FYI | Apr 18 2012
By Greg Peel
One of the fundamental elements of global stock market activity over the past few months and years has been the dominance of the short-term trader over the longer-term investor, exhibited in low volumes and increased volatility. Volatility does not always imply sharp weakness, and the 30% rally in the S&P 500 from October to March is as good an example.
Retail investors have stayed away in droves, and fund managers who have little choice but to invest have weighted portfolios heavily toward cash and bonds and away from risk assets. In 2012 to date, there has only been US$4bn worth of inflows into global equities, representing 0.1% of all assets under management, note Citi's global equity strategists. By contrast, bonds (which includes corporate bonds and not just sovereign bonds) have seen US$110bn of inflows in 2012 year to date. Total inflows into bonds for all of 2011 were US$99bn.
The news gets worse, with the week ending April 11 seeing US$9bn of global equity outflows according to industry data. That's three months to lure in US$4bn and one week to see US$9bn run away. Developed markets copped the hiding, representing US$8bn of those outflows (the largest since November), with emerging markets losing only US$1bn. Emerging markets have seen US$25bn of inflows year to date, half of what flowed out in all of 2011. Redemptions from developed market equity funds have totalled US$21bn year to date, while 2011 saw a total of US$188bn of redemptions.
What is it about April? We all know the old adage “Sell in May and go away” but that has its roots in the traditional northern summer slowdown and not in the post-GFC world. Some argue that the adage should now be “Sell in April” so you can get ahead of the “Sell in May” crowd but the April-May stock market peaks and subsequent corrections of 2010, 2011 and now possibly 2012 have all been based on the three overriding macro themes which have dominated the post-GFC mindset – US recovery (yes or no?), China slowdown (hard or soft?) and European crisis (resolved or simply put off for a while?). After a solid March quarter stock price-wise, we've since seen US economic data waver somewhat (which has a flipside in QE3 or no QE3), Chinese data ease more than expected, and Spain threaten to become this year's “new Greece”.
There's still a seasonal element. US investors seem to typically enter a new calender year with fresh optimism and US December quarter data are usually quite solid. China sees a burst of activity ahead of its week-long New Year shutdown and another burst as factories fire up again thereafter. European officials appear to like to get the latest disaster resolved before Christmas. But then US economic data begin to stall, China enters a seasonal slow patch and eurozone members bring down their annual budgets – these days to the obligatory accompaniment of rioting in the streets. The March quarter ends and April arrives.
So here we are again with debate raging as to whether we head down again in a big way, whether a bit of a correction was needed anyway, and whether Europe's about to blow up in our faces once more. Interestingly however, April also brings the results of various investor surveys and similar data from brokers and researchers, and to look at the results of March surveys you'd think the new bull market had already begun.
This week Russell Investments Australia released the results of its March quarter Investment Management Outlook survey of 40 local fund managers and noted “a clear and positive shift in manager sentiment”, with a strong swing evident in favour of growth assets and risk amidst improving outlooks for both the US and Europe. Australian REITs were enjoying renewed popularity and managers had become bearish on bonds. Some 64% of managers still believe Australian equities are undervalued.
Better US and European outlooks may have encouraged positivity but an “overwhelming majority” of respondents listed Chinese economic growth as the greatest influence over investment decisions, followed by the Aussie dollar, European debt, local interest rates and the local labour market.
Russell Investments' Greg Liddell makes note of the polarisation of global views on China, with those in the “hard landing” school citing significant public debt, weakening export and the property bubble as reasons to be fearful. Liddell suggests these arguments are overblown, with a recession for China's biggest export customer (Europe) as the biggest threat to longer term Chinese growth.
Looking at sector preferences, the “risk on” theme was clear in a growing bearishness from fund managers towards the typical defensives of consumer staples, telcos and healthcare and a growing bullishness towards cyclical industrials, materials and energy. Two RBA rate cuts have helped bring cyclicals back into favour, although there remains a degree of caution on valuations, the survey finds, until a positive trend becomes more clear. Notably, both the December and March quarter Russell surveys found no managers suggesting the Australian stock market to be overvalued.
But has it all come unstuck in April, as far as “risk on” sentiment is concerned?
Global investment manager Standard Life Investments released its Global Outlook for the June quarter today. The manager's conclusion is that there are increasing signs of global economic recovery, particularly as the US enters a new phase of deleveraging, although significant challenges still linger. No prizes – European debt problems have not been solved, concerns remain over the state of the economy in “some” key emerging markets, and also high oil prices “remain a worry”.
Standard Life's Andrew Milligan believes the good news is that the US banking system is in a healthier state and the US housing sector could be on the brink of of making its first positive contribution to GDP post-GFC, if only modestly. An improving housing sector has been an important element of bank re-rating and while a lot of the good news has already been priced into US markets, Standard Life still sees favourable prospects.
The downside is that the resolution of the private sector debt burden has meant passing lot of that burden onto the government, and that legacy will last at least the coming decade, Milligan suggests. “The results of the upcoming US election will be important for all global investors.”
Standard's investment preference is to favour sustainable cashflow through a mix of equity, debt and real estate assets.
So the jury is out on whether April-May 2012 will just see a repeat of 2010-11 or whether this time the undertone of improving risk appetite is enough to dampen correction fears. If the swing does continue to favour renewed interest in equities then PIMCO Australia warns the race for investment returns should not lead to investor risk profiles being ignored.
What PIMCO is suggesting is that investors should maintain a balance of bonds in a portfolio as well as equities as is appropriate to the investor's risk tolerance. PIMCO is, of course, the world's leading bond fund manager, and hence there is an unavoidable element of “talking one's book” in PIMCO recommendations but the stats cannot be denied.
For the five years to September 2011, industry data shows 10 of the top 25 performing funds in Australia were fixed interest funds. (Again we note: funds include corporate as well as government bond investment.) Over the same period, many risky assets have generated negative absolute returns. Including bonds with more risky assets in a portfolio can both increase return and reduce volatility, PIMCO points out.
Perhaps the lesson overall is that risk is not a dirty word in a more balanced portfolio – the sort of portfolio that was popular before the boom that created the GFC.
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