Tuesday, September 29, 2009

Big Picture View - Equities Well Supported (Updated)

Stocks gained on a fresh wave of M&A announcements, including a deal by Xerox to acquire Affiliated Computer Services for $6.4 billion.Abbott Laboratories gained after the company said it will buy the pharmaceutical business of Belgium's Solvay for as much as $7 billion in a deal that will expand its presence in emerging markets. Covidien will acquire brain-monitoring technology firm Aspect Medical Systems for $12 a share in cash, or a total of about $210 million, net of cash and short-term investments acquired. Johnson & Johnson says it's bought 18% of Crucell for 301.8 million euros ($440 million) -- a 30% premium to Friday's close -- and will pay development milestones and royalty payments if flu vaccines that the two firms will develop make it to the market. Among major economic news this week, the Case-Shiller housing price index and consumer confidence data are due out Tuesday morning, while GDP, ADP employment and crude inventories are slated for release on Wednesday. The above news indicate that corporations are more willing to tap the markets for the low rates. Expect more such M&A activity in the coming days. This links up nicely to the article posting below. Of course we have to bear in mind that the US$ weakness is also supporting US equity purchases.

Every now and then, its important to reassess the big picture view. Getting the big picture correct will make for a more confident trading mindset, or reasons not to trade the market. It is clear that the developing economies are recovering more rapidly than developed nations. If you look at central banks at developed countries, they are still keen to keep rates low. This emphasised the fact that while there is some sort of recovery, it will be a long drag to becoming substantive.

By mid-2009, most central banks in advanced economies reached the trough in their rate cycles. Fed and Swiss National bank reduced the lower end of their target bands to 0%. Bank of Japan has been taking a "zero rate interest policy" 0.1% interest rate for sometime now. Sweden's reserve deposit rate is negative, and that's a useful indicator. A few central banks - Fed, BoJ, Sweden and Bank of Canada - have made explicit commitments to keep policy rates low for a long period. Australia should be the first to tighten among the G-10 central banks, as early as Q4 2009. Bank of England could be next, possibly by December/January.

Whether a central bank starts to tighten is a clear indication of how confident the central bankers are of the recovery in their country. The danger is that some could stay loose for too long, thus fomenting a bubble. That is exactly what is happening in HK, owing to its dollar peg, which resulted in very low rates, but that does not correspond with its real economy which is recovering quicker thanks to its ties to China - thus fueling its property boom.

  • ECB held at 1% in June 2009 and may stay there depending on economic data.
  • Federal Reserve held at 0-0.25% since December 2008 and will likely remain there all 2009 and 2010.
  • Bank of Japan held at 0.1% since December 2008 and will likely remain there all 2009 and 2010.
  • Bank of England held at 0.5% since March 2009, lowest rate since 1694.
  • NZ held at 2.5% since April 2009 but may resume cutting to 1.5% later in 2009.
  • RBA of Australia held at 3% in June 2009, lowest since 1960, and may hike in Q4 2009.
  • Canada held at 0.25%, its lower bound, since June 2009 and may resort to quantitative easing.
  • Swiss National Bank cut target range for 3mo Libor to 0-0.75% in March 2009 and may stay there until 2010.
  • Norway cut 25bp to 1.25% in June 2009, its rate trough. Norway may hike in Q4 2009.
  • Denmark cut 10bp to 1.55% in June 2009, maintaining a 55bp spread versus the ECB.
  • Sweden cut repo rate 25bp to 0.25% in July 2009, committed to staying there until end-2010. In a break with the tradition of zero setting the lower bound, the deposit rate was set at -0.25%.
Economic indicators can be sluggish and yet stock prices can rally, there is nothing wrong with that. The equity markets collapsed a few months before the subprime implosion took over. The recent G20 meeting reinforced the view that they will plan to leave the emergency stimulus in place even though there are signs of some recovery. The G20 basically did not want to pull the brakes too soon. That can only mean one thing, higher equity prices. Yes, there will be bouts of minor correction, but these are just bumps. You have very low interest rates, some signs of recovery, an easy monetary policy, a much lower risk aversion attitude, where can you place your bets ... bonds??? ... of course its equities.

Even when stocks rake in just 5% or 6% return, that is still powerful compared to the prevailing interest rates of 2%, and the differentials are substantive enough for people to put their money to work. Asset managers will have to reduce their cash holdings and put them to work in order not to under perform. The very low rates are not designed to prop up the stock markets per se... its really to boost corporate borrowing and corporate lending, which is a much bigger concern, all of the G20 are grappling with unemployment and needs the corporate side to borrow and spend more. The stock markets are just a bystander beneficiary to that objective. Good till year end.

p/s photo: Zhang Xin Yu

1 comment:

jeremy tan said...

Well said Dali, many people have been saying bonds are the way to go, i still believe that equities are still the way to go for the current given economic situation.