FYI | Dec 05 2008
By Andrew Nelson
London has entered winter in the midst of the most chilling year developed markets have experienced since the great depression. But as temperatures drop and the snow piles higher, State Street Global Markets says it sees signs of the coming spring.
By now I’m sure it is no news at all to our FNArena readership that stock markets around the world have been on the receiving end of a brutal beating that resulted in remorseless and sometimes frantic waves of selling over the past twelve months. As a result, equity valuations have been driven down to levels that have rarely been seen and there is almost more blood in the water than there is water in the water.
But it’s this smell of blood that has institutional traders in London thinking there must be some good opportunities to be had for the asking. Accordingly, institutional investors are becoming a little more optimistic.
According to analysts at State Street, the subtle shift in investor sentiment signals the worst could be over for equity markets. The analysts point to the group’s Regime Map, which has now moved into Leverage. This is the most confident investment mood since May 2008.
What has tipped the Regime Map from Riot Point to Leverage? A recovery in fund flows into select emerging markets, especially Latin America.
The broker reports Latin American equities in US dollar terms are down more than 60% from levels just six months ago. Present levels were last seen in 2005. This massive decline has prompted investors to fossick through the scrap heaps looking to make silk purses from what are no longer sows ears.
Short-term value in Latin American is a better bet right now than it may sound. The IMF forecasts this region will at least grow next year. While once upon a time a growth rate of 2.5% was seen as pretty anaemic, in the current environment it represents boom times. The broker thinks this demonstrates the region is in pretty good shape and notes FX reserves across the region are 50% higher than in 2002.
Chile is the current pick of the litter. The country is running a fiscal surplus of almost 7% of GDP at the same time governments around the world are spending money at lightning speed. The country also has a current account surplus and its foreign debt levels are just 1% of GDP.
In an even stronger sign of health and confidence, the nation’s central bank is still raising interest rates to fight inflation like they used to do here in the olden days.
But even without the emerging attractiveness of Latin America, State Street isn’t that surprised that its Regime Map has started to move away from Riot Point. By its unofficial definition, Riot point is the point where investors are ready to storm the place and decapitate the king unless some meaningful changes are made. Over the last few months, meaningful change has come by the bucket full, with rescue packages, bailouts and rate cuts just to name a few.
With zero now looking like the new international target for lending rates, it has become evident that the US has nowhere to go but to progress with the adoption of quantitative easing. State Street notes that Fed chairman Bernanke has made it clear he is following the 2001-2006 Japanese playbook.
This means that not only has the Fed expanded its balance sheet by about US$1.4 trillion since early September, the chairman is now talking about outright purchases of long-dated US Treasuries in order to force down the yields and push investors back to equities.
And it looks like the market is in the mood to help him out.
State Street notes that in the month leading up to Bernanke’s speech on Monday, the yield on the US 10-year Treasury had already fallen 120bp. Since Monday it has continued to drop. This is not only isolated to the US, with the broker noting flows into developed market sovereign bonds have moderated across the board.
The diminishing yields from government bonds might yet be another reason for institutional investors to start building back up their equity exposure. And whether the move back to equity is driven by valuations or the relative unattractiveness of other assets, a revival in investor sentiment is certainly going to be welcomed at the Christmas table.
