FYI | Jul 04 2008
By Rudi Filapek-Vandyck
During a brief meeting this morning, the TechWizard confided to me several of his charts are indicating equity markets may not have seen the worst yet. My response, as has been during the past month, was that more sell-offs would likely coincide with another big push upwards for crude oil. It has take the investment community a while, but right now nobody seems to doubt the direct connection between where share prices are heading, and the price of crude oil.
Such a view would fall in line with projections by market strategists at State Street Global Markets who suggest, on the basis of their in-house Regime Map, there’s likely more rain to come before there will be any chance for a period of plain old uplifting sunshine for global equity markets. State Street does not focus on oil, but talks of a “fearful symmetry” instead, including crude oil, higher lending costs and soaring prices for food currently dogging the outlook for equity markets.
The Regime Map, State Street strategists explain, is being used by State Street strategy teams “as a pictorial guide to investor behaviour and the pattern of cross-border equity flows”. In other words, an instrument has been created so easy to understand that everyone can read it and see where investor funds are heading next. Ok, it’s not that simple. We still need some explanation from State Street market strategists to accurately interpret what we think we are seeing.
Each of the five broad regimes on the pictogram represents a gradation of risk appetite. Currently, State Street believes, global markets have landed in “the relatively risk averse Safety First regime”. The only way this can get worse is for markets to move into “Riot Point”. You guessed it, State Street believes this will be the next station. The good news is, however, that “Riot Point” should at least be followed by a transitionary phase in “Neutral” mode.
Most important thing to remember about the current “Safety First” regime is that it is characterized by a preference for developed equity markets over emerging markets. Historically, reports State Street, emerging markets underperform developed 60% of the time once a Safety First regime has been identified.
State Street believes developing markets are fully valued while inflation in various countries risks to “spiral out of control”. Developed markets on the other hand are facing slower growth, in combination with higher inflation, but at least valuations are undemanding (with downside risks for earnings though). Looking at the two alternatives, it’s probably a fair assumption that international fund managers feel they have to make a choice in favour of the lesser evil (which in essence means: lesser risk) instead of the highest possible rewards.
Says State Street: “Safety First is the second most persistent regime after Leverage. However, if the regime does change the most likely destination is Riot Point. Policymakers are navigating a difficult course between controlling inflation induced by the rising price of oil and other commodities and ameliorating the deflationary impact of credit contraction and an economic slowdown.”
Those readers who can see the graphic illustration included in this story (which is not always the case for those who read FNArena stories through third party channels) can trace back global investor sentiment since January 2007, as depicted by State Street’s Regime Map. Note that overall sentiment for institutional investors as measured by State Street not always coincides with a similar performance of equity markets during that particular month.
