John Authers, my predecessor as Short View writer and co-author of this blog, published some interesting graphs this week about London property, as he worries about a bubble.
I don’t often disagree with him, but on property I think he’s missing a trick. He pointed out that Miami’s housing bubble was far worse than London’s, but that London’s price rise is now approaching where Miami was:
But these prices (rebased to January 2000) were in local currency terms. And London’s property market is so important to the country, and its buyers so international, that it makes more sense to compare these prices in constant-currency terms.
That’s easily done by converting London prices to dollars and then rebasing:
So from an international perspective the boom in London prices was every bit as big as in Miami; they just peaked slightly later. The bust was of the same magnitude, and even more extreme, since it took place through the collapse of sterling rather than the somewhat less rapid fall in property prices. Read more
Greece has become synonymous with dodgy statistics, after its government lied about debt and deficits in order to qualify for the eurozone. If you think government pressure on statisticians is history, think again: Greece started a criminal probe of the head of the new independent statistics agency late last year, for supposedly inflating the national debt (he says he simply told the truth about Greece’s dire situation).
Spain has also repeatedly overshot its deficit goal, although less outrageously than Greece.
It turns out Spain and Greece are just part of a wider picture: economic forecasts from eurozone countries are far more likely to be influenced by wishful thinking than other countries. Even worse, Harvard researchers Jeffrey Frankel and Jesse Schreger found that all the extra optimism showed up when governments were in breach of the Maastrict treaty’s 3 per cent budget deficit rule. Today’s Short View video discusses it, but more below.
There are interesting arguments over whether the US residential housing bubble has really finished correcting, as I argued in a column earlier this week. But if it hasn’t, then the outlook for property in theUK, and most especially London, is alarming.
Of all the local property bubbles, Miami’s was the most extreme. Let’s look at it in comparison with London. For the US, we use the S&P Case-Shiller data, which are now widely followed. For the UK we use data from the LSL Property Services/Acadametrics indices, which is deliberately setting out to map the UK property market in the same way that Case-Shiller maps the US. Handily, both are set so that the beginning of 2000 equals 100.
So Miami plainly had all the symptoms of a bubble, with prices leaving for orbit in a way that they never did in London. But London’s inexorable rise looks extraordinary by comparison. Read more
The Shanghai Composite now rests at its lowest level since March 2009 – which is just when stock markets the rest of the world over began to recover. Admittedly, Shanghai bounced several months earlier, once China started administering its stimulus. But still, this is quite a turn of events given that the Chinese economy continues to grow far faster than the rest of the world.
What gives? Specifically with relation to Shanghai, it entered the period in the aftermath of a historic bubble that looked almost exactly like the Nasdaq bubble that had burst seven years earlier. There follows a chart from the Short View back in late 2007, when the Shanghai had indeed, we now know, peaked.
There is an interesting debate over my column on Monday, which looked at evidence for distorted profits in the US. In brief, there is a long-term discrepancy between the earnings yield on the S&P 500 (the inverse of the price/earnings ratio), and the long-term actual real return to investors (what they receive in dividends and in capital appreciation on an annualised basis). The two ought to be very similar. But in fact, earnings yield runs at about 1.5 percentage points per year higher.
The column highlighted research by the great Andrew Smithers who can be seen here discussing his idea with Martin Sandbu, who is doing a great job on the Authers’ Note video:
Mr Smithers’ explanation for the discrepancy, which does not make him popular, is that earnings are systematically overstated – and that the manipulation has intensified now that the modern bonus culture gives executives a much greater incentive to overstate profits in the short term. However, there is another possible explanation. Read more
Bonds have been rallying hard since Mario Draghi of the European Central Bank raised the prospect of a eurozone solution.
But perhaps what really matters is the US presidential election in November. Uncertainty ahead of the election tends to push investors into bonds, says UBS. It looked at the development of Treasury bond yields in the run-up to elections (excluding 2008, which was overshadowed by the financial crisis). Read more
The Vix index has this week closed at its lowest levels since the crisis began five years ago. That means investors feel less need to hedge in the options markets against future (implied) volatility than at any time since the crisis started.
Is this flashing a red warning light that the equity market is overly complacent, and about to crash? Other measures of dollar-linked short-term implied volatility – on bonds, gold and dollar exchange rates – are also very low.
If the Fed is about to put a floor under prices, handing out free “Bernanke puts” via QE3, why pay for put options yourself to protect your portfolio? Perhaps the over-optimism is really focused on the prospects for Federal Reserve action, not merely bets that the summer rally will continue. US economic conditions have been improving a little, and that ought to reduce the chance of QE3.
This idea is backed up by longer-term versions of the Vix, long-dated volatility. This is trading at a significant premium to short-term volatility, suggesting worries remain, particularly around the end of the year. Indeed, the gap between 3-month (November) and 12-month volatility on the euro/dollar exchange rate is the highest on record.
Charts below show the short and long-dated volatility on the S&P 500, and the ratio of bearish put options to bullish call options on the S&P 500 index, which is also extremely low (as a consequence of the collapse in puts). Read more
Britain is in a double-dip recession, but it isn’t all doom and gloom. Figures out this morning show the country has, for the first time on record, seen unemployment fall during a recession.
This makes a nice change from the so-called recovery since the last recession ended in 2009, when the unemployed saw precious little relief. Read more
Republican Mitt Romney’s pick of Paul Ryan as running mate for November’s US presidential election has catapulted Medicare to the top of the agenda (along with his budget plan).
Already the attack ads have boiled down the essence of the campaign: Ryan wants to push granny off a cliff by handing Medicare budgets to states and turning the medical support for the elderly into a voucher scheme. The Romney response is to attack “Obamacare”, pointing out the scale of cuts to Medicare made by the president in order to fund a wider healthcare scheme.
As usual in politics, neither is addressing the real question: why is American healthcare such poor value for money?
This is best shown by just one amazing statistic: the US government spends a bigger chunk of GDP on health than the British government – which gets a nationwide healthcare system for it. Americans only get care for the elderly (Medicare) and the poor (Medicaid). Read more
The eurozone may be doing a bit better than expected, but its economy is still weak in the extreme. Today’s Short View discusses the prospects for equities and the likelihood that eurozone shares beat US shares.
Lex thinks an improved economic outlook should be bad for shares, as equities are more sensitive to future discount rates (ie higher bond yields) than to the prospects of higher revenue.
And research by the London Business School has demonstrated there is no correlation between the performance of an economy and share prices over the past century and a bit.
But both of these miss the idea of what future prospects are already priced in, something extremely hard to measure. What matters is what people expect, and how it changes. If investors are braced for recession and instead get dismal growth, shares should rise – as we saw towards the end of last year. Read more
So the Federal Reserve did almost nothing, and the Bank of England did nothing. All now rests on the European Central Bank for hopes of monetary policy action this week.
The Fed is forgiveable. The Bank, less so: Britain is suffering in a double-dip recession worse than the eurozone (although the eurozone looks set to catch up soon).
Consider this chart: it shows the UK and US inflation expected by bond markets for the five years starting in five years’ time (the 5 year 5 year breakeven, as it is known, derived from bond futures).
UK and US five year five year breakeven inflation (Source: Bloomberg)
You already knew the manufacturing purchasing managers‘ indices mattered, given today’s disappointing figures for the US ISM. But perhaps you hadn’t appreciated how much Wall Street analysts focused on it.
This chart (with a big h/t to Gerard Minack at Morgan Stanley) demonstrates the value of the ISM, the oldest of the PMI surveys. Read more
It’s PMI day again, and the news so far is once again terrible for Europe. The manufacturing purchasing managers’ indices are one of the best set of indicators of what is going on in the economy, because they are so much more timely than GDP figures.
The data produced by Markit for the eurozone are awful. Greece goes from bad to worse, and even the motor of the eurozone – Germany – is struggling badly, with manufacturing output and new orders falling at the fastest since April 2009, shortly after the recovery began.
This matters for equities. Consider these two charts: Read more
The post-Draghi recovery has stalled. To recap: last Thursday ECB president Mario Draghi said the central bank is ready to do whatever is needed to save the euro, and markets went wild.
The markets are more nuanced today.
- The euro is down (perhaps rationally: if the euro solution is to print money, debasement offsets the continued existence of the currency). Just as important for the technically-minded is that the euro failed to break its 30-day moving average, at $1.237.
- The German 2-year yield has set a new low, coming close to -0.1% before recovering a little. Flight capital, in other words, is still headed for Germany. Longer dated German bond yields remain wider than last week, but are still tighter than at the start of July. There is not much confidence that Draghi will succeed in the face of the Bundesbank’s opposition.
- On the plus side, Spanish yields continue to improve, with the 10-year having now plunged a full percentage point since last Tuesday, and short-dated yields also dropping sharply. Again, though, things remain worse at the end of July than they were at the start.
The two most important eurozone charts after the turn
Humphrey-Hawkins testimony is not always a non-event. Six years ago, Ben Bernanke used his first Humphrey-Hawkins testimony to signal to the market that the steady rise in the Fed Funds target rate was going to end at 5.25 per cent. That seems an impossibly long time ago now, as does the last big surge in the S&P 500 during the “fool’s rally” of the mid-naughties, which that testimony provoked.
Today’s testimony, however, does indeed appear to have been a non-event, as accurately predicted by Mike Mackenzie, deputising for James Mackintosh, in Monday’s Short View:
The line in his testimony that appears to have attracted most attention is that the Fed “is prepared to take further action as appropriate to promote a stronger economic recovery” – it is hard to see how he could possibly have said the opposite. Judging by Twitter, there is also interest in his comment that QE has been “effective” so far but should not be used “lightly”. It is hard to disagree. Some might disagree about the “effectiveness” line, but successive waves of QE have at least succeeded in holding up asset prices and buying time for US banks, which was probably the main intent. Read more
Everyone knows how the dominoes will fall in Europe: Spain, then Italy, then struggling France, stuck with the biggest of big governments, a Socialist president and a population that thinks the work ethic is a type of chocolate biscuit.
Hedge funds spent much of last year warning that France might even leapfrog Italy in the contagion queue, while betting against French government debt. So it must come as a bit of a surprise that the French 2-year bond now yields less than half that of the US, and is below the UK.
French 2 year bond yield (Source: Bloomberg)
Hello, and welcome to FT Long Short.
John and James will be posting investment ideas, charts and links to their FT videos and columns as part of their ongoing efforts to categorise and understand the endlessly fascinating manoeuvres of markets.