Thursday, 19 February 2015

Europe - The tide is coming in. Bunds may submerge.

Today I saw a couple of references to EU equities being a bubble. Which had me asking a few questions

1- Haven't I heard this before, but with reference to the US markets?
2- Wasn’t it only a month or two ago that European equities were seen together with Europe as a whole as the dead men walking of the global markets?
3- Where do we stand with regard to Europe on the classic path to a bubble, specifically on the S curve that depicts most market rallies?
4- How does this attitude shift in equities fit with bonds particularly that in bunds?
5- What happens to Eur/Usd or Eur/Gbp with this?

1- My memory is of course cloudy but at what point did we first hear of an equity bubble in the US with old fashioned valuations of stocks being cited for overboughtness and bubble blowing? I am pretty sure it was when we were around the 1600 SPX level. Since then? well, just look where we are as we approach 2100. At this point I am tempted to revisit a mega long view posted last summer

Equities will keep grinding up boringly, but once past a tipping point, say 2150 on SPX, they will go spectacularly stratospheric in a hyperbolic spike as every Joe piles in on leverage (Zero Hedge rebrands as 'Infinite Hedge'). This happens just at the time that inflation starts to hit which also then careens higher leaving the Fed on the hop, who after trailing the curve for too long will hike dramatically stuffing global markets (includiing EM ) that by then will be fully geared for chasing micro-yield at the expense of risk.

2- The attitude to Europe is shifting. We have the Greece situation hanging over us and the much longer term concern of Russia, yet the Russian situation and any binary risk of shots being fired between East and West still appears to be outside market concern as Ruble is gently strengthening (Oil bounce helping but that looks as though it's rolling over again) and it would appear that Greece is becoming the last stand for the Euro asset bear. Meanwhile a steady asset flow back into Europe appears to be underway, especially from US, as opinion swings from growth doom to one of accepting that nascent growth potential exists. With longer term allocation happening it is no longer a question of 'if' the tide is coming in but of 'how fast’.

3- I would put us somewhere in the middle of the stock S curve, somewhat at the US's SPX 1600 equivalent, but with very sectoral bias towards smaller stocks as some of the mega stocks have been performing more as bonds recently. The rush of the speculator appears to be joining the underlying tide with even bank stock benefitting. I say ‘even' bank stocks as structurally I still don’t see how they are ever going to be allowed to make serious money by state or social system and for the further reason that their bond holdings may be a source of concern as the growth meme moves on to that sector - see next point.

4- If return to growth is the play, and assets are switching from defensive to growth allocation then one would wonder what there is to support European bonds. The peripheries will benefit from a credit function vs the core but the core would be liable to a multiple whammy. Outflows from core into periphery, outflows from bonds to equities and finally outflows from bonds in general on a mood swing on rate expectations from uber dovish to a more normal. the path of US treasuries recently will not be giving much support from a global bond argument either.

5- Eur/Usd is a pig to play on this as rising US rate expectations are balanced by flows and expectations from the above arguments and this opposition could already be visible in Eur/Usd effectively not going anywhere at the moment despite the ‘stronger USD’ idea being so popular. EUR/GBP may be a different story. GBP has done well on Euro safe haven, comparative growth and yield. Yet it doesn't have the strength of underlying rate expectations that the US has, more as robust growth. A switch in European growth expectations could well see a EUR/GBP reversal rather than EUR/USD. ( and anyway, I'm a Brit. We can never see the value of our currency).

Which leaves the last question. What to do? The obvious point of attention for me remains Bunds. they have stopped going up but haven’t started going down. When they do, it wil be very hard to see where the marginal buyer will be coming from with yields where they are. The caveat of course is binary risk over Russia and someone doing somehing competely stupid over greece, like REALLY stupid as basically stupid has been priced in.

Bunds lover the past year  

Bunds recent action 


Anonymous said...

Bunds do feel ridiculous, but cpi adjusted the real yields have got space to fall further, contrast with japan or even switzerland. I realize this is econometric data fiddling, but if cpi is their alleged target, then it is an eventuality that must be considered...and no I am not funny money's fixed income cousin!

Polemic said...

Anon ( though obv a MM reader) nice ref to FM.
I do get your point but I suppose that CPi is backward looking and I am expecting growth pick up and commodity creep up to impact the cpi side of the equation. Problem is cpi lags on passthrough and then on reporting and then CB action lags that. Feel that the first elements of change are entering the start of that pass through pipeline.