Today’s Note video is with the MIT economist Bob Merton – famous both for winning a Nobel memorial prize for his part in drawing up the Black-Scholes options-pricing theory, and for his part at Long-Term Capital Management, the hedge fund that nearly brought down the world credit markets when it came to grief just a year later in 1998.
Prof Merton was talking about a profoundly important subject. We know that the world’s credit markets were dangerously interconnected entering the crisis. He and a team at MIT are now working out how to measure that interconnectedness, in the hopes that by understanding the phenomenon we might be able to get to grips with it better this time. The alarming finding is that credit is even more interconnected now than it was before the crisis. The video appears here:
As we tried to cover a lot of ground in under five minutes, some extra detail on how Merton produced his findings might be useful – see after the break. Read more
The US Federal Reserve’s support for the markets can be measured lots of ways, from the impact on bond yields through to comparisons of equity prices and the central bank’s balance sheet. Here’s one I rather like, with a hat tip over to BNP Paribas’s William De Vijlder.
The third round of the Fed’s quantitative easing, or QE∞, is now 41 weeks old, and during that time there hasn’t been a single really bad week, which I defined as a loss of 2.5 per cent or more. The last time there was such a long period without a big down week was during QE2. Before that it hadn’t happened since early 1997.
The total loss of all the down weeks since QE∞ began, including weeks with only a small loss (a somewhat odd measure, obviously offset by plenty of up weeks) has been just under 18 per cent, close to the lowest reached over rolling 41-week periods during the “great moderation” of 2003-2007, and to that reached under QE2. Read more
As the month draws to a close, the old “sell in May” strategy failed miserably for equity investors – except in Japan and emerging markets.
There are a couple of lessons from this May, but first here’s what the major assets did during May, first in local currency then in dollar terms:
Since the US is still open, both charts are up to the close of the 30th, for consistency, so not quite the full month; European markets today were down about 1 per cent, and Japan up just over 1 per cent, but the broad patterns remain the same. Read more
Here are the two Japan charts that matter after Japanese shares plunged more than 5 per cent today.
First, the Nikkei 225 Average is poised at the 50 day moving average, an important technical support level. If it recovers from here, this will be nothing more than a correction, if a big one, of the excessive optimism which had taken hold. From their peak last Thursday to today’s low Japanese shares were down almost 15 per cent – but are only back to where they stood a month ago. The rally can continue, as the futures market suggests, with futures prices and bond yields both rising sharply after the cash equities market closed. But once the current volatility settles down, a continued rally is likely to come at a far more moderate pace. Read more
Ooh la la! French consumer confidence figures just came in, and they aren’t pretty. The index just matched its lows from late 2008, itself the lowest ever.
So far, so eurozone. It isn’t exactly new news that the French economy is in terrible shape. But this chart shows how consumer confidence has broken away from share prices, something it usually tracks closely. Read more
While you consider the sell-off in Japan, here are a few charts, as of Thursday night prices:
Total returns (including dividends) on various asset classes for the year to date, in local currencies: Read more
The Nikkei 225 is down more than 7 per cent today, its 11th biggest daily fall since it was created in 1950. Explanations abound: the hawkish interpretation of Ben Bernanke’s testimony to Congress (although it can be read either way), the hawkish interpretation of the Fed minutes (ditto) and the surprisingly weak purchasing managers’ index from China, showing manufacturing shrinking slightly.
All these no doubt matter. But the real question is why markets chose to care today. China has been slowing for months, and while Fed-ology always moves prices, it was particularly hard to read anything much new into Wednesday’s comments. Read more
There’s been quite a bit of excitement about the Dax hitting a record high this week, with the Wall Street Journal even splashing its European edition on it. The chart looks impressive:
There’s a lot of excitement now junk bond yields (at least on one index) have dropped below 5 per cent for the first time. What to call them, for one thing. “High yield” no longer seems appropriate, although frankly “junk” was always better, and remains just as good. The fact that they barely ever default any longer, suggesting on its face that they are no longer junk, is yet another problem – as John discusses with Deutsche Bank’s Jim Reid in today’s Note video.
But hold on a minute. It is true yields have plunged. But the following charts show that junk bonds are much shorter dated now than they were, so the drop in yield is not as dramatic as it looks (if you lend someone money for less time, you should expect a lower yield as the loan is less risky). The average duration on the index is at a record-low three and a half years (modified duration is a tad longer, but still a record low).
On the other hand, investment-grade bonds (and top-grade junk too) have longer maturities – in the case of investment grade, the longest since 1980 at more than seven years. So the ultra-low yields (just over 2.5 per cent) of these better-quality bonds are even lower when adjusted for the risk of lending money for longer. Chart-fest after the jump. Read more
Markets aren’t known for their patriotic fervour. Populated by cynics and motivated by money, there is little reason to expect local markets to support their national governments – particularly in the eurozone, where the response by the wealthy in crisis-hit countries has been to ship their cash to Germany or the UK.
But hang on! Perhaps brokers are more patriotic than popularly thought: it turns out that analysts tend to recommend shares in companies from their countries.
A nice piece of work by Charles de Boissezon at Société Générale‘s global equity engineering and advisory unit looked at broker recommendations on German and Spanish blue-chips, the two markets tending to be reasonably domestically-exposed.
Not surprisingly there are more buy recommendations on German than Spanish shares, and more sells on Spanish.
But the breakdown is revealing: analysts at German brokers are much more positive about German companies than analysts working for Spanish brokers, and vice-versa: