Q1 earnings in focus

April 10, 2009 — Mitul Kotecha

Equity markets have continued their ascent albeit with continuing volatility around the Q1 earnings season. Other indicators of market stress have also improved whilst bond yields haved edged higher. Next week will test the markets optimism with a plethora of banks set to release their results for the past quarter. Wells Fargo provided a boost to financials today with its earnings report. Banks will benefit from the changes to mark to market accounting regulations allowing banks more flexibility in valuing their dodgy assets. Although I am somewhat concerned about the political push for the change in these accounting rules it will no doubt ease some of the pressure on banks and their estimates of writedowns.

Meanwhile the economic news continues to be less negative as the bigger than expected narrowing in the US trade deficit reveals. This adds to the run of better than expected numbers over recent weeks that is perhaps showing that the pace of economic deterioration globally is easing. The economic news has also contributed to the better tone to equities and improvement in risk appetite.

Action to prevent the economic and financial crisis from deepening is also creating a floor under markets. The Bank of England left interest rates unchanged but maintained its commitment to conduct asset purchases having done around 1/3 of the planned GBP 75 billion so far, with the remainder to be undertaken over the next couple of months. Elsewhere Japan will provide further fiscal stimulus to boost its flagging economy although the unstable political situation could yet derail such plans. Nonetheless, the picture is clear as policy makers continue their battle to boost sentiment and thaw credit markets.

If markets can get through Q1 earnings without a major set back there maybe hope that the rally really has got legs. I still think there is a whiff of a bear market rally going on but I would happy to be proved wrong.

Posted in Bond markets, central banks, Currencies, Economics, equity markets, Financial crisis, UK, US. Tags: , , , , , , . 1 Comment »

What drives currencies?

April 7, 2009 — Mitul Kotecha

Currency forecasting is never an easy thing to do. The drivers of currencies appear to change over time making it quite tough to develop forecasting tools with great accuracy. This is not an excuse from someone who has been trying to analyse currencies for a number of years but just a statement of reality. Over the past year or so one of the biggest drivers of currencies has been risk appetite. As equity markets sank in 2008 the main winners were the dollar and yen both of which appreciated due to strong repatriation flows and safe haven demand. This influence of risk in determining currency movements saw historical influences such as interest rate differentials pushed into the background.

Where does it leave FX now? Well, if the rally in equity markets continues it implies that both the dollar and yen will fall further whilst long suffering currencies such as the pound will strengthen further. In the pound’s case it has a lot of room to recover given that is massively undervalued by many measures. For instance during my time in Hong Kong the pound against the dollar has dropped by around 30% making things look far more expensive than when I first came. However, to a foreigner UK assets now look quite well priced and London is no longer such an expensive city. Add in the steep drop in house prices and the UK looks even more competitive. This will no doubt benefit the economy in time.

So if the current risk/FX relationship holds it means that we should all be watching equity markets to see where currencies are going to move over coming months. If equity markets fail to sustain their rally it could put the dollar back on the front foot which will see the pound back under pressure. Eventually the dollar will weaken as risk appetite improves and when that happens the pound may be one of the main beneficiaries.

Ps. I hope this works as I am posting this article on holiday. It also means that my contributions may be a bit more sporadic over the next couple of weeks.

Posted in Currencies, Economics, equity markets, Financial crisis. Tags: , , , , , , . 4 Comments »

Spinning the G20

April 4, 2009 — Mitul Kotecha

There seems to been a lot of spin put on the amounts of money pledged in the wake of the G20 summit in London. A lof the money appears to have already been committed and the actual amount of new discretionary fiscal spending is a lot less than the $5 trillion in fiscal spending that was announced.

Even the $1.1 trillion that was all over the headlines in terms of the “additional programme of support” looks overblown. Immediate contributions will only amount to $250 bn and much of this has already been pledged prior to the summit. The timing of the rest is unclear. The $250 bn in SDR‘s will simply be created from thin air, rather like printing money and most of the the $250bn in trade finance will come from the private sector.

Concerns about the actual amount of new money from the G20 meeting may lead to reassessment of the initial euphoria in markets seen last week.

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More delay from the ECB

April 3, 2009 — Mitul Kotecha

Once again the European Central Bank (ECB) left markets hanging following its decision to cut interest rates by less than the market expected. Unlike the Bank of England which has been quick and aggressive in cutting interest rates and adopting unconventional policy the ECB has lagged behind due in large part to the difficulty in forging a consensus with so many council members involved in the decision making progress.

The ECB put off a decision to introduce new unconventional monetary policy tools until the May meeting due to the opposing views of various council members which in the end resulted in an unstable compromise. Although ECB President Trichet kept the door open to further easing the room is now limited, with another cut to 1% possible at the May meeting.

This will be less important and less influential on the economy compared to potential new measures that could include purchasing more commercial paper and corporate debt, widening the pool of collateral accepted in market operations and increasing the maturity of loans to banks. Buying government debt still seems unlikely given the technical problems in doing so.

The euro rallied against the US dollar following the ECB’s decision due to the fact that European interest rates remain relatively high compared to the US but a stronger euro will not come as good news for Eurozone exporters who are struggling in the face of a collapse in global demand.

The ECB may have put off the decision to another day but it will not be able to escape forever. The May meeting will be crucial to determine just how quickly Europe’s economy will recover. At the moment the lack of strong action suggests a delay in recovery compared to the US.

Posted in central banks, Currencies, Economics, Europe, UK. Tags: , , . Leave a Comment »

Pricing in recovery

April 1, 2009 — Mitul Kotecha

As was pointed out to me in one of the comments following my last article there are some signs that the market has become increasingly resistant to bad news. Indeed, it is encouraging that a host of weak economic data, more bad news on the banking sector front, bickering by leaders ahead of the G20 meeting, and the likely bankruptcy of a couple of US automakers has not prompted a more negative reaction.

Is the market tired of selling? It’s highly possible. Having faced an onslaught of bad news over recent months perhaps market players are simply exhausted. Adding weight to this is the fact that any pullback in equities has been relatively small compared to the gains over recent weeks whilst technical indicators are suggesting a more positive picture emerging.

I am not convinced. I will grudgingly admit that the market looks in better shape than it has done for months but this is far from a sustainable rally. Retail investors have yet to get in on this rally and like past equity crashes such as that following the Nasdaq bull burst, it took a long time for many investors to get back into the market having been burned so badly on the way down.

As I write this the US ISM manufacturing and pending home sales data have been released and both have come in on the positive side of expectations. The caveat is that the ISM is still in contractionary territory, consistent with falling GDP. Even if the data coming out now is less negative economic stabilisation is unlikely to take place until at least the end of the year. Based on past trends equity markets begin pricing in recovery around 6 months ahead of actual economic recovery, suggesting that we may only be a few months away from a more sustained turnaround in equity markets.

My only concern with this theory is that this is unlike any previous recession and so the equity market signal may be false. The current US recession has already lasted around 16 months, which is already a few months longer than the average for past recessions. It will need banks to be healthy before the economic outlook improves. If banks continue to remain in bad shape then past history will be a poor guide to the current path of the US economy.

Posted in bank rescue, Economics, equity markets, Financial crisis, US. Tags: , . 1 Comment »
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