Tuesday, June 17, 2014

Macro Views Series: A Global Asset Shortage?

Following austerity and fiscal prudence across majority of developed economies, the budget gaps across countries narrowed considerably. This means bonds supply is going to be lower in future. US had the biggest squeeze in deficit, while Germany already runs a balanced budget. To top this, non-sovereign fixed income supply is low as well. Mainly driven by a large fall in mortgage related issuance in the US and Europe, still recovering from the momentary lapse of reasons before the financial crisis

This along with low interest rates, low inflation expectation,  and large central bank balance sheet size, means that not only there is a shortage of safe asset, there can as well be a shortage of assets in general

Most G7 economies offer negative or very low real return – apart from the longer end of European peripheries (based on absolute return (FX Hedged), US and UK the belly of the curves, seem still cheap). In a word, there is little left on the upside for bonds for long term investors. Especially if you are looking for upside and NOT the carry 

Granted equity valuation is anything but cheap on most parameters. But compared to low bond yields, the relative valuation is attractive.  Especially true if inflation picks up from these low levels (Note: the earning yield above is NOT adjusted for leverage).

So if you are not managing grandmas' retirement fund, the equity upside and valuation still remains compelling, compared to other alternatives. Especially from an absolute return point of view.

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