Thought I would post a little update now that we are firmly into Q2 as to where we are at in terms of the global picture. Quarter 1 was a hugely busy quarter in all economies and asset classes with big moves witnessed across the board in Equities, Bonds, FX and commodities.
FX was firmly in focus from the get go as the G7 struggled to play down talk about currency wars when in fact each nation seemed to be doing their up-most engaging in the battlefield. A currency war is just as it sounds really without the bloodshed, ones country’s attempt to devalue their currency relative to another in order to make their goods and exports seem more attractive to global demand. If often entails a lot of finger pointing and accusations but in reality nearly all countries are guilty of it in some way or another its just who makes it more obvious. The winner of who made it most obvious and the ramifications of which are still impacting all asset classes around the globe was the Japanese Yen. Shinuzo Abe the new PM of Japan and his “independent” central bank the BoJ are furiously attempting to effectively double their monetary base within two years to achieve a 2% inflation rate. Japan as an economy has been mired with deflation and stagnation for nearly two decades now and has amassed a mountainous debt problem in the process, bold action is now required to have a stab at turning this around before they edge over the precipice. The Yen has devalued approx. 25% against most major relative currencies since about November of last year.
Initially you may think that it is just Japanese exporters who will benefit from this at the hands of most importers into Japan. However the structural dynamics of Japan as a country mean that a huge amount of savings and investments have been tied up in their government bonds which offered little yield on a ten year basis. Previously this did not matter as much as in a country with deflation or falling prices then you did not need to achieve a high rate of return on your savings to keep pace. Now they are targeting a 2% inflation rate their is a tidal wave of Japanese money and savings looking for a home being spread out across not only the Nikkei but also in investments offering a higher yield around the world.
FX also dominated for another reason in Q1 where the might greenback the US dollar benefited from not only some improving economic data but also growing concern that the stimulus efforts by the Fed were going to be withdrawn quicker than most had anticipated The dollar raged against most currencies as many rushed to unwind their short dollar positions. This had big spillover effects into not only other curernices obviously like the pound and Euro but also the murky world of commodities.
The pound and Euro both had huge moves lower over Q1 at the hands of not only a strong dollar but some awful data emerging from both the UK and Eurozone, throw in a healthy dose of ineptitude from the EU ministers, Italian political risks and the whole Cyprus fiasco and the Euro had a big move lower from its early year highs of $1.3700. No currency wars needed from the EU politicians or direct action taken to devalue the currency just plain old ineptitude and stupidity helped the euro lower in a race to devaluation, (perhaps the stupidity is on purpose to devalue the currency but that is crediting most EU politicians with more savvy than normally displayed)
Commodities also took a beating. I have written before how commodities as they are majority priced in dollars are often a hedge or move inversely to the dollar. Hence if dollar was going up then commodities were going down. Copper, Oil and gold all fell victim to the rise of the greenback with varying intensity. Gold being the worst performer and took a huge beating on Friday, more than likley from Cyprus government selling there reserves but that’s not official so could just have been another big player “exiting” a position. Sometimes big investors do a “take down” or can also be called a ” get me out” trade, whoever took gold down on Friday certainly wasn’t worried about doing it a sophisticated manner and just wanted to lock something in as quickly as possible.
Most global bonds rallied in prices also which means the yield or return they offer dropped, again this is mostly to do with the Japanese money filtering in while equities specifically US and Japanese went on a stunning uptrend for nearly the whole of quarter 1 and resumed it in the start of quarter 2. Look at a chart, pinpoint when central bankers speak and promise stimulus and then you will understand how the stock market works in a centrally planned global economy.
In terms of major economies current state of affairs a very simplified explanation is on offer here:
The US is probably in the best position in 2013 amongst the recovering economies, showing signs of growth and unemployment which was improving until last week where we got a soft print in non-farms payrolls. Other economic indicators were trucking along quite nicely but some doubt is starting to creep back in with the last jobs report. Investors will rightly worry as the US government fresh with some ideas about cutting expenditure in certain areas due to “sequesterisation cuts” are one of the worlds biggest employers therefore it will be really touch and go to see if the private sector can step up to the plate and substitute employment for jobs lost or cut in the public sector. If any economy can do it right now it is the US, corporate balance sheets are more robust and cash rich than in a long time and after a fresh round of cheap financing from the corporate bond market should be able to push on now and attempt to expand, it seems like it is a case of who is willing to make the first move, confidence is king.
In stark contrast the EU is crawling along the sea floor on its belly, it feels like it wont get much worse than where it is now but its going to take some time and learning a whole new way of swimming to get back above water. Unemployment at its highs, government balance sheets reeling with debt as bailout after bailout has taken its toll. Social tensions are high too, Germany getting tired with being cast as the bad guy and also simultaneously getting tired of financing bailouts, peripheral countries still rallying against austerity, Italy STILL without a government in place, Cyprus situation is still unresolved. German elections to come in September casts some political risk as not so sure Merkel is a shoe in at the moment for re-election and that’s all without discussing the state of EU banking after the recent Cyprus precedent that was set of taxing both insured and uninsured depositors which could and should have wide ranging effects on the future of EU banking, (see previous posts).
The UK is trying similar position to EU only with slightly less hampered government, growth is poor and austerity policies are biting but the slump in financial services probably the biggest poison to deal with. Cant see their relations with the EU improving anytime soon as this is the case, UK may need to go it alone and reclaim London as a financial hotspot free from EU rules on regulation etc.
China gone out of the headlines of late but trucking along at about 6-8% growth still, Copper prices would suggest a slowing down of their economy but there are other reasons for that which I wont go into here. China is a humongous economy with a growth rate that most countries would cut their arm off for, it would be least of my worries.
Japan as discussed above giving it a dam good go to stimulate their economy. They have implemented bold monetary policies but also now need to back that up with just as bold fiscal policies and cooperation from Japanese business stuck in bureaucratic ways. Widespread elimination of red tape and dramatic increases in competiveness in needed to ensure this is not just a devaluation of their currency and then kill their own country with hyperinflation. Made a big effort now they need to see it through properly.
Australia and New Zealand stuck between a rock and a hard place, currencies both soaring again and urgently need to cut interest rates to cut the yield on offer in their government bonds which is causing the high currency. However in the midst of rapidly appreciating house prices another cut in interest rates will send even more money into that sector and further push the bubble. If I were them I would step away and monitor for a while longer and hope that in a few months the turbulence caused by Japan simmers down and they can make a better educated guess at then, remember they cut rates three times last year and we are trading pretty much back at the level before the cuts. So very difficult for both these countries right now, made even harder with decline in commodity prices.
Markets often calm down going into the summer months and traditionally it is often the worst few months for equities as the old adage “sell in May and go away” often holds true, after a ripping Q1 and likely Q2 investors will probably need a break by then.