The current market environment reminds me of the movie “Wayne’s world” that I saw longer ago than I care to remember. The party mood on the markets just continues in the face of clear and present dangers.
Over the last couple of weeks risky assets continued to climb the wall of worry or continued to surf the wall of money, if you prefer. Just think about it. Markets had to face renewed fears of solvency of “weaker” sovereigns following Portugal’s inability to pass a budget, the downgrade of its debt and the resignation of its prime minister.
As I read somewhere over the week-end: “maybe it is not a good idea to have a prime minister called Socrates when you are desperately trying to convince the world that you are not Greece”.
And to be honest the news flow out of Europe has improved quite a bit as countries work together to extend the EFSF, come up with some sort of competitive pact and get closer to more permanently solving the shorter-term liquidity concerns. The longer-term solvency problems (will countries like Greece be able to pay down their debt?) are of course another matter.
However, there is more, much more. There were very weak US housing numbers with new US home sales falling a whopping 16.9 percent (against an expected increase of 2.1 percent) while housing starts came in at a new all-time low.
Then there are the usual suspects like higher oil prices, tensions in the Middle East, the war in Libya, food inflation and the Japanese shock. All of this would at first glance, logically and rationally, been enough to see some sort of a correction after the massive run-up we had since the end of August of last year in all sorts of risky assets.
This has clearly not been the case. The main reason for this is that besides the Fed, that keeps happily printing money, the BOJ has joined them in their effort to liquefy the world economy. After years of passively waiting, the Japanese Central Bank has embarked on a massive program which we could also call Quantitative Easing, even though they are not, like the US, necessarily buying government bonds.
Besides technicalities, the most important thing is that they have been injecting about half the amount of the last US QE2 effort over the course of the last couple of days. The Japanese monetary base (which is published monthly) will not show anything for a couple of months (there is always a delay) but the current account balances have been going up like hell. The BOJ’s total assets now stand close to an all time high.
So as a matter of fact, this is just more of the same. There are certainly a lot of problems in the world economy, but they are made invisible by the flood of money that central banks are injecting in the system. History shows that they can continue doing this far longer than anyone can remain solvent shorting the markets. Are there no limits? Time will tell as this unseen financial experiment drags on. Maybe it will be a further rise in inflation that makes the expansionary Central bankers in the US rethink their actions, just like the ECB is currently doing. The Bank of Japan at this time does not really have a choice as it has to deal with this catastrophe. However, does the Fed really have a choice when you look at housing? I am no longer sure.
Do Not Fight the Trend
So it looks like we will have to deal with this Pavlovian conditioning “do no fight the Fed” for some more time to come. So certainly do not fight the Fed and the BOJ when they are printing together. As long as they keep the money flowing, risky assets will remain well supported. However, make no mistake about this. It is not that there are no risks in the system.
The easiest thing would be to just go with the flow. Knowing though that a large part of this move is artificial does not really make you sleep better at night. I am a very lucky. I do not have to carry to load of daily performance as quite a bit of our clients do. We have been on the road doing presentations and client visits for quite a bit over the last couple of weeks. And we get not much further than explaining the situation and come up with a couple of scenarios. And this is not really helpful as nobody can tell how long this trend is going to last.
It is often said that extended markets can become even more extended. In the current market environment, normal trading discipline rather feels foolish at times. Therefore the best and brightest in our industry, the ones with the sound systems and discipline to execute are currently suffering this much.
It is not at all comfortable to be put in a position where they have to choose between embracing a trend that can that is to a large extend artificial and can end at any moment, or staying disciplined and ending up being underinvested as a result. That has been the dilemma. And it is not an easy one.
New Dawn for Japanese Stocks?
Another question that I am asking myself on this sunny morning: will this change of heart of the Japanese Central Bank not herald a new Spring for Japanese equities? The Japanese equity market has been in a multi decade bear market. And we know that dramatic events very often mark important tops and bottoms in financial markets. The market cap weight of Japanese equities in the World MSCI has dropped to about 10 percent from 40 percent at the height of the Japanese Industrial miracle.
And maybe most importantly, you just cannot find a fund manager that even dreams of investing in a market that has underperformed for so long. All these elements warrant a least a closer look and some more analysis, something that we will be doing over the next couple of weeks.
As for the yen, it has strengthened a bitas, just like in 1995, repatriation of capital (demand for yen) looms. However, up until know, the yen appreciation has been nowhere nearly as strong as it was back after the Kobe earthquake (its value back then went up about 19 percent). Some will remember, an otherwise there are always history books, that after the 1995 disaster the Japanese Central Bank was tightening monetary policy (while the Government was hiking its sales tax).
Now with the BOJ throwing this “wall of money” in yen at the markets, it is logical that the appreciation has not nearly been as strong. Moreover, if they keep injecting liquidity to an amount that is (much) larger than the amount in yen that is/will be repatriated, the yen could/should probably weaken. In itself this would also certainly be helpful for Japanese exporters and equities.
The disaster has clearly put the spotlight back on Japan, which had, from an investment perspective, almost been forgotten. And as with every (natural) disaster, people stand up stand out and rise above themselves. One of the most remarkable stories of bravery I read (and there are certainly many more not always documented) was about the retired employees from the nuclear plant that is in trouble that came to volunteer to take the very dangerous work from the younger generation. A people like this can be down for a while, a long time, but is never out indefinitely.
The author is Philippe Gijsels, head of research, BNP Paribas Fortis Global Markets