Wednesday, August 22, 2007
Well, Macro Man knew it was going to happen. His vacation saw more market fireworks than the 4th of July, Chinese New Year, and the Millennium put together. His return has seen those pyrotechnics extinguished by a steady stream of volatility-dampening drizzle (and alas, he is speaking literally.)
For those who endured the first half of August, the current respite must be welcome. Indeed, this morning's recovery in erstwhile favourites such as the Turkish lira suggests that risk appetite has not been completely eradicated. Anecdotals suggest that volumes are fairly low, however, which is hardly a firm foundation for a sustainable recovery.
Yesterday's meeting between Senate Banking Chairman (and would-be US president) Chris Dodd, Ben Bernanke, and Hank Paulson has helped to calm things as well. Markets appear to have interpreted Dodd's press conference as indicating that the Fed could cut rates should conditions deteriorate further. How this is near-term bullish (rates cuts should things get worse) is a bit of a puzzle to Macro Man, but then again so was the risk asset rally after the last Fed meeting. And we know how that turned out!
While Dodd stopped short of promising rate action (or publicly requesting it), the implication was pretty clear that he'd like some relief. He did his part as well, of course, providing viewers of the press conference with a phone number (1-800-999-HOPE) to ring if their teaser rates are about to reset. Now, Macro Man would guess that the sort of people who watch or read about press conferences from the Senate Banking Committee chairman are generally not the sort of people that need to dial a financial literacy hotline. Nevertheless, it is probably a good thing that SOMEONE is doing something to increase the financial nous of Mr. and Mrs. Joseph Sixpack.
Imagine, though, what the world would be like if our buddy Jim Cramer held political office. Macro Man can just imagine Cramer on CNBC, in full Crazy Eddie-style rant mode:
Mr. Bernanke! The market is broken! My guys are puking stocks at prices so low, they're practically GIVING them away!
Hedge funds! Struggling to shift unwanted inventory? Do you HAVE NO IDEA how you're gonna trim risk and meet redemptions? Prime broker playing hardball and asking for more margin?
Shop around, see what terms they're offering, then call me up and I'll beat 'em!
That's right, dial 1-800-BAIL-OUT and Crazy Cramer will sort you out, pronto! That's 1-800-BAIL-OUT for the finest prices on government prop-ups! 1-800-BAIL-OUT! Call today!
That, we can all be thankful, resides in alternative universe that none of us currently inhabit.
In any event, Macro Man retains the view that the medium-term prognosis for risky assets remains broadly constructive, even if neither economic growth nor market Sharpe ratios can match the pace of the past four years. A key caveat to the view is that the US avoids recession, even if consumers spend at a below trend pace. The rationale for this view is that corporations have not exhibited the type of excesses (in terms of hiring, capital investment, or inventory accumulation) that has almost always foreshadowed periods of negative growth in the United States. Those conditions may be met in the fullness of time, but for now Macro Man believes that 'muddle through' economic growth remains the most likely outcome.
The rationale for the generally upbeat view of risk assets, meanwhile, rests on one word: liquidity. While asset markets have clearly seen a sharp reduction in the amount of micreconomic liquidity available (in other words, the amount of trading that can be done in asset markets without producing catastrophically expensive transaction costs), on a macroeconomic basis, liquidity remains ample.
Now, to demonstrate this fully would require more time and space than Macro Man has at his disposal. So his explanation will be necessarily brief. Suffice to say, however, that a primary tenant of his view is that most market participants and commentators underestimate the impact of the developing world in providing liquidty.
Take, for example, the global monetary policy setting indicator that Macro Man posted yesterday. It showed that global (actually, Macro Man uses the ten largest economies in the world as a proxy for the globe) monetary policy is still slightly accommodative, albeit much less so than it was a few years ago. If we break that down by source (developed markets versus emerging markets), however, we see an interesting disparity. Developed markets (which comprise 82% of the GDP weight in the world's ten largest economies) appear to have a monetary policy setting which is broadly neutral, a conclusion that does not seem unreasonable. The 5 EM countries in the world's top ten largest economies (China, Brazil, Russia, South Korea, and India), while comprising only 18% of the GDP weight, nonetheless contribute 80 bps of policy accommodation to the global economy. (Note that this measure is GDP-weighted.)
Focusing primarily or exclusively on developed market central banks, as many in the market tend to, would lead one to underestimate the degree of policy accommodation left in the global economy, and perhaps by extension the potential for growth and asset returns.
Looking at money supply produces a similar picture. Macro Man has constructed a measure for dollar-terms global money growth, measuring the growth in dollar-term M2 in each of the world's ten largest economies. The picture there also looks constructive for risk assets, and for similar reasons. Dollar money growth, while not at the levels seen in 2003, neverthless remains extremely firm at 12%. And again, the 5 EM countries punch above their weight in contributing; by Macro Man's calculation, the five aforementioned countries have contributed 40% of the dollar-term money growth recently.
Needless to say, the current macroeconomic liquidity environment would appear to remain relatively sanguine for financial risk-taking. A final piece of the puzzle, at least when it comes to the United States, is the level of cash sitting on the sidelines. According to ICI (via Bloomberg), US money market fund assets have risen more than $300 billion so far this year. If you're scoring at home, that's more than twice the amount taken out of conumers' pockets in a year if $500 billion of ARMS reset 3% higher.