Feeling the pinch in the Age of the Crab
By John Authers
Published: June 3 2011 23:22 | Last updated: June 3 2011 23:22
We have been here before. For a second summer in succession, economic data have deteriorated sharply as summer approaches. And for a second summer, financial markets are recoiling.
It is disappointing for all those who are hoping to restore their family’s fortunes after the savage recession of 2008-09. It is also frustrating for investors. After the clear outlines of the great crash from 2007 to 2009, and the rally that followed it, markets have trundled nowhere for the better part of 18 months.
The pattern is clear. The crisis continues to define the economy and the markets. After a severe financial crisis, the historical market sequence has seen a crash, followed by a partial recovery, and then years of sideways movement as the economy and financial system try to regain traction (with plenty of hope and disappointment along the way).
This is the second year of the Age of the Crab. We can expect it to last for many years yet.
The decades after the Great Crash of 1929, and the Tokyo market’s crash of New Year’s day 1990, look very similar to each other. This time, stock markets bottomed out at a slightly higher level, and managed a more convincing initial recovery, but the emerging pattern of recoveries and disappointments now looks very similar.
This is easily explained economically. The debt overhang from the crisis, along with negative equity in the housing market, and weakened financial institutions, push downwards. Attempts to revive activity with low interest rates, the natural effects of the business cycle, and growing demand from emerging economies, led by China, push upwards. The forces cancel out, creating stalemate.
What results is a crab-like move sideways. The cocktail that has slowed things down this year is identical to last year’s mixture: concern about sovereign default in Greece (the continuing manifestation of the crisis); worries about a hard landing in China (which is now pulling back its crisis-time stimulus); and worries about looming rising rates in the western world. There is enough life in the economy to stir with low rates, but not enough for it to withstand a hint of higher rates, or of new financial trouble.
Making money in this environment is about timing the bumps and the dips, which is famously difficult. At least part of this latest slowdown was triggered by an event beyond market screens: the Japanese earthquake in March. Research by New York’s Bespoke Investment shows that the sharp uptick in US unemployment claims, and downturn in the ISM survey of manufacturers, of the past few months are almost identical to the downturn in these measures seen after the 1995 Kobe earthquake.
But there were other warning signals from within markets themselves.
In the US, the Case-Shiller house price indices turned down some months ago, and this week confirmed a double dip. This adds pressure to the banks sitting on mortgage-backed securities, and weakens the consumer.
Then, note patterns within stock markets. Emerging markets started underperforming the developed world last autumn. This was hugely significant. It showed there were doubts over whether emerging markets really could pull the rest of the world in their wake.
Cyclical stocks have lagged more defensive stocks, according to Morgan Stanley’s indices, by about 7.7 per cent since they peaked in February (having previously performed almost exactly twice as well since the market bottom in March 2009). This is a classic indicator that investors are turning cautious.
And financial stocks are far underperforming the market as a whole. So far this year, the KBW banks index in the US has underperformed the S&P 500 by almost 12 per cent – and the banks have underperformed by more than 20 per cent since the Greek sovereign crisis began to take shape last spring. Again, this reverses what was seen during the great relief rally. It betrays growing nerves about another financial crisis.
All of these were indicators of trouble ahead, and may prove useful again in the years that come. Meanwhile, with 10-year US bond yields back around the historically very low level of 3 per cent, normally indicating great bearishness by investors, equities are remarkable chiefly for their resilience.
Last year’s correction saw the FTSE All-World stock index fall more than 16 per cent, peak to trough. At the time of writing, it is at present down less than 5 per cent from its recent peak. It remains about double its low from March 2009, and up about 30 per cent from last year’s low (all in dollar terms).
This is because earnings have held up well – but expectations are beginning to look stretched. Investors are also somewhat starved for somewhere to go, so equities win by a process of elimination. But for the short term, the forces pushing them downwards look strong.
Crabs should be plentiful around the markets for the next few years – more so than bulls or bears. To keep scampering sideways, it may be wise to sidestep equities for a while, as the chances of a true correction, like last summer’s, look strong.
Bond dealers lick wounds after Treasuries turnround
By Michael Mackenzie and Dan McCrum in New York
Published: June 2 2011 20:21 | Last updated: June 2 2011 20:21
Few expected to see this. Yields on benchmark US Treasury bonds have tumbled below 3 per cent for the first time since December amid growing fears for America’s recovery. Some of the world’s biggest bond traders have missed out on an impressive rally. Only weeks ago, investors were focused on the prospect of rising yields. Bill Gross at Pimco has been among those arguing that the forthcoming end of the Federal Reserve’s second round of quantitative easing, dubbed “QE2”, is bearish for bonds. Who, after all, will step in to buy the debt when the biggest buyer, the Fed, steps back? The game changer has been the steady stream of disappointing economic data that, since late April, has raised questions over the strength of the US recovery. After a lacklustre first quarter, some believe the economy has run out of steam and, as a result, expectations for future Fed tightening have been pushed back.
Bond yields, which move inversely to prices, have fallen sharply as dealers have priced in the receding likelihood of interest rate rises.
This week’s data alone have shown the US housing market sliding and poor job creation in the private sector. Closely watched surveys suggest global manufacturing activity is weakening. A weak May employment report on Friday would add to fears, reminiscent of last year, that America faces a possible “double dip” recession. “People are really getting surprised by the data and are now ratcheting down their forecasts for the second quarter,” says Rick Klingman, managing director at BNP Paribas. “The general feeling in the bond market is that the economy has stalled.”
Money managers and traders who expected yields on 10-year Treasuries to hold above 3 per cent, and who have been “short” US debt, are hurting. Some, it appears, are moving to stem further losses.
Rick Rieder, chief investment officer of fixed income for BlackRock, says: “We’ve moved a tremendous amount in terms of where the Treasury market is and we could move a bit more with all the shorts in the market.”
Indeed, further weak data could pull yields much lower and spark additional bond buying by investors who need to match their benchmark, the Barclays Aggregate index, but who have been underweight Treasuries in favour of corporate bonds.
Last month, the Barclays index rose 1.3 per cent as Treasuries rallied, accounting for more than two-fifths of its 3 per cent year-to-date gain.
In a world where basis points matter – where 0.4 of a percentage point of annual performance equates to about 60 places in fund manager rankings – Pimco’s public bet against Treasuries appears to be costing it dearly. The $243bn Total Return fund run by Mr Gross added just 56 basis points last month. It faces a difficult period if Treasuries rally further.
Pimco, moreover, is not alone. “No one is really long the bond market, they are either short or neutral,” says William O’Donnell, strategist at RBS Securities. “Macro funds and big investors have been fighting the steady decline in yields all the way, distracted by QE2 ending.”
Treasury bears could enjoy a short-term reprieve if Friday’s payroll figures are better than the expected 135,000 new jobs created in May. “The bond market has priced in a lot of bad news and yields are vulnerable if the economy picks up,” says Mr Klingman.
And many economists, including the Fed, still expect a rebound in the economy later this summer. They suspect the current “soft patch” of being no more than that. For his part, Mr Rieder believes bond dealers may have swung from over-optimism on growth to excessive pessimism. A drop towards a yield of 2.50 per cent to 2.75 per cent on 10-year paper could well prompt BlackRock to take a bearish view on Treasuries, he says.
For now, 2.50 per cent is seen as the likely extent of any further rally, a scenario that is conditional on data showing stagnant annualised growth of about 1.5 per cent, a pace of expansion that is unlikely to lead to substantial employment gains.
While further Fed easing in the form of “QE3” looks a long shot given core inflation is rising, the longer the central bank indicates it will keep short-term rates anchored near zero, the more room there is for longer dated yields to compress lower.
The prospect of tighter fiscal policy at state and federal level limits the scope for any rebound, too.
“We continue to believe that the Street’s optimistic second-half growth forecasts will be the next casualty,” says Steven Ricchiuto, chief economist at Mizuho Securities. For yields to fall to 2.50 per cent, he suggests investors would need to downgrade their assessments of growth in the second half of 2011.
Given the disbelief among investors at persistent strength of the Treasury rally, a test of October’s low cannot be ruled out. “The hallmark of a rally ending is when everyone is long and there is no one left to buy,” says Mr O’Donnell.
Paulson $9bn hedge fund falls 6% in May
By Sam Jones in London
Published: June 5 2011 22:33 | Last updated: June 5 2011 22:33
Paulson & Co, the world’s third-largest hedge fund, saw the value of its flagship fund drop close to 6 per cent in May, echoing losses across the industry.
The loss tops negative returns in the first quarter at the $37bn New York-based money manager, famed for the spectacular returns gained by shorting the US mortgage market in 2007, and will again raise questions over its portfolio’s volatility.
John Paulson, Paulson & Co’s founder, has maintained his bullish view on the US economy and equity markets, even though many of his peers have recently begun to lower their market exposure levels. May’s loss means that in the year to date, the $9bn Paulson & Co Advantage Plus fund is down 7.6 per cent. The average hedge fund lost 1.39 per cent over the month according to preliminary data from Hedge Fund Research, with “event-driven” strategies such as that operated by Paulson & Co’s main fund down on average 0.62 per cent.
May was also a painful month for Mr Paulson’s other big investment call: gold.
The Paulson & Co Gold fund dropped 6.39 per cent in May, erasing much of its 8.5 per cent April gain. The fund is up 0.9 per cent in the year. Paulson & Co is the world’s largest non-sovereign gold investor.
Performance was better for the firm’s other funds. Its Credit fund was down 0.05 per cent for May, while the Recovery fund, which is geared to the prospects of the US economy, dropped 0.69 per cent. Paulson & Co declined to comment.
In the firm’s most recent correspondence with investors Mr Paulson said difficulties for US banks had been a particular drag on his portfolios but that he remained optimistic.
The US stock market could rally as much as 40 per cent from its first quarter level this year, he said.
June is also shaping up to be a difficult month. Paulson & Co is the largest investor in Sino Forest, the Canadian-listed forestry group that has been accused by short seller Carson Block of fraud, charges that the company disputes.
Mr Paulson is no stranger to volatile returns. Last year saw several months of significant performance swings but the firm ended 2010 with double-digit returns for all its funds.
The Advantage Plus fund returned 17 per cent in 2010. It returned 21.5 per cent in 2009, 37.6 per cent in 2008 and 158.5 per cent in 2007.
