Research Watch

Central banks and market moves. Secular bull market ahead? Why PIGS need FANGS. A gold rally like no other. On video: The man who took on the Big Four.

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 investors run rulers over reams of earnings reports this week, Research Watch's two favourite analysts argue that market moves actually have very little to do with companies' performances. The first details the huge influence of central banks in day-to-day ups and downs '” and how to stay ahead of the game. The second argues that stocks have been weak for more than a decade '” despite earnings growth '” but much larger forces are about to change everything. Then, for the traditionalists, Deutsche Bank offers its thoughts on reporting season thus far, and what it tells us about the year ahead. Meanwhile, find out why the current stock market rally mightn't last much longer, and how gold investing has changed forever. The US and Europe decouple, as fingers are pointed at Germany for not doing its part. We also present market manipulation 101; Obama vs the Dow; and, on video, Societe Generale's defence of that Australian bank funding report.

Don't fight the Fed '¦

“The Fed’s Permanent Open Market Operations (POMOs) have a bigger effect on pushing stock prices up and down than most people would like to believe. The financial media like to convince us that what moves the market up and down are earnings news, employment reports, or concerns about Greek debt. But this week’s charts reveal that the Fed’s thumb on the scale has a big effect. The New York Federal Reserve Bank is the agency conducting these POMOs on behalf of the Federal Reserve, and the NY Fed kindly '¦ gives us a schedule of intended operations up to a month ahead of time, telling us the dates and projected amounts of the purchases and sales that they will be doing as part of Operation Twist '¦ The amounts are supposed to offset each other, but the problem is that the purchases and sales are done on different days. This lumpiness of the Fed’s activities shows up in the stock market’s price movements, as this week’s lead chart illustrates. The effect of these actions on stock prices has become a lot more muted lately '¦ but now we are entering into a period when that leading indication says things should get a little bit rockier. And the POMO schedule says that some big sales are coming up, events which will take money out of the banking system. We can only see out as far as the end of February with this indicator, because that is as far ahead as the NY Fed has announced its planned operations.” (McClellan Market Report, February 18)

A secular bull market is approaching '¦ “The [past 12 years of equity] weakness has not been attributable to the trend in corporate profits, but is entirely about the price that investors are prepared to pay for these earnings '¦ Equity markets have delivered feeble returns this century because price to earnings ratios have fallen from the mid-twenties or higher in 2000, to an 8-12 range at present. Equities started the century at valuations that are associated with low or negative subsequent long run returns. They are now at valuations usually associated with respectably positive long term returns '¦ [But] to make a stronger case in favour of equities, we have to be convinced that the odds favour an end to the 12 year decline in valuations. There are grounds for believing this to be the case. Contrary to received wisdom, PE ratios are not driven by long term interest rates or inflation '¦ A more coherent and robust explanation is to view PE ratios as a product of two main factors. Firstly, PE ratios '¦ reflect demographic balances between equity buyers and sellers within the overall population. Secondly, PE ratios represent a risk premium paid to compensate investors for the uncertainty of the future corporate earnings stream [mostly reflecting macroeconomic risks] '¦ These two factors worked to increase PE ratios in the 1980-2000 period, as economic volatility declined and as the dominant boomer generation aged into their peak equity accumulation years '¦ From 2013 onwards, the demographic pressures should ease as [the boomers] '¦ move into retirement at a much slower pace '¦ Meanwhile, the shrinkage in the equity buying population will also slow, as the boomers’ children age into their peak equity-buying years. Contrary to the bear argument about peak profits margins, this process will be bullish for equities. Because wage inflation will de-lever and de-risk the system faster, it should lead to a decline in perceived economic risks and a rise in equity valuations.” (Tim Bond of Odey Asset Management via Financial Times, February 20)

But the current rally looks stretched '¦

“Barron’s [recently] ran the cover page of 'Dow 15,000'. Over the weekend Alan Abelson ran a column titled 'Everyone In The Pool'. Today, CNBC leads with 'Dow 13,000 May Finally Lure Investors Back Into Stocks'. Unfortunately, for most investors, the headline is probably right '¦ As markets advance in price the risk of investing money, or rather the potential for loss, grows. It is when markets decline that we should be getting excited about investing. Yet, it is exactly the opposite of how individuals react. The media should be hitting the airwaves on down market days with 'The market got CHEAPER today as it declined'¦'” (StreetTalk Advisors via Pragmatic Capitalism, February 22)

