Happy for a While
By John R. Taylor, Jr.
The first year of the American presidential term is almost always good for equities and 2013
looks as though it will add further weight to that rule. Most often the second year looks worse than the first, both in a GDP growth sense and a market sense, and, once again, we find ourselves in agreement with this view. Our cyclical analysis is somewhat more intricate, encompassing many more factors, but if the cycles around the US elections are true, they should correlate with our work, and they do. At the beginning of this year, we were bullish in the first quarter, bearish as we approached the summer and then positive to year-end. We did not get it as right as we would like, as the optimism and strength continued for several months more than we expected before any weakness was seen, and the strength has only recently begun to show through again. It seems to us that we are running about six weeks slow and the global ‘risk-on’ feel should persist into the end of the year. As the long-term cycles see peaks in US interest rates, a peak in the euro, and peaks in most global equity markets, we seem to have significant coincident confirmation. Some weaker markets, like those in emerging market currencies, their interest rates, and equity markets see the period between December 1 and the first few days of January as an intermediate high, to be followed by another half year of decline before a significant low is seen. Most likely, the second year of Obama’s second term will prove quite unpleasant for those of us in the asset management business.
By John R. Taylor, Jr.
The first year of the American presidential term is almost always good for equities and 2013
looks as though it will add further weight to that rule. Most often the second year looks worse than the first, both in a GDP growth sense and a market sense, and, once again, we find ourselves in agreement with this view. Our cyclical analysis is somewhat more intricate, encompassing many more factors, but if the cycles around the US elections are true, they should correlate with our work, and they do. At the beginning of this year, we were bullish in the first quarter, bearish as we approached the summer and then positive to year-end. We did not get it as right as we would like, as the optimism and strength continued for several months more than we expected before any weakness was seen, and the strength has only recently begun to show through again. It seems to us that we are running about six weeks slow and the global ‘risk-on’ feel should persist into the end of the year. As the long-term cycles see peaks in US interest rates, a peak in the euro, and peaks in most global equity markets, we seem to have significant coincident confirmation. Some weaker markets, like those in emerging market currencies, their interest rates, and equity markets see the period between December 1 and the first few days of January as an intermediate high, to be followed by another half year of decline before a significant low is seen. Most likely, the second year of Obama’s second term will prove quite unpleasant for those of us in the asset management business.
As the cycles signal a positive view, we have to conclude that the ‘tapering’ process has been overblown. In fact, the shorter cycles do not call for a minor peak in risk assets until the end of the month. If there is any pause between now and then, it should be fairly insignificant, probably centered around the two days right before the Fed announcement. Obviously some of these feelings have to be nothing more than conjecture after listening to various Fed speakers and other pundits, but we think there are also some significant indications that lead us to conclude that the climb in interest rates and the Fed’s willingness to push them higher will not be as aggressive as the market has been thinking. Although our cyclical picture for US rates calls for them to move higher, we do not see the belly of the curve moving much higher, but rather forming a group of tops as it often does at major turning points. The TIPS market and other indicators imply that the rate of inflation in the US is declining not climbing, and moves towards deflation are not associated with climbing interest rates or a rising stock market. Our view of the cycles in the ‘inflation-expectation’ market are quite similar to those in the emerging markets – that is, there will be a cyclical peak in expected inflation near the end of the year. However, this peak should be unimpressive, compared to the major trend which is now down. The Fed’s favorite measure of inflation, the core PCE, is around 1.20% – rallying from an originally-reported 1.05% two months earlier. These are not numbers that imply sharply rising rates and they do not correlate well with rising stock prices either. Although we understand that Bernanke and many of his Fed supporters would like to close the curtain on their large-scale asset purchases (LSAP), this will eventually be seen as inappropriate, probably at just about the time that Bernanke is leaving office.
Europe Long-Term View Pick Your Risk in Europe
By Jonathan Clark
For global sovereign debt investors, choices in the US are limited to Treasury securities and must one currency – the US dollar. US debt is rated AAA by most rating agencies and is extremely liquid, which makes it safe and attractive. For most of the past five years, the Federal Reserve has been buying Treasury securities, which adds to demand and lowers the risk of mark-to-market losses. Most investment decisions in US sovereign debt tend to involve how far out the yield curve to invest (in other words, what duration to plough money into). The US 10-year Treasury Notes currently have a yield of 2.95% – this is likely to go up as the Fed scales back its debt purchases, causing losses for holders of the debt. Currently, the appetite for US Treasury debt is relatively low.
But, when investing in the Eurozone, the choices are far more diverse, although the choices are denominated in a single currency as well – the euro. There is a smorgasbord of sovereign bonds to buy with 10-years paying a low of 2.04% in Germany, sporting a rating of AAA, to a high of 10.00% in Greece, with a rating of B-. Investors generally choose to invest somewhere between these two extremes. Spain yields 4.48% and has a BBB rating; Ireland yields 3.96% and has a BBB+ rating; and a variety of other options exist as well. The point is that just examining the short-term yield differential between Euribor and Eurodollars – which is typically used to evaluate the carry on EUR/USD – doesn’t accurately describe investment opportunities in Europe. This leaves interesting choices for investors. When they contemplate buying the bonds of an emerging country like Hungary, rated BB, to earn 6.26%, along with this yield, they get saddled with owning the forint. Why buy the currency risk? There are 12 Eurozone member countries that issue sufficiently liquid bonds that, as a group, yields an average of 3.93%, or a pick-up of nearly 1% over US debt. The average credit rating is lower than the US, but with many emerging markets in crisis, the Eurozone appears to be an attractive bet – particularly since investors have a wide variety of risk and duration to choose from. This causes tremendous demand for euros.
The cycles are positive on the single currency into very early October and this overall strength is likely to last into December. The shorter cycles call for a minor peak on Friday and the euro should then pull back for a few days before the uptrend resumes. The most likely time for a medium-term peak is the week of September 30. Our initial target for this uptrend is the 1.3550 area. Following this peak, EUR/USD should pull back for a week or two before the uptrend resumes. The longer-term cycles call for a major peak in December. Our conservative objective is the 1.3700 area. Only a close below 1.3120 means that our positive outlook is wrong and it is headed directly lower into early November, but this is very unlikely.
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com P
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