Wednesday, January 05, 2011
We crack on with our Non-Predictions, but first we were amazed at yesterday's fall in gold prices. We thought it had fallen about $40, but when we checked the UK's latest market for gold at Tesco Gold Exchange,we found , to our shock , that it had absolutely collapsed. An ounce (31.1gm) of 22 ct gold, according to them, is only worth £593.39 or $925 which we estimate would be about $1000 for 24 ct! Either the market has collapsed or someone might be taking the piss with a hefty 37% IRR.
But back to equities. God knows why anyone is trying to put out calls governing a whole year when we heard on Monday that apparently the average holding period for a US equities is currently... 22 seconds. Positively macro compared to last year's 20 seconds. But here we go...
5) SPX will NOT trade below 1150.
Readers will know that TMM are very bullish of Equities, and US equities in particular, as a function of both very cheap valuations and an incipient CapEx cycle as the economic recovery changes gears from the initial inventory and fiscal-led bounce back into a self-sustaining business investment-led expansion as in the early-1990s. While equities are not as cheap as they were on a forward P/E basis, trading at around 14.9x 2011 earnings (see chart below)...
...on TMM's version of the Fed Model (see chart below), which compares the 10yr real bond yield with the trailing earnings yield of the S&P500, equities are still extremely cheap relative to bonds. Of course, much of this is due to historically low real bond yields (partly on the back of the Fed's QE2), but as TMM will discuss in the coming days, we expect the Fed to continue to purchase its full $600bn quota of USTs, and with the output gap still very large, it is hard to imagine real yields rising dramatically.
A corollary to the above is that with free cash flow yields higher than debt costs for a great number of corporates, managements are likely to pursue more (ego-boosting) M&A transactions (see chart below - globally announced M&A transaction values), Private Equity are likely to arbitrage the debt-equity gap, and reallocations out of bond funds into equity funds are likely to gather pace. Even if the expected 19% increase in SPX EPS does not materialise (an outcome TMM struggle to envisage), at 1150 that would leave the market trading on a still inexpensive ~14.3x multiple. Absent a complete European melt-down, TMM cannot see the SPX trading below 1150.
6) The DAX will NOT outperform the IBEX.
In 2010, amongst the backdrop of the European crisis, the large real money reallocation out of peripheral equities into those of Germany resulted in an eye-watering 40% out-performance of the DAX to the IBEX (see chart below).
TMM is of the view that this "one off" portfolio shift is now done, and that valuations for the IBEX plumping their May-panic lows (see chart below) of ~9.6x 2011's earnings (see chart below) look exceptionally low given that (as we have discussed before) a good chunk of the index is Telefonica and Santander. Given these two companies depend more on Latin America and the UK for their earnings and the fact that the US is undergoing an upswing, while the economic data shows persistent strength in the UK (despite the UK media's best efforts to paint it as a catastrophe), TMM reckon it might be worth betting that the IBEX outperforms, perhaps by a margin, the DAX this year.
7) Emerging Markets (MSCI EM) will NOT Outperform Developed Markets.
Long EM has been a great trade for much of the past two years and has been the cause of no small amount of gloating/bragging/"I give up I’m moving to Singapore" being heard in financial circles. Looking at performance for the last decade, it’s no small wonder why – long MSCI Emerging Markets short EAFE has been arguably the trade of the decade. That being said, it is not without its own risks and principal amongst those is the general tendency for EM to blow up whenever food does. The chart below shows MSCI EM/MSCI EAFE and GSCI agricultural commodities – not that big spikes in ag prices often occur around the same time as periods of EM under-performance – 2008 and 2004 and even more the further back you go. EM inflation baskets are food and energy heavy and if our views on energy this year are correct and agricultural prices don’t come down hard and fast it is hard to see that not translating into broadly tighter policy or inflation premia.
Going by the biggest market weights (the BRICs) the picture doesn’t get any rosier. China is cheap and appears to be in the middle of a massive policy tug of war between technocrats who want to bring the investment/credit expansion under control and push for consumption and, on the other hand, local officials who are all about growth and particularly price growth of their apartments in Bejing. It is hard to see this being resolved quickly and the “here it comes / no wait it’s not” of the mooted China property tax is case in point on this.
In India there is a tail risk of a BOP crisis (though TMM doesn’t buy it) but the kind of tightening required to stay credible on that point is nothing good for equities. Roussef is yet to be tried in Brazil and appears soft on inflation and Russia is, well, probably going to do ok on energy prices but it is hard to see the great news there besides. While TMM don’t expect the scope of underperformance to be 08 style due to be more benign global credit conditions it is hard to see the EM permabull team of Jing Ulrich, Jim Rogers and others looking as smug at the end of this year as they were last.