Former US Treasury Secretary Larry Summers warned of the dangers in the eurozone in his latest op-ed for the FT, and it is hard to disagree. But part of what he said bothered me:
A worrisome indicator in much of Europe is the tendency of stock and bond prices to move together. In healthy countries, when sentiment improves stock prices rise and bond prices fall, as risk premiums decline and interest rates rise. In unhealthy economies, as in much of Europe today, bonds are seen as risk assets, so they move just like stocks in response to changes in sentiment.
Ireland’s recent history is a story of hopes dashed. Hope is now being stoked again, not least by those with the most interest in being positive: the Irish government and European lenders.
For Europe, Ireland is the poster child for austerity and must, just must, be recovering. Some positive jobs figures, showing the first growth in employment since 2008 (on which more later) have prompted what passes for elation in the depression-hit island.
European Commission President Jose Manuel Barroso led the cheering this week on a visit to Dublin, saying Ireland’s economy “is turning the corner”.
It shows that the programmes can work. It shows that there can be light at the end of the tunnel.
When there’s a determination we can achieve results. This is a message that’s valid for Ireland and other countries that are going through reforms.
Of course, he wants to believe this. Europe desperately needs a success story to set against the anti-austerity vote in Italy, yet more gloom in Greece and a worsening economic outlook for the eurozone.
But the bond markets agree, and have done for months. Irish 8-year yields (its benchmark) stand at 3.7 per cent, lower than Spain and Italy. The country has successfully returned to bond markets, and hopes to bring in a 10-year benchmark before the end of June. Even the inconclusive Italian elections prompted only a slight wobble.
So, have the markets become too optimistic? Below is a rather longer than usual read on Ireland and the wider eurozone issues.
Has the Great Rotation already started? A couple of startling data points from the last month, covering treasury yields and flows into equity funds, certainly suggest so. But the picture is maddeningly unclear under closer examination.
First, there is the treasury bond market, as discussed in last week’s video with Mike Mackenzie, before 10-year yields had risen above 2 per cent (they’re back below today). Significant rises in yields would be an obvious sign of a rotation. You can see that video, and Mike’s emphatic argument that if the equity rally makes any sense at all then the rotation out of bonds must be coming, here:
Note that even with the brief move above 2 per cent, there is still a way to go before the inexorable downward trend in yields that has now lasted more than a quarter of a century is breached.
The other obvious data to look at concerns flows into equity mutual funds and exchange-traded funds. Until very recently, the trend to pull money from equities and transfer it to stocks has continued unabated. Stephane Deo of UBS discussed this with Ralph Atkins in the Note video available here:
Again there are signs of change, but not enough to make the call that the “Great Rotation” has already begun. Most startlingly, TrimTabs, which can publish flow data quickly because it uses algorithms to derive estimated flows from funds’ performance, found that inflows to all equity mutual funds and ETFs this month have already topped $55bn. That beats the previous monthly record, set ominously in February 2000 on the eve of the dotcom crash.
More than half European companies have dividend yields above corporate bond yields for the first time, while mutual fund sales saw their biggest weekly inflow into equities since the US stock market peaked in 2007. James Mackintosh, investment editor, analyses whether this is the long-awaited rotation from bonds back into stocks – and how to compare them.
The UK’s inflation-linked gilts markets have just seen their largest one-day rise in 25 years – thanks to the decision of statisticians to do nothing. James Mackintosh, investment editor, looks beyond gilts to analyse what the real yields on government bonds are telling us.
Contrarians are usually a grumpy lot, constantly being ridiculed for making mad investments, only to have those that work out dismissed as pure luck.
2012 gave plenty of examples, with pretty much any mainstream equities the clearest (almost no one wanted them in January, everyone does now). For the more adventurous contrarian, Greek bonds bought at the start of the year and held through the default have returned 100 per cent, including coupons, while Portuguese bonds are up 79 per cent on the same basis.
Italian shares fell and bond yields rose as investors reacted badly to losing Mario Monti. Investment editor James Mackintosh says this looks like a classic market over-reaction. But there are reasons to worry that worse might be ahead for the country.
Reasons to be fearful are everywhere: Greece, triple-dip Japan and the looming fiscal cliff in the US. Yet, as James Mackintosh, investment editor, points out, share, bond and currency volatility are all extremely low. Is this complacency or have central banks disconnected the volatility sensors?
FT investment editor James Mackintosh analyses the impact on bondholders if Catalonia and Scotland were to become independent
Being widely hated is one thing, but being widely hated and poor is even worse. This fate almost befell Europe’s bankers earlier this summer. Share prices have soared in the past two months, so all the bankers now have to worry about is mobs with pitchforks.
Seriously, though, European banking seems to be returning to what passes for normal nowadays: money markets have stabilised, bond markets reopened and Americans are even willing (at a price) to put dollars back into French banks, as I discuss in today’s Short View video:
The result has been that eurozone bank shares were one of the smartest investments of the year – as long as you avoided the trouble periphery. This chart shows the split in returns from buying eurozone core or eurozone periphery banks.