three key pieces of data for investors
Over the last several weeks, two pieces of information have emerged that have potentially great importance for equity investors. A third may develop from the US Federal Reserve today.
1. the Case-Schiller index, which is very influential in the US, despite being a lagging (also called confirming) indicator of the state of the housing market, has finally signalled that overall residential prices have bottomed and are on the mend. The five-year slump is over.
Although I think the revival of the housing market gives a second wind to the domestic economic expansion, in the counter-intuitive way Wall Street works, it also has a darker side. Other than Washington suddenly starting to do its fiscal policy job, which would be a huge positive surprise, it’s hard for me to see what new positive market-moving economic development could happen in the US over the coming months.
2. The European Central Bank has announced a broad support plan for the bond markets of the weaker members of the Eurozone. Yesterday, the German high court rejected litigants’ assertions that the German government was barred by that country’s constitution from participating in the plan. Germany is slated to provide over 25% of the financing of the Eurozone rescue plan, so this decision was crucial.
The implication is that EU economies will be stronger over the coming year or so rather than weaker.
3. The Fed may announce further unconventional measures today to support the US economy. The Fed has repeatedly said that fiscal policy would be a much more effective engine to spur growth, but apparently sees about the same chance as I do of that happening.
Two measures are possible. One is additional bond buying, intended to flatten the yield curve. The second is a commitment to hold short-term interest rates at today’s emergency low levels for the next three years. Yikes! Three more years of nearly no income from CDs and money market funds?
I think the second would have the more significant effect for Wall Street. It would give two contrary signals: it would say that there’s no need to flee the bond market anytime soon; and it would imply that the only liquid investment that will provide significant income for savers any time soon is the stock market.
three places to see their effects
1. the performance of general stock markets in their local currencies.
The S&P 500 is up 9% over the past three months. I think the recovery of house prices, which is the major source of wealth for most Americans, is the main reason. EU growth should also have a positive rub-off effect on US firms involved in foreign trade, as well as the many S&P firms with substantial operations in Europe.
The Eurostoxx 50 is up 19% over the same span. Broader indices are up in the mid-teens. Most of the outperformance of the S&P has come in the past month, when Eurozone rescue plans have been publicized. Dollar-based returns on the EU indices are much larger.
2. You can also changes in the lists of sectoral winners and losers, as I’ve written about on the Keeping Score page on PSI. Generally, the US investor has shifted away from defensive sectors toward IT and Consumer Discretionary, two moderately bullish areas, while not to sectors like Materials that would benefit from a strong general economic upsurge.
3. Most US investors generally ignore the third area–currency movements. I think it’s certainly true this time. But from mid-July until now, the € has risen from a value of $1.20 each to $1.29, or 7%. True, the ¥ has been rising since March, when holder had to pay 84 to get $1. But it has also recently risen above the 78 level that the Tokyo government had been trying to defend.
To my mind, the Japanese economy still has nothing much going for it. Seeing that currency rise at all–which normally happens only in a healthy country–really says something.
If we add a currency gain of 7% to, say, a 14% rise in European stocks, the total return to an American investor in the past month is more than 20%. If we have indeed made a major turn in the EU, the party is far from over, in my judgment.
Many European stocks still have strikingly high dividend yields–certainly a temptation to income-oriented investors but also a warning of potential risk.
I’ve been advocating having a severe underweight in the EU, with exposure only to companies listed there but with significant operations elsewhere. I haven’t made any changes yet, but I’ve got to at least reconsider my position.
Conversely, US-listed companies with large businesses in the EU may not be having great local currency sales at the moment, but they’re enjoying a big boost in dollar terms.
The rise in the ¥ tells me that at least a part of what is happening is not foreign currency strength. It’s dollar weakness. That may be because of continuing fiscal policy failure here, or just the perception that all the potential good news is already out.
The much greater € strength suggests that real economic improvement is expected in the EU. I’m still mostly convinced that Greece will be forced out of the Eurozone (and the EU). But markets may not be willing to wait for this final shoe to drop.
To sum up: we may be in the early stages of a significant shift in the attitude of global equity portfolio managers about where they want to place their clients’ money. If so, I think the clearest sign is coming from the currency markets–it’s mildly against the US, strongly for the EU.