The last 15%. Both the S&P 500 and the MSCI Asia ex-Japan index are within just 15% of their all time highs. [This is] incredible, considering the carnage that took place and the major issues that still exist, but not so incredible considering the amount of money that has been thrown at the problem – not to mention the persistently low interest rates that have been in place for sometime (the Fed Fund Target Rate has been 0.25% for coming up to 2 ½ years). What is also somewhat incredible is that the VIX index went below 15 late last week for the first time since mid-2007 considering the issues the world faces.
Damian goes on to quote a note from the analysts at GaveKal:
“One of the more amazing features of the performance in equity markets this year has been the continued lack of volatility. Investors who had placed bets on the VIX as a hedge against potential 'black swan' events must by now be wondering why they bothered. After all, we have recently witnessed: a) a tragedy in the world's third-largest economy with consequent disruptions on global supply chains, b) an eruption of political unrest across the Middle-East and a surge in oil prices, c) continued acceleration of inflation across emerging markets and further tightening of central bank monetary policies, d) the admission by three separate European sovereigns of their inability to pay back their debt, and e) S&P warns of a possible future downgrade of the US' AAA rating. And yet, in spite of these destabilizing events, global equity markets have stayed in a fairly tight range, epitomized by the 1250-1330 band in which the S&P 500 has hovered in all year.”
Which highlights the real quandary for investors at present: risk is being embraced since there are considered few alternatives: cash earns you negative returns after inflation, bond and commodity markets look equally overvalued.
The one clear trend has been that of the weakness of the US Dollar, notwithstanding the fact that it's impossible to say with any conviction that the other major currency choices look any more (or less) compelling.
In many respects, there is clear evidence of an inverse relationship between the USD and stockmarkets, which may be exaggerated by a carry trade: borrowing in USD's to invest in other currencies merely exacerbates the downward pressure on the USD. We have been concerned about a USD bounce for some months now - we've been wrong on that one (obviously) - but this remains the clear flag to look for as a signal of a turnaround in stock, bond and commodity markets. A USD bounce would reflect a return in interest rate tightening expectations, thereby reversing the Fed's current stance of allowing the USD to take the pressure from prevailing low interest rates (which seem likely to remain a fact of life well into next year).
As the Fed's latest round of easy liquidity (QE2) ends at the end of next month, it will be interesting to see what impact this has on sentiment and interest rate expectations. There is little doubt that the Fed would find pushing through a new round of easy liquidity difficult in the context of a changed Washingtonian political environment, so, for the time being, one assumes that there is going to be no new launch of the QE2's sister ship, QE3. Of course this will depend on the US economy continuing to recover, however slowly, and unemployment continuing to decline.
Back to Damian's point, then: with core markets in the US and Asia within 15% of their all time highs (notably, the Korean market is now 7% above its previous all time high, which itself accounts for much of the outperformance of the pan-Asian and EM indices), how much further can we expect this liquidity fueled rally to continue?
The answer is for as long as liquidity remains easy.
In Asia, where rates have been tightening steadily in markets such as China and India, the impact of tightening has already extracted a toll on their respective markets: the Bombay index is down 7.4% YTD, whilst although the Shanghai index is marginally up for the year, it is still substantially below its all time high of 2008.
So the turnaround seems likely to be flagged by a stronger USD and weaker commodity prices since these will seemingly predict the start of a rise in US interest rates. Watche them carefully. However, since there's not much sign of that happening any time soon, though, we continue to hang on with our fingernails.
e-mail: steve.davies@javelinwealth.com
contact: +65 65577185
website: http://www.javelinwealth.com
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