The US and Europe go their separate ways '¦

“The recent crop of crises among countries on the periphery of the eurozone – most dramatically Greece, but also Ireland, Portugal, Spain and Italy – has caused industrial production to plunge in the eurozone as a whole. Ironically, at the same time, the same data in the United States has rebounded, helping to fuel confidence in the US economy and fuelling the recent stock market rally. So, on a relative basis, the US economy looks particularly robust.” (Alpha Now, February 21)

Because PIGS need FANGs '¦

“The rebalancing of European current accounts imbalances across member states is underway, but is not taking the form of a general convergence towards neutral balances. Peripherals are making good progress while no major change is occurring in surplus countries. The two “victims” are France and Italy, where current account deficits – albeit still more manageable than in most peripherals – continue to deteriorate '¦ Exhortations that the 'FANG’ countries [Finland, Austria, Netherlands, Germany] should contribute to rebalancing by importing more are misguided, because they are importing more '¦ The problem for the peripherals, is that Germany et al’s rising imports do not come from the eurozone.” (Deutsche Bank via FT Alphaville, February 21)

A gold rally unlike any other '¦

“A useful chart from GMO, showing gold demand from Emerging Asia over the past decade. I would comment that here in the West, both gold trading and gold investment demand remain over-focused on quantitative easing, and track more closely the policy decisions of the Federal Reserve. To this point, it bears mentioning that OECD investment demand for gold still remains far, far below historical highs from 30 years ago. But the broader view suggests, in contrast, that reserve-accumulating economies in Asia are the larger drivers of demand, as they must offset their long exposure to OECD currencies. Indeed, according to the GMO chart, emerging Asia has now crossed the 50% threshold as a portion of global demand. This underscores again that the current bull market in gold has few similarities to the previous example, and analysts should use caution when drawing on the experience of the late 1970s.” (, February 20)

Now that's how you manipulate a market '¦ “Six people in South Korea have been arrested for rigging share prices by spreading false rumours about a nuclear accident in North Korea '¦ The group are accused of using online messaging services to tell market analysts and brokers that a light-water reactor had exploded in North Korea on January 6, causing a radiation leak. The claims were baseless, but the Cyber Terror Response Centre said they allowed the group to make 61 million won ($54,314) in profits amid the scramble to move financial markets. Singapore's Strait Times and AFP report that the messages caused share prices to fall by more than 2% and the South Korean won fell 0.88% cent against the US dollar.” (Global Post, February 21)

And the next US President is '¦ “According to a new study '¦ voters don’t care about jobs numbers. Instead, they respond to fluctuations in the Dow Jones industrial average. The relationship between how an incumbent performs and the changes in inflation, gross domestic product and unemployment is 'often insignificant,' according to [researchers] Robert R. Prechter Jr., Deepak Goel, Wayne D. Parker and Matthew Lampert '¦ Voters unconsciously credit or blame the leader for their mood '” and the best indicator of mood isn’t joblessness, they say; it’s the Dow. This may be bad news for Romney and the other Republican contenders '” despite the European debt crisis and a decline in housing prices, the Dow has hit its highest point since 2008 '¦ If recent market trends hold steady, the country could be in too good a mood to oust the president.” (Washington Post, February 13)

Roubini's downside risks '¦ “First, the eurozone is in deep recession, especially in the periphery, but now also in the core economies, as the latest data show an output contraction in Germany and France '¦Second, there is now evidence of weakening performance in China and the rest of Asia. In China, the economic slowdown underway is unmistakable. Export growth is down sharply, turning negative vis-à-vis the eurozone’s periphery. Import growth, a sign of future exports, has also fallen '¦ Third, while US data have been surprisingly encouraging, America’s growth momentum appears to be peaking. Fiscal tightening will escalate in 2012 and 2013, contributing to a slowdown, as will the expiration of tax benefits that boosted capital spending in 2011 '¦Finally, geopolitical risks in the Middle East are rising, owing to the possibility of an Israeli military response to Iran’s nuclear ambitions. While the risk of armed conflict remains low, the current war of words is escalating, as is the covert war in which Israel and the US are engaged with Iran; and now Iran is lashing back with terrorist attacks against Israeli diplomats.” (Nouriel Roubini via Pragmatic Capitalism, February 21)

Prepare for magical Greek growth '¦

“The effect of all this fiscal tightening? Magic growth! '¦ Greece is five years into a gruesome recession with the worst effects of austerity yet to hit. But somehow the eurozone expects that Greece will bounce back to zero real GDP growth in 2013, and positive real GDP growth from 2014 onwards.” (Felix Salmon, February 21)

Video of the Week: The man who took on the Big Four '¦ Christian Carrillo explains his controversial call on Australian bank funding costs.


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