Over­com­ing the macro break­down

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

The fi­nan­cial cri­sis of 2008-2009 her­alded a golden age for macro in­vestors. As the whole­sale mar­ket crash ren­dered the rel­a­tive value judg­ments of stock pick­ers ir­rel­e­vant, macro in­vestors en­joyed a boom time—es­pe­cially ones who had had the fore­sight to short US hous­ing, global fi­nan­cials, or eu­ro­zone pe­riph­eral debt. Now, as the cri­sis re­cedes fur­ther into the rear view mir­ror, macro in­vestors have strug­gled to adapt to a world in which es­tab­lished re­la­tion­ships have bro­ken down, leav­ing in their place a mul­ti­tude of puz­zling con­tra­dic­tions.

Take for ex­am­ple this year’s sud­den de­cel­er­a­tion of China’s con­struc­tion boom. As you would ex­pect, this has hit iron-ore prices and Baltic freight rates (which are back to their 2008 lows). But de­spite this un­ap­peal­ing back­drop, the CRB com­mod­ity in­dex is up 9% year-to-date while the Aus­tralian dol­lar is the world’s best per­form­ing ma­jor cur­rency this year. Just as awk­wardly for many macro in­vestors, Ja­panese in­fla­tion has re­bounded by more than 150bp on the back of the Bank of Ja­pan’s ag­gres­sively re­fla­tion­ary poli­cies. Yet JGB yields re­main stuck to the floor and Ja­panese re­fla­tion plays are among the world’s worst per­form­ing trades so far in 2014. Mean­while the yen, with gains of 2.7% against the US dol­lar and 4.1% against the euro, has con­founded all pre­dic­tions of a sus­tained bear mar­ket.

Then there has been the rally in US trea­suries. With the Fed ta­per­ing, with loan growth in the US in dou­ble dig­its and with wages ris­ing, most in­vestors felt that 2014 would fol­low in 2013’s foot­steps and deliver poor re­turns for bond portfolios. In­stead, 30-year US trea­suries have de­liv­ered among the high­est re­turns of any as­set class so far this year.

This break­down in macro re­la­tion­ships that in­vestors had come to take for granted is the over-arch­ing is­sue. There are four key sub-is­sues:

- With China ex­pe­ri­enc­ing a com­bi­na­tion of dis­ap­point­ing growth and limited room for ma­neu­ver on stim­u­lus, Bei­jing will have lit­tle choice but to em­brace more ag­gres­sive re­forms. This means we should ex­pect fresh sur­prises on the pol­icy front-which in turn should un­leash some in­ter­est­ing in­vest­ment op­por­tu­ni­ties.

- Will Ja­pan re­gain its re­fla­tion­ary mojo? The Topix has now risen for ten con­sec­u­tive days, partly on the back of a promised cor­po­rate in­come tax cut. Will cor­po­rate tax cuts, com­bined with an ever-re­fla­tion­ary BoJ, lift Ja­panese eq­ui­ties from their place as this year’s worst per­form­ing ma­jor stock mar­ket to a more re­spectable po­si­tion in the league ta­ble?

- Is in­fla­tion in the US set to ac­cel­er­ate? For struc­tural rea­sons we have long held the view that de­fla­tion con­sti­tutes a big­ger risk for most de­vel­oped economies than in­fla­tion. But hav­ing said that, we recog­nise that US in­fla­tion data has been tick­ing higher re­cently and we have to pon­der whether this is the start of a new trend. If it is, will it mark a pro­found change in the in­vest­ment en­vi­ron­ment?

- One place where a pick-up in in­fla­tion

is def­i­nitely not hap­pen­ing is euroland. In­stead, in­fla­tion continues to make new lows, even in healthy economies such as Ger­many. Does this mean the ECB will now em­brace un­con­ven­tional mon­e­tary poli­cies, and do so for as far as the eye can see? In the ab­sence of ag­gres­sive con­ti­nent-wide fis­cal stim­u­lus, an overly easy ECB may seem to most ob­servers the only way to keep the euro-show on the road.

The an­swers to these ques­tions should help dic­tate the path of fi­nan­cial mar­kets over the com­ing quar­ters.

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