One down, ninety to go. We're just one day into the new quarter and already it's been a doozy. As yesterday's post observed, it was not a complete surprise that the first day of the new quarter saw some buying. A 3.6% rally in the SPX and anecdotal reports of large amount of cash on the sideline surely suggest that it might be time to dust off the long-dormant constructive worldview on equities?

Not so fast, my friend. While global stock indices certainly look cheap on a forward looking P/E basis, there remains very considerable uncertainty surrounding the denominator in that metric. And even the price action yesterday gave Macro Man pause for thought. Volume wasn't exactly massive; indeed, it wass slightly below the average of the past 3 weeks, a period which has seen the SPX meander off its near-lows.
Moreover, it's important to remember that high-volatility up days generally occur in bear, rather than bull, markets. Consider the table below. During the 1991-2000 bull market, the SPX rose by 271%...and there were exactly seven days during that time in which the SPX rallied 3% or more. During the bear market that lasted from the Nasdaq top to the Iraq invasion, the SPX tumbled 38%. However, during that time there were 24 days in which the S&P rose 3% or more.
In the subsequent bull market, the SPX rose 70% and didn't have a daily rally of 3% or more a single time. Since the start of this year, meanwhile, there have been 3% up days. While the total index decline this year has eased to just 6.7%, the upside volatility certainly suggests that the underlying trend is a bearish one.

Of course, this is a problem being encountered in markets other than the US. The rolling three year return:risk ratio of a notional pension fund portfolio (60% equity, 35% fixed income, 5% cash) has now turned negative Japan and is swiftly falling in the US and Europe.

Interestingly, one a one year horizon, returns in Japan and Europe have turned negative, while US returns remain (barely) positive. Insofar as superior investment returns have been a lynchpin of the EUR/USD bull run, one could argue one key support for the single currency has been removed, just as the euro has hit dramatically overvalued levels.

You can judge for yourself what the long term investment implications of this may be....
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CV
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April 2, 2008 at 11:43 AM ×

You are quick these days MM ... no title :) ...

Anyways, what a wonderful couple of graphs that is. I will tell you what it means for long term global investment flows. It means NO de-coupling and re-balancing. At least not in terms of those hailing a dollar meltdown scenario since the meltdown will come first somewhere else. However, I still think that the USD is now set to lose its clout to a basket of EM currencies (e.g. the Rupee, the Real, the Lira, the RMB(?), Bhat etc) but all this also depends on these countries' willingness to open up (well Turkey is pretty damn open it seems :)) and go from being capital exporters to importers.

I am still not sure whether to pile up against the Eur at this point. The EUR/USD has been pretty volatile the last couple of weeks jumping between 1.53-1.58/9. So, as you said recently, perhaps it is best to wait a little longer but for how long ... timing I guess pretty darn important in this world.

Claus

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vlade
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April 2, 2008 at 11:54 AM ×

If you look at returns in USD though, FT EUR 350 is still positive. Say if I compare early August I get ERU350 at around 4300, EURUSD at 1.36, value USD 5848, today EUR 350 at 3770, EURUSD 15 1.56, value 5881.
So, if one invested one's greenbacks in Europe, one would have actually made money!
Of course, conversly, if an european (or just about anyone else) invested in US, they lost money big time.

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Quarrel
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April 2, 2008 at 1:09 PM ×

MM,

You need a new acronym - the DBOTW have gone out of style, and the new thing is surely to sell the rallies.

RSOTW?


--Q

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Anonymous
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April 2, 2008 at 1:13 PM ×

Is it fair to use equities/bonds/cash? The trend toward allocation to alternatives suggest it might be worth including real estate/private equity/hedge funds?

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Macro Man
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April 2, 2008 at 2:10 PM ×

CV, Doh! Didn't realize I'd forgotten the title.

Vlade, while it's true that the "dollar terms" performance of Europe is better, in practice many pension funds farm out currency management to partially or totally hedge out all of the currency risk in their portfolios, allowing their mangers to concentrate on local-currency returns.

Quarrel, on current form its the SLOTW (stop lossers of the world.)

Anon, yes, pension funds use more alternatives...but then again Japanese pension funds have much more fixed income/much less equity than these ratios. This analysis is really just a shorthand way of comparing asset return environments in different markets.

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Mr. Prop
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April 2, 2008 at 7:50 PM ×

M-squared - too bearish...Ben is way past helicopters. The Fed is the new new super-duper SIV. Banks can finance at Fed Funds + 25 and hold assets at Libor + 200. Its a money machine. Now this may not do much for earnings as profits are used to rebuild capital that is so desperately needed. For valuations it does not matter if its earnings or capital that is built. With book values at such low levels ( C is 1 times book) market reflates. Reds get slaugtered as V is priced in, dollar roars as confidence returns, and the SP500 soars 40% off the lows, fed by a reversal in uber-bearish sentiment. AAII is reversing already, but 20-day put call is just now getting the joke. Buy stocks. Real economy is going to love monetary accomodation and discount it large. Remember that except for post bubble period it always pays to buy stocks when monthly payrolls has two consecutive negative numbers, same for consumer confidence is so low, and ISM is in the 40s...I love it when a plan comes together

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Anonymous
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April 2, 2008 at 11:17 PM ×

"Remember that except for post bubble period it always pays to buy stocks when monthly payrolls has two consecutive negative numbers"

This is not a post-bubble period?

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Edward Hugh
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April 3, 2008 at 8:54 AM ×

Interesting stuff everyone.

"This is not a post-bubble period?"

Well in the US it is not that straightforward (which isn't to say, as we all know, that there aren't some very important problems). But in Spain.... perhaps.

A lot of big action seems to be taking place on the food front at the moment, and it seems to be the case that food prices are going to continue to be a big issue as far ahead as we can see.

Yesterday the FT was citing Paul Braks - a commodities analyst at Rabobank - as saying that even highly productive exporters such as Ukraine were now imposing export restrictions on wheat.His view was that:


"In the medium term, high prices should encourage more land to come into production, particularly in Ukraine and Russia. Thus.....World grain prices are likely to be high and volatile over the next two crop years, and then from 2010 the supply response should start to bring prices slowly down".

The interesting question is where the two above mentioned countries are going to find the labour force necessary to bring these areas into production. (China is a not entirely disimilar case).

Last night I was looking at the quarterly labour survey data for Ukraine going back to early 2005, and the situation is really quite striking. The total number of unemployed has dropped by about a third over the period, but numbers in employment have remained virtually stationary. Obviously at some point push comes to shove here. Meantime Ukranians are working away all over the place, and inflation is, of course, rampant in both the CPI and the PPI. (incidentally some such impact can also be noted even in Vietnam - which is the world's thrid largest rice exporter - with people queueing up from points across the globe - including the Czech Republic - trying to recruit migrant Vienamese labour, and shortages of agricultural workers starting to appear out in rural Vietnam).

So on the real economy side all I can see is some sort of stagflation (mild or otherwise) scenario for the OECD economies, although quite what the implications of this will be for the financial side I am not sure.

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