No Merry Note, Nor Cause of Merriment

The revisions of US 2014 Q1 GDP so far. Comparing the contribution to real GDP

Contribution to real GDP in percentage points (from BEA)

Most of the revision is basically from PCE, and the rest from EXIM (both exports and imports worsened). This is just a point estimate, but will definitely cause some serious re-think on the recovery. The PCE has been the flagship of US recovery so far. And this prints definitely NOT good.

If US enters a recession, inspite of QE3, that will shake the confidence of the public in general, and will not be exciting for equities. Are we back to rates rally?

Most of the other data, including something that you can rely on, like Federal Reserve FoF data, still show encouraging trend. So I would say nothing to worry as of yet, but be watchful.

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.

NIFTY: Inside Stories

Reported insider selling has been quite active lately for Indian listed equities. So we take a quick look at it

Looking at the graphs, here are some stylized facts

1) the inside selling activity has been most wide spread recently. Although the total value of gross and net insider selling has come off the peak in April 14, the number of companies involved is still much higher than last few years average

2) The aggregated inside selling does not appear to be a good predictor of the general direction of the market. It seems, the company insiders are usually happy to lock in a local maxima after a slump in price.

3) Give 1 and 2 above, it may not be time yet to worry about the end of the bull market

2014 H1: Top 5 Pain Trade

#1. Short Rates: USD, GBP (USD shown below)

#2. Short JPY vs USD: (and Long NKY)

#3. Flattener: in USD and in GBP (USD shown below, see short ED + notes vs long in long bonds)

#4: Long CNY Carry

#5 Short EM

And now after the ECB, we are back to carry trades

Rates: Preparing for An ECB Disappointment!

EUR 5s10s slope in swaps is too steep

Comparing EUR with all other CCY 2s5s10s fly is trading at a too high level. Even with own history, it is trading at all time high (see below). At the same time compared to JPY, the 5s10s30s too flat.

On top in recent time, the beta of 5y to change in 10y swap has been highly assymetric for large moves (see below)

The trades are

#1: Pay belly in 2s5s10s in EUR

#2: Pay belly in 2s5s10s in EUR vs receive belly in 5s10s30s

Will work good in case of a disappointment. And downside should not be great in case of expected actions. Now a shock and awe from Mr Draghi is a different matter. So preparing for an ECB disappointment is not a bad strategy, given - a) the amount of expectation and b) history of ECB

Of Secular Stagnation and Other Worries

We have seen quite a bull run in the bonds market since the start of the year. Which has caught many people off the guard. The usual suspects are flow chasing yields after equity peaking off the tops, and risk off from Ukraine crisis. But perhaps something more at play here, and we take a look about the secular stagnation and a global japanification that is priced in the rates markets now. After the good rally this week

The peak nominal equilibrium rate priced in is maximum for USD. This is in spite of the recent difference between GBP and USD. This prices in a convergence of UK and US inflation and a higher long term real GDP for US. The recent bullish phase has been less about re-pricing the pace of rate hikes, and more about the terminal rate, i.e. estimate of natural rate of interest. Except in GBP where there is a large re-price of peak rate time (by 3 years!)

This, in my opinion, reflect a much less optimistic re-assessment compared to last year. The terminal rates should be determined by the potential output of the economy, and the pace of hike is an estimate of central bank’s degree of dovishness. This re-pricing of terminal  rate shows a possible shift downward of potential output itself

This brings us back to the pricing of a possible secular stagnation and Japanification. We run a simulation assuming 1) a further 50bps reduction in the maximum future rates (secular stagnation) and 2) as mentioned under 1, but also the maximum rate is attained 8 quarters from the current priced-in pace of hikes. The effect of these on long end rates are obvious, both depress the long end further, and 2) is more severe than 1). 

However, the interesting point to note is how the curve slopes get re-priced. From current level, scenario 1) shows a flattening, while scenario 2) shows a steepening. Indeed the curve slopes in JPY are in general steeper than G3. I think any re-pricing of pace of hike is less likely, especially if inflation has indeed bottomed out (for USD and GBP). We still have a chance for re-pricing of pace of hike for EUR. So as I see it, flattening to continue in USD and GBP, and expect further steepening in EUR.

Oh, and there is this interesting piece from FT Alphaville. Do check the link. 

NIFTY: Are FIIs Really Overweight India?

I have my doubts

Here is an interesting article from the good folks from FTAlphaville

What is striking is that although the general feeling is that the FIIs have been "euphoric" about India and its' resurgence under Mr Modi as the PM, as I see, the data fails to show the same. Here are couple of charts to drive home the point.

So irrespective of what analysts at foreign banks says, I think a large part of the rally in the Indian equity markets so far this year has been driven by domestic buyers or may be even retail money. And a lots of potential FIIs flows sitting on the sidelines. Through the last phase of the election campaigns and actual elections, my perception is that FIIs have been cautious and decided to follow a wait and watch policy. And it would not take a dramatic positive results for NDA to kick start the next leg of the bull run. A simple confirmation of average exit polls prediction will do.