubble peaked in March 2000 and aggressive growth funds only began to witness consistent outflows in mid-2002; a full 26 months later. Hence, at the first sign of bond fund losses, we deem it doubtful that people will immediately give up on a 30-year bond rally.’” (Business Insider, January 29)

And deleveraging may still rule 2013...

“The investment scene in the US and elsewhere is dominated by … the deleveraging of private economic sectors and financial institutions. … The deleveraging process for both sectors has begun, though it has a long way to go to return to the long-run flat trends. I foresee about five more years of deleveraging, bringing the total span to about 10 years, which is about the normal duration of this process after major financial bubbles. I’ve consistently forecast average real US GDP growth of about 2% in this age of deleveraging. Since the process began in the fourth quarter of 2007, the average growth rate has been 0.5%; it has been 2.2% since the recovery started in the second quarter of 2009. … The average current rate of growth is far below the 3.3% it takes just to keep the unemployment rate steady. With 2% real GDP growth, the jobless rate will rise a little more than one percentage point a year. No government -- left, right or centre -- can endure high and rising unemployment. As a result, the pressure to create jobs will remain strong. And so will the huge federal deficits that have been created by increased spending and weaker tax revenue. … For now, however, the impact of private-sector deleveraging is severe. Economic growth remains slow at best despite the fiscal and monetary stimulus in the US and elsewhere since 2008. As a result, responsibility to aid the economy has shifted to central banks.” (Gary Shilling, president of A Gary Shilling & Co, via Bloomberg, January 28)

The euro will stay — and strengthen...

“George Soros, one of the most outspoken critics of Germany’s proposed austerity policies to solve the European debt crisis, said the euro is here to stay and will gain as other nations seek to devalue their currencies. Soros, who made $1 billion shorting the British pound in 1992, said that while the causes of the euro crisis haven’t been solved, the acute phase of the turmoil is over. ... ‘Currencies have been remarkably stable in the last few years,’ Soros said. ‘Now there is the making of more fireworks, more volatility.’ … Soros said the extent to which Japan can push its currency lower will be limited by what the US is willing to tolerate. The momentum is for the ‘euro to rise and yen to fall,’ Soros said. ‘I generally don’t know how far things go but I can see which way they are going.’” (Bloomberg, January 24)

On the long path to a functioning monetary union ...

“Deutsche Bank strategist Stuart Parkinson makes the interesting argument that it took about 147 years for the US to become a monetary union. Specifically, he is talking about the US meeting the following conditions of monetary union:

  1. One unit of account
  2. One circulating medium of exchange;
  3. A fully functioning Central Bank;
  4. An optimum currency area.

… Parkinson has an optimistic take on this long road to US monetary union — look how much the Eurozone has achieved in a relatively short period! He writes: ‘Seventeen countries use the Euro now versus just sixteen states that were in the US Union by 1802 (in today’s numbers, by the way, those sixteen states make up barely one-third of US GDP); The Euro-area had one circulating medium of exchange within three years (aka the Euro) whereas it took the US more than 70 years until the National Banking Act was introduced for modern-day Greenbacks to drive out private banknotes; The ECB actually preceded the introduction of the Euro by six months whereas it took the US 150 years to build the Federal Reserve System as we know it today; The Euro may admittedly struggle to qualify as an Optimal Currency area as of today – 14 years in – but it took the US 150 years to achieve that status.’” (FT Alphaville, January 29)

But don’t discount a 1987 redux...

“The big question [in Europe] is the imbalances have not been solved and these could come back and harm the markets and the euro at some point in the future. In terms of stockmarkets, I have advocated one year ago, between April and June of last year, to buy stocks in Portugal, Spain, Italy, Greece and France because they were extremely depressed. Since then, the markets have rallied very sharply. Greece is up from the lows by 100%. That tells you anything can go up when you print money. … [Europe] made the secular low roughly one year ago, but I have argued that it is the time right now to reduce equity positions. I think the markets are at the difficult juncture between overbought and a euphoric state. I am not ruling out that they could go up somewhat more like in 1987, going up 40% between January and August, but we also fell 40% in two months’ time. So the gains were wiped out quickly. … I think regardless of what the markets do, near-term, a correction is overdue and usually February is a seasonally weak month. … It will be interesting to see how the correction unfolds.” (Marc Faber, January 25)

Does this mark a top for bond prices?...

Graph for Research Watch

“Something we’ve written a lot about around these parts it the ‘New HQ curse.’ Right around the time a company unveils a gleaming new HQ, the company then turns and does a swan dive. The headquarters of PIMCO (home of the world’s largest bond fund) is probably the closest thing the bond market has to its own HQ, and now according to Bill McBride, the firm’s new gleaming building is just about done. And of course it just so happens at a time when money is rushing into equities, and people are talking seriously about a ‘Great Rotation’ out of bonds and into stocks. McBride himself asks: ‘Does completion of the PIMCO building mark the top for bond prices?’ (Money Game, January 27)

How to think about Lloyd Blankfein’s new beard...

Graph for Research Watch

  1. [Goldman Sachs CEO] Lloyd says that his beard was a by-product of not wanting to work. ‘I always had a beard on vacation, and I’d think to myself, ‘Gosh, wouldn’t it just prolong the vacation if I kept the beard?’” he told CNBC. Let’s get therapist’s-couchy for a moment and float the possibility that Lloyd is considering retirement sometime this year, and letting himself go in anticipation. It could happen!
  2. There is more therapist’s-couch fodder in this statement (relayed from Bloomberg’s Christine Harper) that Lloyd feels like his beard is the “wrong colour,” in that it is not the virile brown thatch he once sported, before he became co-president of Goldman. The inexorable march of time hits CEOs and busboys alike, and Lloyd is surely coping with his mortality with each millimetre of grey that emerges.
  3. Over the next few weeks, dozens if not hundreds of junior bankers and traders at Goldman Sachs’s 200 West Street headquarters will come to believe that they, too, can start sporting facial hair. They will be wrong. This privilege is reserved only for CEOs and is known as the ‘Corzine Rule.’
  4. Could the beard be a late-in-the-making PR move, engineered in a shadowy boardroom by Goldman PR chief Jake Siewert, to make Blankfein more relatable among the unwashed Occupy crowd? (No.)”

(New York Magazine, January 25)

Oh what a beautiful morning...

“Using textual analysis software, we examine whether and how the tone of the question and answer portion of earnings-related conference calls varies with the time of day. We find that, for calls initiated later in the day when managers and analysts participating in the calls are likely to be suffering from greater physical and mental fatigue, the tone of the conversations between analysts and managers is significantly more negative than for earlier calls. Calls that are held later in the day also exhibit significantly greater textual uncertainty, suggesting that the conversational tone is more wavering and less resolute. We also document that conversational tone has economic consequences: more negatively toned conversations are associated with more negative abnormal stock returns during the call period. Further analyses show that there is negative drift during the 15-day post-call period for both morning and afternoon ‘bad news’ calls, but that there is relatively higher positive abnormal returns over the subsequent 45 trading days (i.e., days 16-60) for afternoon calls. The combined results suggest that there is an initial and negative over reaction to both bad news earnings information and, incrementally, to negative tone and to calls initiated in the afternoon, that eventually (at least partially) reverses.” (Jing Chen of New York University, Elizabeth Demers of the University of Virginia and Baruch Lev of New York University, December 1, 2012)

Video of the Week: Hedge fund fisticuffs...

After weeks of disagreement over a Herbalife short, Bill Ackman and Carl Icahn let it all out on CNBC.
Graph for Research Watch

(CNBC, January 25)